(What’s Left of) Our Economy: New Data Showing the Fed Really has Worsened Inequality

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asset prices, Bank of America, Ben Bernanke, bubbles, Federal Reserve, finance, housing, inequality, interest rates, Janet Yellen, QE, quantitative easing, recovery, stocks, Wall Street, zero interest rate policy, ZIRP, {What's Left of) Our Economy

Here’s a shock! A study claiming that the Federal Reserve’s historically unprecedented easy money policies have supercharged Wall Street (and the rich) and left Main Street (and the rest) in the dust! And it comes from Wall Street!

The debate over how the central bank’s zero interest rate policy (ZIRP) and quantitative easing bond-buying program (QE) has impacted inequality in America has been just as heated as the debate over how these decisions have impacted economic growth and the prospects for recreating real national prosperity.

The critics charge that easy money has greatly widened the rich-poor gap, largely by boosting incentives to buy and own stocks, and thereby fueling a long, powerful bull market that has overwhelmingly benefited the wealthy because they dominate stock ownership.

The mainstream Fed position was stated by Chair Janet Yellen at the September press conference following the decision to keep interest rates on hold:

“It is true that interest rates affect asset prices, but they have a complex effect through balance sheets, through liabilities and assets. To me, the main thing that an accommodative monetary policy does is put people back to work. And since income inequality is surely exacerbated by a high—having high unemployment and a weak job market that has the most profound negative effects on the most vulnerable individuals, to me, putting people back to work and seeing a strengthening of the labor market that has a disproportionately favorable effect on vulnerable portions of our population, that’s not something that increases income inequality.”

Her predecessor, Ben Bernanke, has made similar points, albeit with more reservations.

A new study from Bank of America, however, contains some data strongly indicating that the Fed’s critics deserve to win this clash hands down. For example, the B of A researchers examined the fate of various possible uses of $100 since the Fed began massively supporting the U.S. economy after the collapse of Lehman Brothers in the fall of 2008. The main findings? A $100 dollar investment in a standard stock and bond portfolio during this time would have more than doubled in value. But a $100 dollar wage would be worth only 14 percent more.

The same methodology also reveals that the financial system is channeling much more credit to the wealthy than to the rest. Thus for every $100 they raised at the start of 2010, venture capital and private equity funds are now raising $275. But for every $100 of mortgage credit extended in America since then, just $61 is being loaned and accepted today. And prime real estate in the nation has appreciated in value more than ten times as much as all U.S. residential real estate.

These results (and others in the study) hardly end the debate over the Fed and inequality. Bernanke and Yellen still make powerful “counterfactual”-based arguments – i.e., claiming that as bad as the situation is now, it would be even worse had the central bank not acted so decisively. And B of A’s possible motives need to be noted. Generally speaking, the financial sector has been campaigning strongly for a Fed rate hike because rock bottom interest rates have greatly reduced the profitability of lending.  (In that respect, this report may not be such a shock.)

But the B of A study should greatly increase the burden on the Fed to demonstrate that its monetary policies haven’t been little more than a boondoggle for the nation’s upper classes – not to mention a flop in and possibly an obstacle to restoring genuine economic health.

(What’s Left of) Our Economy: Why Today’s Fed Rates Announcement Really Matters

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asset prices, bubbles, federal funds rate, Federal Reserve, Financial Crisis, financial markets, Great Recession, interest rates, investors, Janet Yellen, moral hazard, Obama, OECD, recovery, {What's Left of) Our Economy

As the world economy anxiously awaits the Federal Reserve’s announcement this afternoon about how much longer it will keep the interest rates it controls near zero, the release yesterday of a new official report on global growth prospects is especially well timed. The latest global economic assessment from the Organization for Economic Cooperation and Development (OECD) valuably reminds the world’s leaders and publics alike that the main economic challenge of our time is not quickening the slow pace of recovery from the financial crisis and Great Recession. Instead, it’s generating the kind of robust growth that won’t almost inevitably trigger another crisis.

The OECD, an organization of the world’s high income countries (and some middle-income countries, like Mexico), raised its projections for overall global growth, and for growth in most major countries and regions, from those in its previous forecast in November. (Most of the main old and new numbers were conveniently presented in this Financial Times piece.) But the OECD also warned that too much of this improvement stems from the same forces that during the last decade inflated asset bubbles around the world that eventually burst disastrously.

