By Greg Peel
In the past two months, the US economy has shed 347,000 jobs, notes the UK Telegraph's Ambrose Evans-Pritchard, roughly comparable with the rate of loss seen post-GFC. Why, then, would the Fed even consider tapering?
The US ten-year bond yield has risen 140 basis points since the Fed flagged possible tapering back in June. The Fed might just have well have raised rates six times, says Evans-Pritchard. Rising mortgage costs and the tightening of financial conditions could slow growth, said the Fed. Therein lies the Catch-22.
The US unemployment rate has been quietly ticking down recently not because new jobs are being created but because those without jobs who don't choose to look for work are not counted. The labour participation rate fell to 63.2% in July, its lowest level since the 1970s recession. Americans are giving up on finding a job. A record 20.2% of US households are now on food stamps.
US GDP has grown by 0.1%, 1.1% and 2.5% in the last three quarters, which Evans-Pritchard notes is below the Fed's "stall speed" indicator of 2% averaged over two quarters. The US economy has nevertheless weathered the greatest fiscal tightening (sequestration) since the end of the Korean War remarkably well, with the shale gas revolution providing a buffer, but it is yet to reach "escape velocity". Growth in the broad money supply (M3) has slowed to a rate which suggests it would turn negative but for QE.
It would be a grave error, Evans-Pritchard suggests, for the Fed to start tapering bond purchases at a time emerging markets are facing a turn in the credit cycle (Brazil, India, Turkey, South Africa, Indonesia, Ukraine et al) and given the danger of another eurozone "debt spasm", as occurred at the end of QE1 and QE2.
"The Bernanke Fed has twice misjudged the global effects of premature tightening already, each time precipitating a credit and stock market crash within weeks, and each time forcing the Fed to capitulate. Third time lucky?"
Is the Fed's desire to extract itself from QE all about jobs and inflation? Or something else? A former Fed governor has warned the Fed will struggle to extract itself from QE if it delays until 2014, potentially drowning in losses on its US$3.6 trillion of bond holdings once yields rise. But perhaps the real problem is the legitimate concern of fuelling an asset price bubble, which is how we got into this mess in the first place. Total public and private debt levels are 30% higher as a share of GDP in advanced economies than they were in 2007, and a new problem is bubbles in emerging markets as well.
Thus the conundrum is as to which is the lesser of the evils. Does the Fed pop the asset bubble, thus triggering a ruinous slump? Or could the Fed maintain QE without feeding the bubble further?
"The root of our global crisis," says Evans-Pritchard, "is the [US]$10 trillion reserve accumulation by the emerging powers, massive over-investment in China, and extreme levels of inequality within the West... The combined effect is to create excess capital, and lack of consumption, pushing the global savings rate to a record 25%. This chronic disorder keeps blocking economic recovery. It is embedded in the structure of globalisation."
If the US economy needs more stimulus, then that stimulus needs to be directed more creatively, suggest Evans-Pritchard. QE could, for example, be used to build houses, thus injecting money into "the veins of the economy instead of the veins of hedge funds". The fear of an asset bubble is not a good reason to shut off stimulus prematurely if the economy still needs it.
Bernanke is a scholar of the Great Depression. In 1937, the Fed tightened monetary policy. It proved a costly error saved only by a war. As to whether the Fed can be creative is yet to be seen, but with Bernanke electing not to tighten US monetary policy last night, we have dodged a bullet, says Evans-Pritchard.