Give the man credit, he did manage to keep a straight face when he blew this bubble while pumping an additional $85bn per month into the financial system and pursuing an unprecedented policy of financial repression to force the muppets up the risk curve just ahead of calling the end of the party. Ouch!
Perhaps Kermit should have paid heed to this earlier pearl from the professor - “The Federal Reserve is not currently forecasting a recession” Ben Bernanke, January 2008. This is not to suggest that the Fed Chairman’s ability to anticipate changes in economic trends is rubbish, but that like the oracle in Matrix, he tells us what he feels we need to believe. (A well-worn weapon up any central banker’s arsenal - see note*1 below)
So what are markets to make from ‘Bubbles’ Ben’s latest bit of news manipulation? Having dribbled it out the possibility of an earlier than expect end to QE to the usual market “sources”, he now appears to have confirmed the “tapering” stories. The official line is that QE has been such a success, that the rate of asset purchases can now be reduced by the year and assuming the rather important caveat of a highly ambitious ‘real’ GDP growth forecast for 2014 of +3-3.5%, possibly ended entirely by this time next year. So well done ‘Bubbles’, you can now safely retire at the end of you current term in January 2014 (and helpfully confirmed by President Obama) knowing that the US economy has been restored to self-sustaining growth.
Unfortunately, the numbers do not support such a Panglossian interpretation of recent history or forecasts of sustained recovery. As such, the recent events seem more to be part of an exit strategy. What is less clear however at this stage is whether it represents an escape route for the man or a more fundamental recognition and refutation of what to many has become a highly damaging strategy to the whole bedrock on the capitalist system; the market pricing of risk.
Item 1: QE – has it worked? To justify fiscal stimulus, Keynesian economists tend to over-state the expected returns from increasing government expenditure (to soak-up excess capacity during recession - the expenditure multiplier), knowing that validation post-event can be obscured by the usual “what-if” arguments. However, for the US Govt to reflate significantly faster this time, yet experience a commensurately weaker recovery presents an obvious problem. If one were to take seriously the recent IMF study suggesting a fiscal multiplier was as high as 1.7x for the 28 economies it surveyed during the “crisis years of 2010-11”, then how are we to reconcile the simple maths of US GDP lagging the growth in Govt debt. Since the economic trough in 2009, US nominal GDP has increased by only $2.1tn, an average CAGR of only +3.6% pa. Federal debt however has increased by 3.5 times this amount over the same period and by over $7tn.
On any analysis, this sucks, with every $1 increase in Federal debt being accompanied by only a 40c rise in nominal GDP. Add in the tail wind that a 2-4pts reduction in key interest rates over the period on household debt (100% of GDP in 2009, nearer 85% now) and Federal debt (now >100% of GDP) should have delivered and perhaps the IMF’s original fiscal multiplier premise of only 0.3x was nearer the mark – a fiscal divider?
As well as depressing ‘risk free’ returns and driving up risk asset prices (to bailout the banks), let’s not forget that QE has also been directly funding a substantial portion of the Govt largesse (ie to bailout Obama); increasing its balance sheet ‘assets’ by over $2.1tn at a zero initial funding cost. Even assuming a fiscal multiplier effect on this alone, would more than halve the already anaemic rate of GDP growth in this recovery to well under +2% CAGR; ie little more than real inflation.
The inescapable conclusion? US Govt expenditure increases and associated QE support has failed to demonstrate a fiscal multiplier of over 1x; indeed given the distortions to pricing market risk, QE may be becoming the problem rather than the cure as corporates continue to sit on investment. Generating the political will to kick the QE habit however will be very difficult. QE tapering, let alone reversal, would inevitably return interest rates to more normalised levels unless accompanied by credible plans to tackle structural Govt deficits. With headwinds also coming from slowing growth in China, competitive Japanese devaluations and continued recession across the EU, next year’s GDP growth targets look vulnerable and therefore could provide the all-too-easy get-out clause to resume QE and attempt to kick the can back down the road. Ultimately this remains a political issue. Will electorates support responsible policies to fund their deficits or again bequeath these to future generations as a politically expedient policy to secure re-election. Unfortunately demographics is working against a fundamental resolution. We all know the madness of Greece, as irresponsible Governments were re-elected on promises that could never be kept. Unfortunately that seems an inevitable consequence of when there are more people voting for a living than earning one. In this regard the trend in the US is not favourable. Private sector employment into the supposed recovery is increasing at no more than the overall growth in working age population notwithstanding the scale of fiscal stimulus. Longer term however, the trend is clear, the private sector is representing a diminishing proportion of the economy and is now the minority, but still supporting the majority.
Note:*1 “Blah, Blah Blah” remains the central bankers weapon of choice. Although my point is perhaps not as studiously made as by Michael Woodford (see NBER working paper 15714: Simple analytics of the Government Expenditure Multiplier – http://www.nber.org/papers/w15714), the antics of this bunch of neo-Keynesian diehards has done little to convince investors that markets have become no more than casinos geared towards front-running the next, but increasingly threadbare statement from Bernanke, Draghi et al.
original post on 21 June 2013 at www.wyt-i.com
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