Over lunch this week, a Seattle financial executive told me he believed the market has already priced in the “tapering off” of the Federal Reserve’s massive bond-buying program. Maybe so. It’s an open question as to whether the central bank should change course with the economy growing so slowly and unemployment still high. But Chairman Ben Bernanke seems committed to the move. Overseas, things might not go so well. Stephen Roach, the former chief economist for Morgan Stanley, wrote on Project Syndicate recently that “the global economy could be in the early stages of another crisis” partly because of the Fed.
As I wrote last week, the problem is centered in emerging economies. “Hot money,” short term investments, rushed into nations such as India, Indonesia, Brazil and Turkey because of the artificially low interest rates of the Fed’s QE programs. This allowed for large current account deficits to be cloaked by seeming prosperity. Now, investment is flowing back out with damaging results. Roach writes:
Under the leadership of Ben Bernanke and his predecessor, Alan Greenspan, the Fed condoned asset and credit bubbles, treating them as new sources of economic growth. Bernanke has gone even further, arguing that the growth windfall from QE would be more than sufficient to compensate for any destabilizing hot-money flows in and out of emerging economies. Yet the absence of any such growth windfall in a still-sluggish US economy has unmasked QE as little more than a yield-seeking liquidity foil.
The danger to the global economy is not just misery in these individual countries, but also contagion to advanced economies including the United States. But this isn’t the only risk facing the central bank. The recession that hit in 2008 was so severe that conventional monetary policy — lowering interest rates — didn’t work. Under Bernanke, who as a professor had been a prominent scholar of Fed policy during the Great Depression — the central bank resorted to a variety of unconventional measures. These ranged from a huge expansion of the monetary base to so-called quantitative easing, including $85 billion a month spent buying mortgage-backed securities.
A couple of charts — the total monetary base and Fed holdings of mortgage-backed securities — show the overhang of these policies:
Bernanke’s Fed prevented another Great Depression by not engaging in the tightening that his predecessor has done after the 1929 stock crash. He famously apologized to Milton Friedman before the great economist’s death: “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” Friedman and Anna Schwartz had done the pathbreaking research on how the earlier Fed had turned a severe contraction into the Great Depression. This time, Bernanke was committed to “whatever it takes.”
But now we’re in territory that macroeconomics can’t easily explain. “Whatever it takes” stabilized a crisis and didn’t make it worse, but it also failed to return the economy to historic growth rates and normal unemployment. All those assets, and all that money, will have to go somewhere. This is not a screed against “fiat money.” I don’t have the answers, particularly since the other Washington is committed to austerity rather than stimulus. But tapering will be easier said than done, and the stock market is often badly surprised.
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Today’s Econ Haiku:
The new Gilded Age
Without Teddy Roosevelt
A rough ride ahead