The Fed Panicked

Here is the Fed Open Market Committee’s announcement of November 25, 2008 announcing the implementation of QE1, a $600 billion bond purchase program:

This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally.

On March 18, 2009, the Fed announced a second phase of QE1, expanding the program by another $750 billion to bring the Fed’s total to $1.25 trillion for the QE1 program. The Fed noted that:

Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth. …

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. …

On November 3, 2010 they announced another round of quantitative easing called QE2 in which they purchased another $600 billion of longer term Treasurys:

Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts continue to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters. …

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.

On September 21, 2011 the Fed announced Operation Twist in which they extended the maturity dates of $400 billion of their Treasury portfolio in order to drive down interest rates and to “support a stronger economic recovery”. The Fed’s reason:

Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.

Recall also that the Fed has kept the Fed Funds rate at almost zero rates (ZIRP) since the beginning of the 2008 crash.

Today, the Fed announced an open-ended purchase of “agency” mortgage-backed securities of $40 billion per month at least until the end of the year, which along with its Operation Twist purchases, amount to $85 billion of such purchases each month. Again they wish to “support a stronger economic recovery”. Their justification was:

Information received since the Federal Open Market Committee met in August suggests that economic activity has continued to expand at a moderate pace in recent months. Growth in employment has been slow, and the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment appears to have slowed. The housing sector has shown some further signs of improvement, albeit from a depressed level. Inflation has been subdued, although the prices of some key commodities have increased recently. Longer-term inflation expectations have remained stable.

 This time the Fed added some significant wording:

… If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability. …

The bottom line is that the Fed panicked. It is extraordinary that the Fed would announce an open-ended “we’ll print as much as it takes, as long as it takes” policy. Chairman Bernanke is sending a signal to the markets and to government that the economy is bad and getting worse and that the Fed will do its part as everyone expects them to do. This is a clear signal to the markets and the world that the Fed stands for monetary inflation. They don’t know what else to do.

As we have long been telling readers, unemployment is the key to Fed policy and they have formally made it their policy linchpin. As far back as May, 2011, on Fox Business News I said that Mr. Bernanke has no other real alternatives other than QE and that with rising unemployment, he would be pressured to “do something.”

One may ask why none of these policies have led to economic recovery. Why didn’t QE1 work? After all they told us then that it would promote “sustainable economic growth”. By the time QE2 was released we heard much of the same thing: it would “promote a stronger pace of economic recovery”. Had QE1 worked as they said, why did they need QE2? Now the Fed tells us again that another round will “support a stronger economic recovery”.

That begs this question: If QE1 and QE2 and Operation Twist didn’t work, why would QE3 work?

The quick answer is that it will fail like its predecessors.

I discussed this at length in my February 14, 2012 article, “Is This Recovery.” In that article I anticipated that the following things would happen:

1. The economic “good news” is largely based on fiat money steroids and will not last without continuous injections of new fiat money into the economy.

2. The last injection of fiat money (QE2) is already wearing out and money supply is most likely declining.

3. A declining MS will result in further economic weakness (stagnation) and flattening-to-increasing unemployment.

4. This is likely to occur in Q2-Q3 2012.

5. As soon as unemployment goes up again, the Fed will announce QE3.

6. The dollar will continue to be weak.

7. It is likely that price inflation will continue to be “modest” (as the Fed sees it) in light of ongoing real estate related asset devaluation. This depends on the amount of QE.

The article thoroughly discusses the reasons why the economy is stagnating and why further rounds of quantitative easing will not change it. One of the charts from that article (shown below) attempts to show that each round of QE has been less effective at boosting nominal GDP. The vertical bars show the dates of QE1 (orange) and QE2 (light blue), the money supply (TMS2- aqua-blue line), and GDP (thin black line with its own scale [left]). The result is that economic growth measured by nominal GDP has been largely illusionary.

The truth is that GDP is not a very good measure of economic growth, at least when the Fed increases the money supply through QE. Since GDP measures spending, if new money is injected into the economy, there will be more spending and thus GDP will increase. The second point is that “printing” money never creates organic economic growth. In fact it never has at any time in history.

What can we expect the consequences of QE3 will be?

 1. Money steroids will give a temporary boost to the financial markets as evidenced by today’s euphoric response to the Fed’s announcement.

2. The impact on organic economic growth will be nil even though it may slightly increase GDP by Q1 2013.

3. Unemployment will remain high.

4. Economic growth will stagnate, if not decline, through the remainder of 2012 as money supply growth declines (TMS2).

5. Post Q1 2013, economic activity will again stagnate, assuming there are no policy changes or political changes (Romney is elected).

6. Europe and the rest of the world’s economies are in decline which will further depress the U.S. economy.

7. Price inflation is a guessing game. My guess is that it will remain within the Fed’s parameters. The key to price inflation will be credit creation through lenders and, while lending has shown some life (mainly the big banks with big companies), it is likely to flatten again as the economy stagnates, thus inflation will remain “Japanese.”

8. Interest rates will remain around their historic lows. While the housing market is showing some signs of life, its recovery largely depends on job growth which will remain subdued.

