Is The Fed Sorry It Promised QE2?
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BEING STREET SMART
by Sy Harding
The Bubble Machine is Cranking! November 5, 2010.
The Federal Reserve has cranked up the bubble-machine again, pumping up
opportunities as well as risk.
In doing so it is on the wrong side of the economic cycle again, as it so often
has been in the past, beginning to ease too late to prevent recessions, and then
continuing to ease too long after recoveries are underway, creating bubbles.
For example, in 1998, although having already warned of the inflationary risk in
the overheated economy and “irrational exuberance” in the stock market, the
Greenspan Fed panicked when Asian markets began to collapse. It cut interest
rates to hold the U.S. stock market up, producing another round of irrational
exuberance, and boosting the stock market up into the 1999 bubble. The Fed did
not reverse and begin tightening monetary policy until June, 1999, and by then
it was too late. The bubble was formed and burst with dire consequences in early
2000.
Then, apparently not realizing the stock market collapse was an advance warning
of a coming recession, the Fed continued raising interest rates until May, 2000,
and did not begin cutting interest rates to prevent a recession until January,
2001. By then, the 2001 recession was already upon us.
To help pull the economy out of the 2001 recession the Fed then cut rates a
total of 13 times, not stopping until June, 2003, well after the economy was
recovering and the 2002-2007 bull market was well underway.
And that failure to get ahead of the curve resulted in the real estate bubble.
When it burst, the resulting recession of 2007-2009 was the worst since the
Great Depression, and the 2007-2009 bear market was the worst since the 1930’s.
This time around it seems the Fed had it right last spring when it ended its
first round of quantitative easing in March, earlier than scheduled. It said low
interest rates would be needed “for an extended period”, but it was time to
begin removing the other massive stimulus efforts of 2008 and 2009. The
recession had ended in June last year and the economic recovery was underway.
It stuck with that outlook until August, projecting that economic growth would
slow for a couple of quarters but not into recession, and then begin to grow
again in the last half of the year and through next year.
But in August, when the stock market was down and economic reports from the
summer months were worsening (as the Fed had supposedly expected) it panicked,
reversed its bias and promised a second round of quantitative easing “if
needed.”
When the economic numbers began improving three or four weeks ago, I was sure
the Fed would decide the “if needed”
conditions had not arrived yet (and might not), and would either postpone the
decision on QE2, or announce a very watered-down token program. I wrote a column
three weeks ago titled Is The Fed Sorry It
Even Mentioned QE2?
But no, at its FOMC meeting this week the Fed remained in panic mode and
announced an aggressive program in which it will pour roughly $100 billion a
month of additional liquidity into the financial system until next June.
I believe part of the Fed’s problem is allowing itself to be influenced by the
complaints from Main Street and Washington regarding the high level of
unemployment, and that the economic recovery is not creating jobs fast enough.
The Fed singled out the continuing high unemployment as a major reason more
easing is needed.
But surely the Fed knows that employment is a lagging indicator, and using it as
a leading indicator for its policies is almost sure to have it on the wrong side
of the cycle. Employers don’t begin hiring more workers to any degree until the
economy has already recovered significantly enough that they can no longer keep
up with increasing business by giving current workers more hours, and hiring
part-time help.
The Fed has apparently ignored recent jumps in the ISM Mfg Index, ISM Non-Mfg
Index (service sector), retail sales, durable goods orders, and the like, which
indicated even the point in the recovery may be near where the employment
situation improves.
That seemed to also be indicated on Friday by the Labor Department’s latest
monthly employment report. It was that 151,000 new jobs were created in October,
the highest number since May, more than double the forecasts of 70,000 that
economists expected. And the previously reported numbers for August and
September were revised to show 103,000 more jobs were created over those two
months than previously reported.
The evidence that the Fed is again behind the curve could hardly be clearer.
So at this point, the additional liquidity the Fed has decided to pump into the
financial system will surely go toward continuing the Fed’s history of creating
bubbles.
Picking the location of those bubbles will probably be very profitable over the
next year or two. The initial betting is that they’ll be in commodities and
emerging markets, and that bond prices will tumble. Other possibilities will
also emerge. It’s bubble-detecting time!
Sy Harding is
president of Asset Management Research Corp, and editor of
www.StreetSmartReport.com,
and the
free daily market blog,
www.streetsmartpost.com.
These reports reflect
our opinions and are based on our best judgment, but no warranty is given or
implied as to their accuracy. Past performance does not guarantee future
performance.
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