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FEW PEOPLE WILL TAKE NOTE of Oct. 6 as a key date in history. Far more memorable is Oct. 4, which will be marked forever for that wonderful day in 1955, when the Brooklyn Dodgers, the fabled Boys of Summer, won their only World Series. I was too young to recognize what was happening at the time, but I'm sure there was unabashed joy in my Dodger-rooting household, even though it was within walking distance of Yankee Stadium.
On Oct. 6, 1979, the Federal Reserve embarked on a fierce campaign to restore the dollar's value, both in terms of inflation at home and in the global currency markets. It meant extreme actions, culminating in short-term interest rates reaching the unprecedented heights of 20%. The U.S. economy sank into what then was the worst contraction and the longest period of sustained 9%-plus unemployment since the Great Depression. Once inflation was finally crushed, the economy embarked on the longest expansion ever known, interrupted only by two trivial recessions until the great credit collapse beginning in 2008.
Since then, monetary policy has been the polar opposite—short-term rates cut to an irreducible zero; massive Fed asset purchases to push down yields on intermediate- and long-term Treasuries and especially mortgages; and now, stimulus through a lower dollar, albeit unofficially. The aim has been to arrest a decline in inflation that now has been explicitly deemed as too low—which couldn't be much more different than 31 years ago. And while the U.S. economy emerged from the worst recession since the Great Depression, unemployment remains elevated above 9% for the longest stretch since the 1930s.
The basic change from three decades ago is that monetary policies of the central banks of the major developed nations could be characterized as either tight or tighter in order to rein in inflation. Now, every major central bank has policy rates at or near zero, and are actively searching for ways to ease conditions in less conventional manners.
The latest was the Bank of Japan, which announced early Tuesday some ¥5 trillion ($60 billion) worth of easing measures, consisting of the purchase of ¥3.5 trillion of Japanese government bonds, ¥1 trillion in commercial paper and corporate bonds, and ¥500 billion of exchange traded funds and real estate investment trusts. This follows the BoJ's massive ¥2 trillion unsterilized purchase of dollars last month, another form of quantitative easing to add liquidity in order to counter the yen's strength.
Markets inferred from the BoJ's move, coupled with further comments by Federal Reserve officials, that the U.S. central bank is about to join in QE2, and sent stocks soaring 2% on Wall Street Tuesday. In an interview with the Wall Street Journal, Chicago Fed President Charles Evans said flatly, "The unemployment rate is too high; inflation is lower than what I think price stability is," and called for "large scale asset purchases" (the Fed's preferred phrase instead of QE and since dubbed LSAP by the cognoscenti.)
That echoes New York Fed President William Dudley's speech Friday, in which he declared: "Viewed through the lens of the Federal Reserve's dual mandate—the pursuit of the highest level of employment consistent with price stability, the current situation is wholly unsatisfactory. Given the outlook that the upturn appears likely to strengthen only gradually, it will likely be several years before employment and inflation return to levels consistent with the Federal Reserve's dual mandate."
While Dudley made the standard disclaimer that his comments represented just his views and not the entire Federal Open Market Committee. But as Ed McKelvey, a senior economist at Goldman Sachs , observed it's unlikely Dudley would "give a speech of this significance without the concurrence of Fed Chairman [Ben] Bernanke and probably other key members of committee."
It also should be recalled when Dudley was McKelvey's colleague as chief U.S. economist at Goldman before going to the Fed, he correctly forecast in 2002 the Fed would continue to ease even though the recession of 2000-01 had officially ended. The Fed would go on to cut the federal fund's target rate two more times, to a then-record low of 1% by 2003.
So far, the Fed has been concentrating on buying Treasuries. In its current open-market operations, it has been replacing maturing agency mortgage-backed securities with Treasuries. Fed officials suggesting a new LSAP also talk mainly of buying Treasuries as an indirect means to lower borrowing costs through the economy.
But if the Fed's intention is to stimulate lending, why not buy bank loans outright? That provocative suggestion comes from Clifford D. Corso, chief executive and chief investment officer with Cutwater Asset Management, an Armonk, N.Y. fixed-income shop with $43 billion under management. "To fight the credit crisis, the Fed came up with all sorts of facilities to support the credit markets, such as the commercial paper market."
If bank lending (or lack thereof) is the problem, why not have the Fed buy loans from the banks? It seems less of a stretch than the BoJ's scheme to buy ETFs and REITs.
Whatever form it takes, Uwe Parpart, Cantor Fitzgerald's perceptive Asian strategist, wrote U.S. markets jumped for joy "anticipating the early arrival of Christmas or who knows what on Nov. 3 when the Fed is expected to announce another round of quantitative easing in earnest."
He advises readers to curb their enthusiasm, however."The Fed (much like the BOJ in 2001-2006) is attempting to push investors into risk assets and companies sitting on cash into hard assets. It didn't work in Japan then, it won't work in the U.S. now. The central bank cannot substitute itself for the government and the private sector and bring about real growth and job creation in face of disincentives (Obamacare, higher taxes.)"
Indeed, adds market maven Doug Kass, general partner of Seabreeze Partners, the main effect of Fed purchases has been to inflate asset prices artificially. Indeed, he cites those very words from Brian Sack, who oversees the Fed's System Open Market Account at the New York Fed, "Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be,"(with Kass boldfacing for emphasis.)
While Sack contends the economy is completely insensitive to changes in financial conditions and asset prices, Parpart's observation that the limited effect such actions had in Japan should be considered.
Indeed, the Fed's actions could backfire. Expectations of Fed ease are sending commodities soaring, with crude oil back to $83 a barrel. And it's promptly showing up at the retail gasoline pumps. As 2008 showed, U.S. consumers are sensitive to paying over $3 a gallon and could pull back just as the holidays approach if the price at the pump continues to climb.
If all it took to ensure prosperity were to print money, we wouldn't be having any problems. Liquidity expansion will boost asset prices, so enjoy. But don't expect miracles.
E-mail: randall.forsyth@barrons.com
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