I'll start off by saying: I was dead wrong about "no QE3" this time. With the dollar in crash mode and equities at multi-year highs, I did not expect the Fed to do anything more than continue their "Virtual QE3" talking-points program.
With that bit of crow-eating out of the way, it's time to adjust to the new reality and discuss what the program might mean for the market and the economy; additionally, one simply cannot avoid some discussion on the moral hazard and the politics of it.
Let's start off with what the program entails. Quantitative Easing is government-speak for "printing more money" (although, in today's world, this is less about the physical printing press and more about digital transfers). The Fed has been reduced to printing because their usual go-to monetary tool, which is lowering interest rates, has long been maxed-out and ineffective. Fed fund rates are already effectively negative; thus there's nothing more to be done in that regard.
The Fed has departed somewhat radically even from previous QE programs, as this is the first program with no fixed end-date. Therefore, instead of calling it “QE3,” it seems appropriate to name the new program "QE-Infinity" (I would simply use a lemniscate after "QE," but my font doesn't allow it). On Thursday, the Fed committed to buying $40 billion worth of Mortgage Backed Securities (MBS) every month in an ongoing open-ended program, which, for those keeping tabs, equals a total commitment of $85 billion a month when combined with existing programs. This will cease when the Fed "sees substantial improvement in the labor market."
Of course, this immediately begs the question, "What will the Fed view as 'substantial improvement?' What are the qualifiers, and where will it end?"
The answer is a resounding: "Nobody knows." In Bernanke's own words: "We haven't yet come to a set of numbers, but we're guaranteeing that we won't tighten too soon." That statement alone should create some discomfort with American taxpayers, as the unaccountable (to voters) Fed is admittedly setting a far-reaching policy with no qualifiers. But naysayers are glibly refuted, as Bernanke demonstrates in a statement discussed later.
Printing money floods the market with more dollars, which makes dollars worth less (supply and demand: more supply equals lower value), which means that tangible assets priced in dollars -- such as oil and food -- end up costing more. This is euphemistically referred to as "inflation."
One of the arguments against prolonged low interest rates and flooding the money supply is that these actions punish savers in two ways: Artificially low interest rates hit savers' accounts directly; and printing money hits them a second time and forces them into high-risk assets as they try to keep up with inflation.
In a weak attempt to address the fact that his policies punish savers, Bernanke responded with this glib straw-man argument: "You can't save without a job."
Yes, that's a true statement. But it's not a legitimate argument. Even in this depressed labor market, there are still far more Americans with jobs than without them; and there are more and more retirees struggling to survive on savings being held in accounts that currently yield virtually no return.
Bernanke's argument that trying to add a few percentage points to the employment rate justifies punishing everyone else because "you can't save without a job" is akin to the automotive industry announcing that, henceforth, they're only going to produce super-cheap cars that have no seatbelts, no bumpers, and no other safety features -- on the justification that these dirt-cheap cars will allow more people to afford cars. Ben's simplistic logic is essentially: "You can't die in a car wreck if you don't have a car!" Can't argue with that statement. But it doesn't address the real issue at all; it merely reframes it into a venue where he can seemingly win the argument.
His statement also assumes the underlying presupposition that an ongoing QE program will actually improve the labor market -- and that assumption is not a given. There is an ongoing debate over how much influence the Fed actually holds over the labor market, and the question was asked of Bernanke yesterday: "How does boosting assets really help the real economy?" Bernanke replied, "There are a number of different channels: Mortgage rates, corporate bond rates, and increase in home prices and stock prices."
This is another non-answer that avoids the real question. Bernanke responds that there are "different channels," but he does not establish that these channels have any direct causation in creating more jobs (he also argued this earlier, but again in a cursory manner based on unproven presuppositions).
Nor does Bernanke establish how these "channels" materially differ from what's already been tried. In fact, Esther George, president of the Federal Reserve bank in Kansas City, recently asked this rhetorical question: “Is there anyone not borrowing today or purchasing a house because interest rates aren’t low enough? Do we expect that businesses will hire if their long-term rates are lower?”
The follow-up question that needed to be asked was, "I understand that, Mr. Bernanke; allow me to rephrase: How do these 'different channels' actually help the labor market?"
QE1 and QE2 did not appreciably help the labor market, as shown on the employment chart below. But, hey, this time will be different, right?
While the QE programs haven't helped the labor market, they have pushed up equities (and commodities) through inflation, as shown on the chart below:
(Click to enlarge)
As the chart suggests, a disappointment from Bernanke here would likely have had ramifications for the stock market -- but one might ask why this would matter to Bernanke when the market is trading at multi-year highs. I know politics is always a heated venue, but in an attempt to answer that question, let's briefly talk reality in a neutral manner.
It's no secret that Bernanke's term ends in 2014 -- and Mitt Romney has stated that, if elected, he would not reappoint Bernanke. This is not "supposed" to influence an alleged independent entity like the Fed; but the Fed is made up of humans, not emotionless robots. If you knew with certainty that your boss losing his job meant you would lose your job too, would you not work extra hard to keep your boss employed? If Obama loses the election, Ben will have to start shopping his resume. I don't care who you are or where you fall in the political spectrum: That type of perceived threat influences human action, and Bernanke is human (I'm 80% certain he is, anyway).
Finally, for the sake of argument, let's assume the best possible outcome: success of QE-Infinity! The Fed prints boatloads of money and successfully drives up housing and stock prices, which is Bernanke's stated goal. Great work, Ben! I'm buying drinks!
Whoa, not so fast...let's take this train to its logical conclusion.
Didn't we all agree (in the very recent past) that the last housing market mania was a bubble? Even if these policies are successful, how is reflating that bubble any kind of meaningful solution? What about stocks -- can't the same be said there? These "different channels" Bernanke speaks of just don't sound any different; instead it appears we're actively trying to repeat the exact same mistakes all over again. Are our leaders' memories really that short?
What do we do when these newly-reflated bubbles pop next time, somewhere down the road? What "tools" will the Fed still have left at its disposal, after all these bullets have already been fired just to get us back to the same situation we're trying to recover from in the first place?
As the old saying goes: "Rome wasn't built in a day" -- and neither was its economy. It would seem wiser to finish taking our bitter medicine now and let the market recover more naturally over time. But we don't and we won't, because our leaders have become addicted to a false sense of prosperity. We all know "there ain't no such thing as a free lunch" -- but printing money from thin air gives us the illusion that there is; and, unfortunately, the prevailing mentality at the Fed seems to be that the bubbles must be reflated at any cost.
We can't solve problems by using the same type of thinking we used when we created them.
-- Albert Einstein
(Also see Jason Haver's market update: SPX Update: Did the Fed Just Kill the Bear Case?)
By Jason Haver
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