Amid the recent weakness in financial markets and escalating calls for the Federal Reserve to embark on a third round of quantitative easing (QE3), Dr. John Hussman wrote a particularly interesting piece about the U.S. central bank and its monetary policies.
In his latest Weekly Market Comment, the founder of The Hussman Funds and former economics professor had the following to say about the money printing activities of Chairman Ben Bernanke and his fellow central bankers:
Without question, one of the notions buoying Wall Street optimism here is the hope that the Fed will pull another rabbit out of its hat by initiating QE3. That’s a nice sentiment, but it does overlook one minor detail. QE2 didn’t work.
Actually, that’s not quite fair. The Federal Reserve was indeed successful at provoking a speculative frenzy in the financial markets, which has now been completely wiped out. The Fed was also successful in leveraging its balance sheet by more than 55-to-1 (more than Bear Stearns, Lehman, Fannie Mae, Freddie Mac, or even Long-Term Capital Management ever achieved), and driving the monetary base to more than 18 cents for every dollar of GDP – a level that requires short-term interest rates to remain below about 3 basis points in order to maintain price stability ( see Charles Plosser and the 50% Contraction in the Fed’s Balance Sheet ). The Fed was indeed successful in provoking a wave of commodity hoarding that affected global supplies and injured the poorest of the poor – particularly in developing countries. The Fed was successful in setting off a very predictable decline in the value of the U.S. dollar. The Fed was successful in punishing savers and the risk averse, and driving investors to reach for yield in risky investments that they would normally avoid were it not for the absence of yield. The Fed was successful in provoking those with strong balance sheets to pay down existing higher interest-rate debt, and in creating an incentive for those with weak balance sheets to issue more of it at low rates, resulting in a simultaneous deterioration of credit quality and compensation for risk in the financial system. The Fed was successful at boosting the trading profits of the banks that serve as primary dealers, by announcing precisely which securities it would be buying prior to Treasury auctions, and buying them on the open market a few days later from the dealers that acquired them. The Fed was successful in creating a portfolio of low yielding securities that will be almost impossible to disgorge without capital losses unless the Fed holds them to maturity. On proper reflection, the list of the Fed’s successes from QE2 is nothing short of stunning.
It is beyond comprehension why anyone would wish for more of this recklessness.
Later Hussman wrote:
Think about Fed actions in this context. Ten-year Treasury yields were already below 3% before Bernanke breathed a word about QE2. Treasury bill yields were already at just 15 basis points. Mortgage rates were already low. A long record of historical evidence was available to demonstrate that every 1% move in stock prices has only a 0.03-0.05% impact on real GDP, and a transitory one at that. Banks already held a trillion dollars of idle reserves on their balance sheets. How could a policy targeted at further suppressing yields and distorting financial markets possibly be viewed as a way to relieve binding constraints? How could an economy already plagued by “moral hazard” possibly benefit from the belief that the Fed had provided a “backstop” for speculative risk-taking? With interest rates already at zero, what possible intent could increasing the stock of zero-interest assets by $600 billion have, except to provoke investors to “reach for yield” by accepting greater risk without the material likelihood of durable reward?
Ben Bernanke’s objective of distorting the investment opportunity set and suppressing all risk aversion is dangerous, and is ultimately hopeless as a strategy to improve economic performance. In our view, the prospect of QE3 is questionable, and would be unlikely to draw the same market response as QE2 anyway, given that investors now have more information about its ineffectiveness. The latest iteration of Fed distortion was last week’s explicit promise to suppress interest rates for two more years, until mid-2013. Even that action was met by more opposition from FOMC members than any other decision under Bernanke’s tenure. Nevertheless, the promise to extend zero interest rates for two more years is simply a further attempt – now becoming desperate – to distort the financial markets by dressing up the same pig with lipstick and a flirty dress.
The full version of Hussman’s commentary is available here:
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