Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Thursday, 13 September 2012

Employment in dire straits prompts Ben to print money for nothing


Caution: Written in a mood of bemused anger. Reader discretion is advised before proceeding further.

I certainly read Ben Bernanke wrong. I gave him too much credit for circumspection and he turned out to be a maniac. Today’s FOMC decision highlights the boy with the hammer syndrome that he’s suffering from. To the Chairman with a monetarist ideology, all problems are monetary. As pointed out earlier, QE hasn’t achieved much and isn’t going to either. If printing money strengthened an economy Mugabe would be presiding over an economic superpower.

In any case there is no point in ranting about Ben’s decision to boldly go where von Havenstein has gone before. Analysing the impact is more interesting. Three main points come to the fore.

The first point is about the ambiguous nature of the action – $40bn a month until the labour market improves “substantially”. Even the press conference did not clarify this point. All Ben said was that employment has to come down in a “sustained” way. This effectively means that $40bn-a-month or more is going to be printed until the Chairman is satisfied. Or deposed at the end of his term. However, it also means that every data point and every statement of every official is going to be scrutinized minutely and interpreted differently. Kudos for injecting more uncertainty into an already uncertain market.

Secondly, the inflation part of the Fed’s mandate has been thrown out of the window. The explicit statement that the Fed will remain accommodative for a “considerable time” after recovery makes it crystal clear. The mention of price stability in the statement is mere tokenism. Wasn’t Greenspan’s ‘too low for too long’ policy which got us into this mess in the first place? The law of unintended consequences is clearly not consequential enough for the gurus of the Federal Reserve (Lacker exempted).

The third point concerns the effect of Fed actions on the supply of safe assets. By withdrawing agency-MBS onto its balance sheet it reduces the supply of safe assets in the market. This is clearly intended as the Fed wants the funds to go into risky assets and drive growth. (Side note: Unfortunately there was once an economist called Keynes who cogently pointed out why it may not happen and indeed why it didn’t happen during the Great Depression. Unfortunately he’s considered quite unfashionable in the exalted monetary circles that Ben and company move in). The safe asset supply will be further curtailed due to the impending fiscal cliff which will reduce the deficit and hence UST issuance. The effects of these are not easy to analyse. Market distortions such as rising delivery failures are just one aspect. What happens if a shock leads to an investor rush into safe dollar assets? Certainly one to watch and ponder.

The markets are unsurprisingly jubilant but it’ll be interesting to see the longer term reaction to the consequences of what is possibly the last throw of the monetary die. (I use ‘possibly’ because I don’t know if Ben’s next step to nudge unemployment into a significant and sustained downtrend would be to buy houses outright). 

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