9. How much QE is a good question. I cannot see that any Fed chairman would print endlessly to a point of high price inflation. That would require much greater amounts of QE-type monetary stimulus plus it would require banks to lend, which means businesses would be willing to borrow, thus expanding credit and money supply to much higher levels. QE is not an efficient way to price inflation, and in a stagnating economy, borrowing will remain flat.

If you are a true believer and feel that the Fed is correct, you have to ask yourself hard questions about your assumptions since the Fed has been consistently wrong in their forecasts and policies. Now they insist on pursuing the same failed policies. Why would they work now?

The Fed continues to follow the same wrong policies as it has since the beginning of this depression. We now have one of the longest depressions in history that has been caused by the Fed and the fiscal policies of the Bush and Obama Administrations. They are devaluing the dollar, destroying capital, thwarting growth, and cheating savers out of their hard earned money. It is a cruel blow to the 23.1 million un/under-employed in the U.S. who need economic growth to create jobs. We need a new direction.


14 comments to The Fed Panicked

  • dd

    brilliant, a great read, Jeff. thanks for posting.

    i am getting less optimistic that we will see a change in the Oval Office. i think we’re hosed and could see some kind of dollar crisis in the next 3-5 years. maybe sooner, maybe later, but it’s going to happen.

  • Orlando

    Hi Jeff: tremendous work. Here’s some sobering news: Unemployment rate at the ‘start’ of qe in 3/09 8%, unemployment now 8.2%. QE has not made a dent in the rate of unemployment, even with official statistics, ignoring the shrinking of the labor force.

    Why now. ECB is doing it. IF ecb does QE with banks in Europe leveraged 80:1, that means the EURO will drop, precipitously, to .71 to the dollar (250B x 80 will create that much more currency than no QE fed).

    The FED has a dual mandate, it serves the banks and the politicians. In this case, QE is necessitated to keep the US ‘competitive’ in the depressionary race to the bottom of currency devaluation. This QE keeps the banks in play and the currency from over appreciating too much. The first two QE pushed the EUM to 1.60. That is clearly not happening now. My guess is that gold will go to around 3000 per ounce based on the amount of money the speculators will have access to. If the program goes two years, we’ll see it at 4100 per ounce or more. I can’t see this economy missing recession with the commodity price explosion this is going to create.

    In my opinion, with falling monetary velocity, and no demand, this monetary stimulus is going to go mostly into commodity speculation. What do you think?


  • Jeff, given my role on the site, I normally don’t comment, but I wanted to add my vote for this post (article) of yours. It’s a real help to have all these statements of the FOMC assembled in one place, along with your analysis.

  • I.M.Skeptical

    Orlando, agree, the money flow has to go into commodities (particularly food, energy, precious metals).

    I want to add that the fact that the FED is printing so close to the election really appears highly politically motivated to me. They dump a huge pile of cash in the economy and get quick boost to re-elect his boss (Obama) and thus Bernanke will also get re-appointed. Of course this action also helps his big-bank-buddies too. Mr. & Mrs. Main Street — you get stiffed with the (hidden tax) bill if you happened to be prudent and manage to have savings at all.

    We really don’t have free markets when the FED keeps intervening all the time. What a sham!!

    Best regards Folks.

  • Jaker

    Bernanke is either “Berserk or Mad”!

  • [...] Fed panicked, you shouldn’t. Link excerpt: Here is the Fed Open Market Committee’s announcement of November 25, 2008 [...]

  • Doug Terpstra

    Well done. Indeed it looks like the Fed panicked. But why? Bulls are charging and stocks are near all-time highs, housing is “in recovery” (for sure this time, trust NAR), and BLS unemployment is falling. Is there an election coming soon? Wall Street is clearly taking no chances on the reselection of their Trojan Horse.

  • C

    Does the FED print money or not? I see so many contradicting entries on how the Fed’s printed money will negatively affect the U.S. I just read that the Fed doesnt print unless severe conditions warrant it which hasnt happened since 2008. Everything the Fed has done since then has just affected liquidity by playing with mortgage backed and treasury securities. The Fed doesnt print money, the mint does.

    • I.M.Skeptical

      “C”, is your question serious? “Does the FED print money?”

      When the FED purchases Treasury Bonds and Mortgage Bonds it is essentially the same as printing real paper money. With the click of a few ’0′ keys on their accounting computer, they add funds to purchase the MBS and Treasuries to their balance sheet and transfer the newly created funds to a Bank where they purchased the MBS and Treasuries from, thus putting the cash which was previously not in existence on the books of the Bank. Now the Bank can lend these new funds out to everyone… and thus you have the FED cash circulating in the real economy.
      Therefore the FED does print (digital) money from thin air. QED.

  • [...] Jeff Harding at the Daily Capitalist : The FED panicked [...]

  • [...] The investors seem to love it, because the stock market is booming. The elites think it’s a free lunch, a win-win-win barrel of awesome sauce that’s going to save the economy or something. The doom-peddlers think it’s a reinflation of distorted bubbles that’s going to backfire into a terrible collapse or something. [...]