Last week, the Federal Reserve announced its third-round of
quantitative easing, whereby the bank essentially prints money and
then buys assets with it in order to add liquidity to the financial
system and bring down interest rates. The ultimate goal of this
monetary policy tool is to spur economic growth and lower the
unemployment rate.
The Fed also changed the language of its interest rate forecast
and now sees the Fed funds rate remaining exceptionally low through
mid-2015. Previously, the Fed had said that the rate would remain
near zero through at least 2014, so the change in language extends
the forecast by roughly half a year.
The announcement of QE3 is wearisome for many reasons. When the
Federal Reserve and Treasury started down the path of radical
market intervention, many enlightened investors opined that the
intervention may go on into perpetuity. By all accounts, this
prognostication has been borne out thus far.
The counter-argument to the incessant monetary and fiscal
machinations of the policy makers is that these actions have
fundamentally changed the nature of global markets. The effect of
the bailouts, stimulus and quantitative easing could be argued to
have prevented the economy from a natural re-set.
While the stimulative policies are temporary and artificial, the
laws of economics are not. Asset prices have not been able to reach
an equilibrium level as a result of overwhelming intervention.
Mal-investment and bad debt has been subsidized, and market prices
have become distorted. In such a scenario, it would seem there is
no solid foundation upon which a strong recovery can be
sustained.
Asset prices have been artificially manipulated and do not
reflect long-term economic reality. Consider for example, the U.S.
Treasury market. The yield on the 10-year note is currently around
1.84 percent. Is this an accurate reflection of the
credit-worthiness and fiscal situation of the U.S. government? Does
it accurately reflect inflation expectations?
Nearly all asset classes have become distorted in the wake of
the unprecedented market intervention that has taken place to
combat the fallout of the financial crisis. Last week, once again,
commodity prices rose as investors sought to hedge themselves
against a falling U.S. dollar. Quantitative easing serves to dilute
the money supply, and naturally the value of the money
declines.
The trend of a falling dollar and rising commodity prices may
continue to cause dire consequences across the world. It is
devastating to savers who keep money in conservative, low-yielding
assets. Even more harmful, it has forced the price of essential
commodities such as food and energy higher at the worst possible
time for most global citizens.
In a low-growth environment with sky-high unemployment levels,
the effect of rising costs for essential items such as food and
gasoline is extremely destructive to the economy. This is a global
phenomenon, as the stimulative measures taken by the world's
central banks do not seem to be having the intended effect.
Instead of citizens noticing the effects in more jobs and a
strengthened economy, they see them at the gas pump and in the
grocery store. What appears to be happening, is that the United
States and other developed nations are creating catastrophic
systemic risks as a result of the policies intended to engender an
economic recovery.
During financial times such as these, it may be useful to take a
step back and evaluate how this has happened. In 2007, the U.S.
mortgage market melted down, triggering a devastating global
recession. The very same policy-makers upon whom our economic
future relies were caught completely by surprise.
Former Treasury Secretary Hank Paulson, Federal Reserve Chairman
Ben Bernanke, Congress, corporate CEOs -- they all were tantamount
to deer in headlights when the mortgage tidal wave hit. Yet, these
same people (in particular Ben Bernanke and the Federal Reserve)
purport to have the solutions to the problems that they never once
saw coming.
The reality is that the central planners across the world have
very little visibility out of the windshield, and the effectiveness
of their reactionary measures has been dubious at best. The former
statement has been proven time and again, and the latter is fairly
obvious given the state of the economy. Unfortunately, the policy
makers cannot admit this and act accordingly -- i.e., with a more
hands-off approach.
What is even more disconcerting than the realization that the
authorities continue to operate with the idea that they can
manipulate, control and accurately forecast the economy, is that
their policies are heaping risk onto an already fragile system.
If they are in fact incapable of accurately forecasting the
economy and achieving the desired outcomes through their policies,
then what is the benefit of the massive risks being taken in that
quest?
Readers should consider what another severe recession could look
like in light of what has occurred since the financial crisis.
Between 2007 and the present, governments have taken on crushing
debt loads by transferring private liabilities onto the public
balance sheet. The balance sheets of global central banks have also
ballooned to grotesque levels as a result of stimulative
policies.
The consequences of these actions are abundantly clear as a
global sovereign debt crisis continues to unfold. These
consequences are most obvious in Europe, but they could envelop the
entire developed world.
So, here is the question -- what if these policies fail and the
economy takes another nose dive? The position of governments and
central banks will be exponentially weaker than they were in 2007,
and the likelihood of currency and sovereign debt implosions will
be multitudes higher across the world.
It is a very real possibility that the fiscal and monetary
policy actions taken in the wake of the Great Recession have set
the scene for a far greater crisis in the not too distant
future.
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