July 26, 2012
The above-the-fold headline of [last week's] Wall Street Journal, “Fed Moves Closer to Action”, signals an impossibly deluded Federal Reserve utterly blind to the damage its machinations are bringing to the U.S. and global economy. Though the Fed’s policies are the single greatest barrier to economic growth, Ben Bernanke, its walking, talking contarian indicator of a Chairman, seems determined to insert even more poison into the patient; presumably with an eye toward QE4 when his latest treatment logically fails.
That QE3 will certainly fail is the good news for a long suffering electorate, and it is because the weakened economic result of this most fanciful of notions will force its hopelessly naive defenders to finally acknowledge the obvious: central banks can’t create economic growth, but they can undeniably suffocate it. In short, the inherent contradiction that is QE3 is our best friend at the moment for its failure ensuring the collapse of the unfortunate Bernanke regime. Until then, however, the electorate will be forced to suffer an economic form of brutal chemotherapy that can remarkably still claim advocates.
Along the lines of the above, a little ways back the Wall Street Journal’s Jon Hilsenrath asked whether the Fed’s supposed monetary stimulus had proven stimulative to the stock market. He concluded that indeed it had.
As he wrote, the Fed’s monetary machinations do “seem to be stimulating markets. The Dow Jones Industrial Average is up more then 50% since the Fed launched its first bond-buying effort in November 2008, and stock prices seem to jump every time a new hint of Fed action emerges.” But is the correlation sound?
Perhaps ignored by Hilsenrath was the stock market’s response to the June 1 announcement of a U.S. unemployment rate that had risen from 8.1% to 8.2%. The Dow plunged over 200 points that day, and while conventional wisdom pointed to investor fear of an economy that appeared worse than assumed, that supposed wisdom seemed lacking.
Far from barometers of an economy’s present health (the U.S. economy wasn’t in recession territory when the Dow crashed 22.5% in October of 1987), stock markets are more realistically discounting future growth. The limp unemployment report to some degree heralded future action from a Fed maniacally devoted to keeping the economy afloat, yet at least on the first day of June investors didn’t seem terribly optimistic that more money creation and tinkering with long interest rates would lift stocks.
Though one day’s market returns don’t necessarily endorse or decry a policy, it’s entirely possible that investors were channeling their doubts about money creation that has historically fostered dollar devaluation. Along those lines, it certainly can’t be stressed enough that when investors commit capital to the stock markets, they are tautologically buying future dollar income streams.
Since they are, any policy meant to devalue those income streams would necessarily reduce, as opposed to boost, stock prices. Empirical research done at H.C. Wainwright Economics seems to support this presumption. As a report from last year noted, over ten-year periods the correlation between money creation and stock prices “is clearly inverse.” With markets once again a barometer of the future economic outlook, it can then be said that investors would have no long-term reason (at the very least) to buy on the assumption that the Fed will resume its bond buying and selling to reduce long-term rates.
Considering the aforementioned 50% increase in the Dow since the Fed began its various programs weighted toward easing, it’s worth asking if investors made money in real terms. Economics writer Louis Woodhill uses a “Real Dow” calculation meant to achieve some kind of answer.
The numbers don’t endorse the Fed’s actions in favor of ease. Woodhill calculates the Real Dow by dividing the Dow’s price with the price of gold. Back in September of 2008 the price was in the 8,000 range and gold traded at roughly $900/ounce on the way to a Real Dow of 9. Though the Dow trades around 12,676 today, the dollar has fallen to $1,600/ounce of gold; the Real Dow having fallen to 7.8. Put plainly, any gains in this commonly used stock market benchmark have been eroded by a declining dollar.
Logic says the decline shouldn’t surprise us. As it is, policies of devaluation as mentioned earlier reduce the value of the very income streams that serve as to lures to investors to begin with.
Beyond that, we must consider the purpose of the Fed’s actions. In pursuing policies meant to reduce long-term interest rates the Fed is seeking to prop up banks with massive exposure to mortgage securities whose value would presumably have declined if the Fed did nothing. The policy fails on four major counts:
For one, capitalism is only capitalism if failure is embraced as much as success is. To this day investors overly exalt the banks as essential sources of finance, but if true, a policy meant to prop up the failures would necessarily weaken the banking system overall. It would because healthy banks with quality management wouldn’t as easily be able to acquire on the cheap the financial institutions that deserved to fall into bankruptcy on the way to healthier banks overall, and then as evidenced by the myriad rules and regulations that have been imposed on banks since the Fed (and Congress with TARP) began to act, bailouts are never free. Though many major financial institutions have been saved thanks to various policy initiatives since 2008, the increasingly ominous story is that the same federal monolith that saved them is slowly strangling them with more and more rules.
