Thursday, March 14, 2013

A Plan to Blow a Bubble

Below is a response from Fed Chairman Ben Bernanke to a reporter’s question on QE (quantitative easing) and the recovery. We have taken the quote directly as reported by The Economist.
“The tools we have involve affecting financial asset prices, and ... those are the tools of monetary policy. There are a number of different channels—mortgage rates, I mentioned other interest rates, corporate bond rates, but also the prices of various assets, like, for example, the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they’ll feel more disposed to spend. If house prices are rising, people may be more willing to buy homes because they think that they’ll, you know, make a better return on that purchase. So house prices [are] one vehicle. Stock prices—many people own stocks directly or indirectly. The issue here is whether or not improving asset prices generally will make people more willing to spend. One of the main concerns that firms have is there is not enough demand, there’s not enough people coming and demanding their products. And if people feel that their financial situation is better because their 401(k) looks better or for whatever reason, their house is worth more, they are more willing to go out and spend, and that’s going to provide the demand that firms need in order to be willing to hire and to invest.”
Chairman Bernanke makes it very clear that his goal is to stimulate a rise in asset prices. In essence, he has indicated that the Fed is trying to positively impact the prices of real and financial assets to stimulate consumption. Disregard the fact that Americans spent the 25 years prior to the crisis consuming far too much while saving and investing far too little, Mr. Bernanke thinks the solution to the nation’s weak economic growth is to once again ensure that Americans spend too much while saving and investing too little. How does he plan to ensure that they do so? By forcing up the prices on both real and financial assets, regardless of their valuations and long-term fundamentals, to make people “feel wealthier” and once again overspend. As learned as the Chairman is, he seems to skillfully avoid the reality that feeling wealthier is not the same as being wealthier.  Americans may well feel wealthier due to the bubbles that the Fed may help create, but they will be left poorer once again when such bubbles collapse. He also seems to avoid the reality that over consumption reduces saving and investment today, thereby reducing growth tomorrow. In short, his goals, if achieved, will reduce the long-tern growth potential of the US economy. This is a classic game of creating short-term gain at the expense of long-term pain. An intelligent approach to economics, or life for that matter, would suggest the opposite: i.e. a willingness to accept short-term pain for long-term gain.
It is nothing short of amazing that the head of the central bank in the largest economy in the world is suggesting that the intelligent way to stimulate the nation’s economy is to build consumption on the back of what are likely to be fleeting gains in financial assets rather than through personal income growth. This is simply bad economics and the question is not whether it will end badly, but when.  The markets can stay irrational longer than we’d like and its anyone’s guess when this will end. But we remain convinced that it will not end well.