You can lead an Economy to Water, but can you make it Create Jobs?
So it‟s now official, the U.S. Economy is going through a “soft spot”. According to the U.S. Federal Reserve Chairman Ben S. Bernanke, speaking last week at an International Monetary Conference in Atlanta:
• "The U.S. economy is recovering from both the worst financial crisis and the most severe housing bust since the Great Depression, and it faces additional headwinds ranging from the effects of the Japanese disaster to global pressures in commodity markets. In this context, monetary policy cannot be a panacea."
• …the economic recovery is “uneven …and frustratingly slow”
• The Fed will keep interest rates bottomed out for “an extended period.”
A few conclusions spring forth from these quotes:
• The Fed will keep Interest Rates low for as long as
possible; longer than most economists currently
believe. Bonds won‟t be under too much interest rate
pressure for a while yet.
• Chairman Ben Bernanke currently feels the launch of a
third round of monetary easing will probably do nothing
to stimulate „real‟ economic demand; principally
meaning create jobs.
• Ben is looking for help from the Government and
Private Sectors in his efforts to inflate the economy.
• The Fed expected QE2 to have more impact on jobs
and GDP. The money benefitted the banking industry
but not industry in general.
It‟s possible to explain away the „soft spot‟ as a result of the Spring 2011 Supply Shocks in Japan and the Middle East; it may even be possible to extrapolate this thinking to justify a return to GDP growth in the Fall.
But one thing remains, until the job market shows signs of sustained improvement, long term confidence in a persistent domestic economic recovery will be questionable.
“Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established”, another quote from Ben Bernanke.
Monetary policy cannot be a Panacea
Is The Fed saying that it has done as much as it can through Monetary Easing; the printing and circulating of more money?
QE1 and QE2 achieved their objectives by:
• Saving the U.S. Banking System, and therefore the world‟s banking system.
• Raising the price of Equities
• Reducing Interest Rates and the Dollar
But QE2 or QE3 can‟t sustain economic growth. Quantitative Easing was initially a protective measure; pump liquidity into the economy and provide banks with copious amounts of free capital.
Thereafter, it was intended to be a box of matches that could set the economy ablaze. Well, now all the QE matches have been struck, the economic wildfire still refuses to spread.
Employment is the fuel necessary to get this fire to spontaneously combust.
How to Stimulate Employment?
Jobs are a common byproduct of economic activity; however, productivity increases (together with an amount of outsourcing) has created an economic recovery with fewer new jobs than expected.
So what‟s a government to do about job creation?
The Fed obviously thinks: “QE1 and QE2 didn‟t ignite the job market, so why would QE3 do any better?” Additionally, the debt created by quantitative easing requires repayment at some stage (seriously). Repayment will require deficit reduction which will require cut backs in economic activity.
Conclusion: QE3 may ultimately hurt the job market.
Keeping Interest Rates and the Dollar Low?
The Fed may have ended the QE programs, but it will still try to keep interest rates and the dollar low by other means; means too complex to detail here.
Why keep Interest Rates and the Dollar Low?
• Lower interest rates encourage investment (loans cost less) and discourage savers (don‟t put your money in the bank; put it into riskier assets or a business).
• A lower dollar makes domestic goods cheaper and more competitive overseas while making imports more expensive.
Although recent balance of payments data shows U.S. exports have benefitted from a lower dollar, it‟s clear that low interest rates have failed to stimulate lending and economic activity. Why pump more money into the monetary system when it isn‟t finding its way to enough businesses and households. The Government needs to direct the monetary faucet where it can create jobs.
If the printing presses don‟t stop creating money soon, the risk of inflation will increase dramatically. In turn, this may cause interest rates to rise which would defeat the object of the stimulus exercise.
Rising interest rates are synonymous with monetary tightening. Monetary tightening normally means fewer jobs; a downwards spiral no one wants to see at the moment.
Failure to control spending can actually hurt jobs in a similar way to reducing spending.
Note: For all you bond investors, a domestic “rising interest rate environment” may yet be a year or two away if the Fed has their way.
Government & Private Sector Stimulus
Chairman Bernanke‟s comment: “monetary policy cannot be a panacea” begs the question “What else will help monetary policy to create sustainable growth?”
"Policymakers urgently need to put the Federal governments' finances on a sustainable trajectory," Bernanke said in Atlanta. "Establishing a credible plan for reducing future deficits now would not only enhance economic performance in the long run, but could also yield near-term benefits by leading to lower long-term interest rates."
Looks like Ben thinks it's now up to the politicians to help the economy by reducing the federal deficit.
And now the good news – it appears both sides of the political divide agree that the deficit must be reduced. The debate has moved on to:
• How to Reduce the Deficit: Reduce Spending or Increase Taxes?
• How much to Reduce the Deficit by
At a time when investors are looking for a clear direction, let us weigh in with a decisive conclusion:
Let’s wait and see what the Government agrees and what kind of earnings season we have starting early July…
PS: Have you noticed the increasing number of States and Municipalities implementing fiscal tightening activities. Nowhere near enough to make a difference yet, but a step in the right direction and a shining beacon for the route the Federal Government will have to follow soon.