Second, though a strong case can be made that the bailouts themselves were the driver of the financial crisis, the simple truth is that a rush into housing and mortgage securities underlying home purchases was what brought the banking system to its knees not so long ago. If so, and with economic growth in mind, wise government minds would have let the markets correct the value of mortgage securities to their proper level in 2008 and beyond with an eye on rooting out always limited capital from a portion of the economy that the markets no longer valued. Instead, the Fed sought and continues to try and prop up those securities; its tinkering necessarily locking up capital that could otherwise fund real growth.
Third, the mechanism used to keep mortgage rates lower than normal was and remains the sale of short-term Treasuries in order to purchase long-term Treasuries. Implicit there is that the Fed is promising to protect investors in U.S. government debt from any kind of decline in the value of those debt assets. This is perhaps good for the U.S. Treasury which regularly enters the debt markets, but bad for private sector businesses that might be able to access credit with greater ease were the federal government not consuming so much of it. Here it should also be said that in times of economic uncertainty, the last thing a central bank should do is strive to keep interest rates artificially low. Credit is a price, limp economic times point to a lot of credit destruction, so the wiser move from the Fed would be to let rates reach their natural level so that savers can be properly compensated for replenishing the capital base.
Fourth, too often forgotten is that recessions, though painful, are a sign of an economy fixing itself whereby all the bad business concepts, malinvestment and misuses of labor are cleansed from the commercial sector. The Fed, seemingly having learned all the wrong lessons from the Great Depression, has with its imposition of various QE actions sought to dull the necessary economic pain of a sharp recession. Of course in doing so it has arguably robbed investors and the broader economy of a much more vibrant stock-market and economic rally since 2008. Considering the empirical history of quantitative easing with regard to stocks in concert with its modern theoretical implications, it would be hard to conclude that the Fed’s actions have stimulated either the economy or the stock market. Quite the opposite.
Though it would be near impossible to prove the driver or drivers of the infinite inputs that move stock markets, the best guess here is that is that stocks have moved up 50% due to investor relief. Having expected much worse, investors softly bid up stocks when the “worst” didn’t reveal itself over three years ago.
Figure the Obama stimulus package passed in 2009, and rather than moving up, stocks fell to their modern low in March of 2009. It was then that a president who oversaw Democratic majorities in the House and Senate began his perhaps quixotic push to reform healthcare. Whatever the end result of the Roberts’ decision for a healthcare sector that was already heavily regulated, the effort to get the Affordable Care Act passed consumed much of the Administration’s energy.
The result of a distracted Obama administration was that proposed income and capital gains tax increases didn’t materialize, and then environmental legislation limiting emissions ran aground due to limited support in Congress. Stocks rallied on investor relief that Obama wouldn’t steamroll Congress with his full agenda, and then in 2010 the electorate, perhaps fearful of the leftward tilt of Washington, handed control of the House back to the Republicans. Whatever one’s opinion of either political party, gridlock as evidenced by stock market returns during the Reagan and Clinton years tends to be good for stocks. At the very least it should be said that the 2010 elections forced Obama’s hand in terms of taxes such that the 2003 reductions on income and capital gains were maintained.
After that, though the recession experienced in 2008 wasn’t as cleansing as it would have been absent all of the aforementioned intervention, the U.S. economy certainly experienced a substantial reversal such that some kind of snapback was inevitable. The rise in the Dow since 2008 to some degree speaks to allowance of just that.
The historical record as it applies to stock market returns and money creation by the Fed makes it difficult to conclude that Chairman Bernanke’s tinkering with interest rates and the money supply since 2008 has boosted the markets. Fed ease of the kind we’ve seen since 2008 has been historically inflationary, something the markets wouldn’t cheer, after which it’s been pursued to prop up the failed economic ideas of yesterday. The Fed should not be credited with the rise in stock prices in 2008, nor the end of the recession, though it’s realistic to argue that markets and the economy would be much healthier today absent our interventionist central bank.
Instead, the more realistic conclusion would be that stocks have enjoyed a nominally limp rally that’s a function of investor relief that policy since 2008 wasn’t much worse. Unseen, and this is what’s so unfortunate, is where the Dow Jones Industrial Average and the economy would be today if the Bernanke Fed had chosen to do no harm as opposed to overmedicating an economic patient that needed to be left alone to heal.
Back to the good news, QE3 will fail, and it will because money creation for the sake of money creation, and bond buying meant to prop up Washington and mortgages, is by definition an economic retardant for it signaling an economy moving backwards into the horrid concepts of the past. QE3′s failure will happily mean the end of Ben Bernanke’s very unfortunate reign at the Fed; the only question at this point one of whether President Obama will remove him in order to save his faltering presidency, or whether a President Romney will remove him in order to have a shot at a successful one.
John Tamny is editor of RealClearMarkets and Forbes Opinions, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com). He can be reached at firstname.lastname@example.org.
This article originally appeared on RealClearMarkets and is reposted with the kind permission of the author.