This week provided strong testimony to and evidence of the Fed’s controlling influence over stock prices. Dallas Fed President Richard Fisher, an outspoken opponent of the Fed’s expansive monetary policy, was interviewed on CNBC on Monday. Despite his past strong critiques of the unparalleled levels of stimulus, he argued that stopping quantitative easing immediately “…would be too violent for the marketplace.” It was a clear admission that he believes today’s equity price level to be dependent on continuing stimulus. In a nice turn of phrase, he cautioned against going from a “Wild Turkey” monetary policy to “cold turkey” overnight.
On Wednesday, Fed Chairman Ben Bernanke read a prepared statement to the U.S. House of Representatives in which he acknowledged the Fed’s recognition that it would have to reduce its massive monthly stimulus over time. To stifle any concern that such a reduction was imminent, he took great pains to indicate that Fed largesse would continue–in fact might even increase–if sluggish economic conditions persist. Wall Street loved that prospect of an indefinite stream of essentially free money, and the Dow shot up by 155 points. Following his statement, Bernanke’s responses to questions from the representatives, complemented by a release of the Fed’s meeting minutes, took the bloom off the rose. It became apparent that a growing number of other Fed governors were in favor of tapering the amount of stimulus. When free money appeared less certain, the Dow rapidly fell by over 275 points.
On the day before Bernanke’s session with Congress, Pimco’s Mohamed El-Erian penned an article for Financial Times about recent large fluctuations in the price of gold. In it he included the following caution about the possibility of a failed Fed effort:
“Today’s global economy is in the midst of its own stable disequilibrium; and markets have outpaced fundamentals on the expectation that western central banks, together with a more functional political system, will deliver higher growth. If that fails to materialize, investors will worry about a lot more than the intrinsic value of gold.”
On Wednesday, in his monthly Elliott Wave Theorist, Robert Prechter expressed a far greater level of derision toward the Fed’s ongoing actions:
“The nominal values of the world’s financial assets have been serially inflated like a school of puffer fish by record levels of unpayable debt.”
The Fed has painted itself into a very dangerous corner. Starting with unprecedented government intervention in 2008, monetary officials have bent monumental efforts toward saving the banking system and the economy generally from a spectacular breakdown. I suspect that their expectation at the time was that such a massive rescue and stimulus effort would certainly put the economy on the path to a glorious recovery, which would eventually take the U.S. taxpayer off the hook. It was, after all, shock and awe. The reality, however, is that initial and subsequent efforts have spawned a minimal recovery at best, by far the weakest in the post-WWII era. As each new and expensive rescue effort has failed to produce an economic escape velocity, the Fed has had to up the ante and put today’s and tomorrow’s taxpayers at increased risk. At this point, they’re unable to admit defeat and seem committed to increasing further what Prechter characterized as “record levels of unpayable debt.”
There is no attractive alternative. As I argued at the time, the U.S. made moral hazard-laden decisions in 1998 to rescue Long-Term Capital Management, in principle not unlike earlier bank rescues in the ill-fated oil patch and lesser-developed country eras. Horrible as outcomes might have been in those earlier instances had banks and other businesses been allowed to fail, they would have been progressively less severe had the specter of failure hung over the heads of owners and top executives.
Obviously the Fed’s fear of recession and its painful consequences is high or it would not continue to boost government debt levels. Unfortunately, each unsuccessful rescue effort makes tomorrow’s consequences even more painful. Those hurt the most will always be individuals on the lowest rung of the economic ladder. It is long past time that the Fed should abandon its ill-fated rescue policy. Allow the markets and the economy to reset. Stop penalizing the fixed income-dependent elderly retired and future generations that will inherit monumental debt burdens. Stop rewarding debtors at the expense of savers. Accept whatever pain might initially flow from eliminating central bank support. An economy free of the guiding hand of meddling central bankers will, as it has in decades past, eventually reward entrepreneurs and produce a more vital economy capable of producing many millions of jobs.