The Aftermath of QE2
Inflation is all Ben Bernanke’s fault. And that may actually be a good thing.
When Fed Chief Ben Bernanke told us that he believed inflation was “transitory”, he was saying that commodity prices were higher due to Fed monetary policy.
When Bernanke went on to say that he would let QE2 end and not immediately fire up the QE3 engine, because the risks of further inflation were not being offset by gains in employment.
Put simply, Bernanke said inflation was all (or at least mostly) his fault.
Since these statements were made in conjunction with the last FOMC meeting, oil has dropped from $112+ to below $100 a barrel. Gold prices have dropped back to the $1500 level. And the U.S. dollar has rallied.
Interestingly though, stocks have only suffered a mild correction so far…
*****It’s easy to vilify Bernanke for the higher prices we’ve paid lately, especially at the pump. But let’s not forget that one of the explicit goals of QE2 was to bring about a little inflation. Bernanke has been very worried about deflation ever since the financial crisis and ensuing spike in unemployment.
Deflation is a vicious cycle. Prices fall, salaries fall, demand falls, and employment falls. And we can see that there are still deflationary pressures in the economy. Housing prices are stuck in a downward spiral. And wages are not rising, despite some improvement in jobs growth.
If commodity prices can moderate, without a fall in job growth and spending, then it may eventually be concluded that Bernanke was right, and QE2 was money well spent. If, on the other hand, the gains that have been made in monthly payroll data reverse, then we can be sure there was no lasting effect from QE2.
Interestingly, much may depend on the credibility of the threat that the Fed will engage in more stimulus in the future. It seems to me that the Fed has no qualms about easing. It’s done it a couple times now, and the market should have no doubt that the Fed will ease again if it deems it necessary. That potential, or threat, could well be enough to keep price stability at current levels.
*****We should also remember a critical difference between the Fed’s monetary policy and Federal fiscal policy. Under QE2, the Fed bought Treasury bonds. In essence, it exchanged one asset (cash) for another (Treasury bonds). At some point, the Fed can sell those bonds, or let them mature and collect the cash.
In other words, the Fed isn’t just spending money in the same way that Congress does.
Federal fiscal policy is just spending. And when it’s deficit spending, it also adds debt, which means interest payments.
It would be great if the government treated more of its spending as an investment, something that would generate a return. Spending on high-speed railroads, or alternative energy generates a greater benefit that spending on highways.
*****We are halfway through with the month of May. While we’ve seen a lot of volatility, especially for commodities, it’s too soon yet to say of “sell in May” was the right call this year.
With the S&P 500 trading at essentially fair value, and corporate profits strong once again, we could make the case that there is upside potential.
But then there’s the European debt problems. That Greece may be forced to restructure its debt has been in the news for quite a while. So long, in fact, that many investors are probably tired of hearing about it.
Don’t make that mistake. Greek restructuring could have wide implications. So could more bailout money. Europe is considering making bondholders assume some of the cost of another bailout.
If bondholders lose money on Greek bonds, either through a restructuring or in a “normal” bailout, it can lead to selling, as bonds are often used as collateral for lending.
Say a bank holds Greek bonds as part of its Tier 1 capital. Tier 1 capital is what defines how much a bank can lend. If that Tier 1 capital falls, then the bank is forced to sell assets to cover existing loans. And it can be forced to curtail new loans.
Now, I’m not predicting that Greece’s debt problems will cause a major correction for stocks. Just that this is another thing we’ll need to keep an eye on.
