Irwin Stelzer: Fed gambles with inflation to give jobs boost
Comment of the Day

December 17 2012

Commentary by David Fuller

Irwin Stelzer: Fed gambles with inflation to give jobs boost

This is an informative view from the Hudson Institute director and columnist for The Times (subscription required for the full column, PDF also provided). Here is the opening:
The fiscal cliff is a diversion, designed by politicians to conceal their inability to come to grips with the facts that they continue to spend too much, and refuse to reform a tax structure that reduces the competitiveness of American companies in world markets. No matter what deal is cut, whether before or after the new year, it will at best nibble at the edges of the trillion-dollar annual deficits that are being piled up.

The real action has shifted from America's inactive politicians to our hyperactive central bankers, the members of the monetary policy committee, who are making Las Vegas high rollers look like risk-averse wimps. And the highest roller of all is the bewhiskered former Princeton economics professor who presides over the Federal Reserve Board's printing presses. Ben Bernanke, the board's chairman, has an advantage over his Vegas counterparts: he can't run out of money because he can always print more.

Bernanke's "risky bet", to borrow a characterisation from The Wall Street Journal, is that he can safely keep pumping money into the economy until the unemployment rate drops from its current level of 7.7% to at least 6.5%. Unless, of course, the decline in the unemployment rate is due to a drop in the labour force participation rate, in which case quantitative easing will continue. If you think none of this matters because Bernanke will exit stage left in 2014, consider that his likely successor, vice-chairman Janet Yellen, says the Fed's complex mathematical models show that interest rates should not reach 1% by 2017 if unemployment is to reach acceptable levels.

And the conclusion:

To be fair to Bernanke, it is not clear that he has got it wrong. First, it is arguable that his launch of QE1 and QE2 created vehicles that could and did throw life rafts to financial institutions that were drowning in flawed debt instruments, and that QE3 boosted post-recession growth. To mix my metaphors, another dose of an efficacious medicine might just be in the patient's interest. Second, a new QE that dare not speak its name - make no mistake, the new policy is QE4 - might well be needed if fiscal policy tightens when taxes go up and spending comes down, as will happen in 2013 no matter how the fiscal cliff is resolved, or even if no deal is made.

Finally, Bernanke believes that the economy will grow at the unsatisfactory rate of 1.7%-1.8% this year, and 2.7% next year (the central point of the predicted range), in part because uncertainty over the governability of the nation is driving down consumer confidence and stifling business investment.

There you have it. The Fed has been buying $40bn of mortgage-backed securities and $45bn of long-term Treasuries every month, but until now it has also been selling $45bn in short-term government securities. Those sales have stopped, so net purchases will go from $40bn per month to $85bn. Do that for a few months, and you have to print a lot of money. Do that until 2017 and you just might have a currency so debased that paying off the national debt will be a snap. So unless you are sitting on a batch of Uncle Sam's IOUs, as are the Chinese, don't worry, be happy. We will print our way out of our debt.

David Fuller's view This is an unprecedented and therefore uncertain situation, except that the rise in US government debt will not be reduced by anything that President Obama's administration will be able to push through in addressing the so-called fiscal cliff. In fact, his policies will almost certainly ensure that the debt continues to spiral higher. For this reason, I would have preferred Mitt Romney's economic steerage, although social aspects of the Republican Party's platform, which I did not like, made it improbable that the President would be defeated in the last election, despite the USA's ballooning debt and weak economy.

Nevertheless, there are at least two and possibly three known wildcards which could mitigate the damage.

1) By far the most important US economic factor, so often discussed by Fullermoney in recent years, is its huge lead in developing the USA's vast reserves of unconventional shale oil and gas deposits. Ironically, President Obama and his party are the main political beneficiaries of this ground breaking (pun intended) development. They opposed it, including blocking the development of shale deposits on government land, in favour of so-called green energy which remains both expensive and commercially inefficient, being ahead of its developmental time. Today, the USA is by far the most competitive energy producer of any diversified economic power. The economic benefits of the USA's vast shale deposits and its technology to develop them, have the capacity to transform the US economy for many years ahead, including reducing the country's ballooning government debt.

2) During the USA's dreadfully long election process and now the fiscal cliff tedium, we often hear what Erwin Stelzer mentions above as "…uncertainty over the governability of the nation is driving down consumer confidence and stifling business investment." Well, yes, to an extent but successful US Autonomies and Dividend Aristocrats, which this service continues to discuss and review at length, are often economic powerhouses, benefiting from technological innovation, continued growth in Asian-led economies, globalisation and a rising global population. The USA has more Autonomies and Dividend Aristocrats than any other country, and while these firms may have been biding time to assess US political and economic developments, they have been busy elsewhere and will soon face fewer uncertainties in terms of US economic policies. Fullermoney likes these companies, subject to timing in volatile conditions, which we can all monitor on the price charts.

3) Federal Reserve Chairman Bernanke's controversial policies have certainly taken us into the unknown and are often described as a gamble. Fullermoney takes a broadly agnostic view of what Mr Bernanke is doing, if only in an effort to maintain analytical equilibrium. In other words, we are less concerned about the 'right' or 'wrong' of his efforts to avoid Japanese-style deflation and perpetually slow GDP growth since the early 1990s. Instead, we want to know how to invest in this environment, preferably by avoiding bubbles and also by seeking out value. In today's environment, that leads us to quality equities on a global basis, plus gold and other precious metals. There are also cyclical opportunities in the broader commodity markets which we will continue to highlight.

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