Mythbusting Part 2: QE2 and the Cliches Just Keep Rolling
Just last week I was lamenting how much misinformation people were slinging around about QE2. Further, I was lamenting the intense focus on macroeconomics and bigger picture issues crowding out some important company-specific topics. The reasoning behind my frustration is two-fold: first, these days when the market goes up the focus is the micro (i.e. the performance of individual companies) and when the market goes down the focus is macro; secondly, the vastness of misinformation is so intense, and the politicization of apolitical issues so out of control that it’s flat out scary.
In the last edition of Mythbusting, I tackled the questions as to whether QE worked the first time around, if it punishes savers for the benefit of the irresponsible spenders, and if QE is “just printing money.” Today there’s a new slate of cliches lined up that deserve an equal amount of attention.
1. We’re just doing this for the jobs.
Yesterday Senator Bob Corker of Tennessee was grabbing headlines with his proposal to rid the Federal Reserve Bank of its dual mandate which requires the Fed to both maintain price stability and maximum employment. This is a clearly an action taken in response to the Fed’s QE2 initiative, because some in the political arena are trying to pitch this action as one to boost employment at the risk of generating runaway inflation (we’ve tackled the inflation discussion the first edition of Mythbusting, and have no fear we will do so again today).
Let’s forget about the fact that such an approach is morally bankrupt in a time when many are unemployed and focus on whether this actually makes a difference in terms of the Fed’s policy outlook. When the Fed is talking about inflation, they are looking at broader indicators than just the CPI. They also want to know the direction of the money supply (i.e. is it growing or contracting) and they want to know the velocity of money (i.e. how quickly $1 becomes more than $1 in the economy).
Right now, considering we are in the middle of a private sector credit contraction. What that means is the money supply in the private sector is shrinking on its own, because more people are saving and/or paying down their debt than there are people taking no new debt. Whether good or bad, the fact of the matter is that even the CPI remains exceptionally low in this environment and so long as deflation remains the imminent threat the Fed will use the tools at its disposal to fight it. Typically the tool of choice is to cut interest rates, yet we’re at the 0 bound right now and that option is off the table. The next tool to turn to is quantitative easing.
See what just happened here? We reached the point of QE solely by talking about price levels, credit and the money supply. Nowhere did unemployment have to factor into this consideration. The high unemployment rate is simply one more reason to pursue QE2 and not THE reason in and of itself. Therefore, removing the dual mandate would do nothing to change Fed policy at all in what the politicos are perceiving as egregious market intervention by our central bank.
2. There’s already inflation because of QE2.
Now maybe I should have broached this topic first, but the dual mandate thing is the major press and the inflation discussion is relevant in just about any comment re: QE2. As I stated above, inflation is far broader than just the CPI (which this very morning came in up 0.2% with core CPI flat). This is both very low and very dangerous. But even beyond that, the typical counterpoint would focus on grocery prices and would then mention that bread, beef, etc. are all higher than a few months ago. Moreover, the argument asserts that but for QE2, this would not be the case. And to these people I can’t help say anything other than “wrong, and wrong again.”
First of all, using a 6-month datapoint for grocery prices is fairly misleading. Six months ago was a cyclical low-point in prices and today is a cyclical highpoint. Within the broader cycle, moving back one, and even two years, food prices have been modestly lower to stable. Sure anyone can pick an arbitrary point in time to make an appealing argument, but facts and facts and inflation just isn’t there.
Beyond that, the accusation holds QE2 accountable for this recent surge in food prices and that could not be farther from the truth. These prices started moving upwards before QE2 was even on the table. What was the catalyst? Well considering how short-term the news cycle is these days it’s no surprise that we’ve already forgotten, but there were major wildfires in late July and August destroyed a significant amount of the Russian wheat crop and as a result, sent global prices higher. The catalyst was not QE2, it was a supply shock to the global food supply.
3. We’re doing this for the wealth effect.
This is one of the most trumpeted lines, the notion that the Fed is simply trying to make people feel wealthier in order to induce spending. While the wealth effect may or may not be an effect of QE2, the goal in the Fed’s action is not the wealth effect. The Fed’s goal is to make clear to people that deflation will not happen and inflation will. Ben Bernanke is trying to make clear through both action and words that inflation is a stated goal of the central bank today, while deflation remains a risk.
The wealth effect further asserts that we’re simply blowing bubbles and to that argument, I take issue. By many historical metrics, US equities are cheap. The goal with this action is to encourage investment and having that investment pile into equities while valuations are relatively compelling is no different than cutting interest rates in a slack economy. For 2010, the S&P 500 earnings should fall somewhere between 84 and 86. At a 15 P/E ratio, the market’s historical average, that would put the price somewhere between 1,260 and 1,290, yet today the S&P is trading at just south of 1,180. Where’s the bubble? It’s certainly not in equities.
But regardless, I think the wealth effect talk is missing the point anyway. The goal is to encourage investment. And with investments come rising stock prices, with rising stock prices comes less “uncertainty” to trouble the nervous CEOs, and with fewer nervous CEOs comes more domestic hiring. This is where the wealth effect has value, not in terms of encouraging the wealthy people who own stocks to spend more.