Risk on, baby

The Wall Street Journal has a good editorial (“As contractions go,” — behind its subscription paywall but available via Google News) on yesterday’s announced fourth quarter contraction in the economy. Does anyone think that more of the same monetary policy will deliver us from Obama’s slow growth/no-growth economy? The Journal comments: “Bad economy=more Fed cowbell=higher stock prices. Risk on, baby.”

The Journal concludes the editorial with comments on the Fed’s current QE-Infinity, near zero percent interest rate policy:

Meanwhile, and right on cue for Wall Street, the Fed announced Wednesday after its two-day meeting that it will stick with its bond-buying spectacular. This means buying $40 billion in mortgage-backed securities a month and another $45 billion in longer-term Treasurys. The Fed is on pace to expand its balance sheet by another $1 trillion or so through the end of this year—its fifth in a row of near-zero interest rates and some form of “quantitative easing.”

These have been heady days at the Eccles Building, or at least they were before the GDP report. Stock and housing prices have been rising, and investors are walking further out on the risk curve, just as Chairman Ben Bernanke hopes. The Fed has also led a parade of easing around the world, as other central bankers follow to prevent their currencies from rising too much. Even Japan has finally succumbed, raising its inflation target.

Yet the economic paradox of our time is slow growth and lousy job creation despite these monetary exertions. This continues to be the 2% recovery, the slowest in the modern era. The Keynesian explanation is that we’re still recovering from the financial panic, though it’s worth recalling that in January 2010 the Fed predicted that growth in 2012 would be 3.5% to 4.5%, not 2.2%.

Stanford economist John Taylor offered a different explanation this week, saying on these pages that the Fed’s excessive ease may actually be hampering growth thanks to unintended consequences. These include the misallocation of capital as investors chase yield above all, a subsidy for excessive federal spending by disguising the real cost of repaying debt, and the uncertainty of when the Fed will finally have to stop the party.

This debate won’t be settled for years, and in any case Mr. Bernanke doesn’t listen to Mr. Taylor or us. By now the world knows he’ll keep doing what he’s been doing until faster growth returns or the markets force him to stop. Risk on, baby.

As of the first of this year, as I understand it, the Fed’s purchases of Treasury obligations become pure exercises in money creation (i.e., are “unsterilized” by the simultaneous selling of assets to cover the purchases). The interesting chart below tracks the expansion of the Fed’s balance sheet, with more coming soon. See also “A look inside the Fed’s balance sheet.”

Might Fed policy itself have a hand in the perpetuation of Obama’s slow growth/no growth economy? That is the question addressed by Stanford economist John Taylor, cited in the editorial above, in his column “Fed policy is a drag on the economy.” We seem to be approaching the time contemplated by Irwin Stelzer in his recent Weekly Standard post, articulating the unspoken train of thought underlying the current situation:

As for the deficit, worry not. We can afford existing entitlement programs that protect children and the elderly without running the risk of over-borrowing and defaulting on our mounting debts. Which is certainly true, since if investors decide that they are no longer willing to lend us $40 for every $100 we spend, we can run the presses, and pay off our debts with a depreciated currency, something that troubles our Chinese creditors. That would continue the massive wealth transfer now underway from creditors—savers and investors, victims of the zero-interest policy being pursued by the monetary policy gurus at the Federal Reserve Board—to debtors who will be able to repay their creditors with cheap money.

Haven’t we reached the moment when we are running the presses to borrow $40 for every dollar we spend? Or am I missing something?

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