In addition to lower oil prices, OECD chief economist Catherine L. Mann contended, monetary easing has “brought the world economy to a turning point, with the potential for the acceleration of growth that has been needed in many countries.” But she also specified that “excessive reliance on monetary policy alone [like the massive easing implemented by the Federal Reserve since the crisis broke out] is building-up financial risks, while not yet reviving business investment.”

As the United States and the rest of the world should have learned since the dark days of 2007-2009, no challenge is easier for governments to meet than creating the illusion of growth temporarily. They can simply promote borrowing and spending that have nothing to do with genuine wealth creation and the rising incomes it produces.

Actually, I’ve been surprised at how long easy money from the Fed and other leading central banks has kept the world economy afloat in the last few years. But this extraordinary official subsidization of economic activity is showing big signs of the same dangerous consequences produced by wildly excessive credit creation before 2007-8. It’s spurred a flood of capital into ever more dubious schemes from investors desperate for decent returns but also fully confident that governments will protect them from any risk. After all, if resources can be created at will by monetary authorities, and losses will be covered, why not throw caution to the wind? Why spend lots of time trying to figure out how to use them carefully or productively?  Why not take full advantage of what economists call “moral hazard”?

Ironically, and encouragingly, these worries about oceans of capital being invested without significant market disciplines seem to be shared by what has so far been the world’s biggest credit pusher – the Federal Reserve, or at least many of its leaders. At least as of this morning, that’s why it’s been widely reported that Chair Janet Yellen and her colleagues will start preparing markets and the rest of the world for the likelihood that they’ll raise the federal funds rate sooner rather than later – if only by a little. That also appears to be mainly why, for all the boosterism surrounding the U.S. economy throughout the current recovery – including President Obama’s claim that the nation has “turned the page” – American investors are reacting to even a modest rate hike so bearishly. They recognize that artificial legs have been the only legs that asset prices and the underlying real U.S. economy have been showing.

(What’s Left of) Our Economy: Japan Goes All In

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asset prices, Bank of Japan, bubbles, currency, currency manipulation, dollar, Fed, Financial Crisis, free markets, Global Imbalances, investing, Japan, QE, stimulus, Trade, Trans-Pacific Partnership, yen, {What's Left of) Our Economy

I was already having a hard enough time trying to figure out whether to focus this morning on three big data releases or on some of the other economic and non-economic developments crowding the headlines – and then the Japanese government rocked the economic world with two mega-announcements.

So the Labor Department’s Employment Cost Index, the Commerce Department’s survey of personal incomes and saving, and the Chicago purchasing managers‘ new monthly sounding all will have to take a back seat to the Japanese central bank’s unveiling of a massive new stimulus program, and the Japanese government pension fund’s announcement that it’s going to start investing considerably more in stocks both in Japan and around the world.

There’s no need to review the most obvious implications of this news. Just Google “Bank of Japan” and “GPIF” (Government Pension Investment Fund). You’ll quickly see that the former’s decision to buy many more Japanese government bonds, along with stocks and other financial assets, is expected to boost the prices of the such assets all around the world, further weaken Japan’s yen, and fend off another bout of deflation — with all the damage that would do to the Japanese and global economies. Financial assets will also get a major lift – all else equal of course! – from the Japanese government employee pension fund (the world’s biggest public sector investor) shifting its strategy to buying more stocks in Japan and abroad.

To me, the less obvious implications matter more, especially these two:

First, one of the biggest long run dangers of the unprecedented central bank stimulus programs adopted to contain the financial crisis is that investment capital around the world will be spent badly. The idea is that if investors know that the Federal Reserve and the European Central Bank or the Bank of Japan will ride to their rescue with yet more credit if they make mistakes in allocating funds, the discipline that’s supposed to be one of the main virtues of free markets and capitalism will be badly eroded and possibly destroyed.

The crisis itself clearly was fueled in the first place by the glut of credit provided by the Fed in particular during the bubble decade. Super-easy money encouraged both Wall Street and homeowners to bid up the price of fundamentally unproductive assets like houses wildly beyond sensible levels. Government housing subsidies and implicit guarantees didn’t hurt, either.

The Fed doesn’t buy stocks but its Japanese counterpart has invested in exchange-traded funds and real estate investment trusts. Now the Bank of Japan will triple those purchases, along with boosting its bond buys. Is it remotely possible that this step will increase the efficiency of capital allocation in Japan, the United States, or anywhere?

In addition, the $1 trillion-plus Japan government pension fund, the world’s largest public investor, will more than double its holdings of Japanese and foreign stocks to 25 percent each. Of course, public pension funds have long been major players in financial markets. But U.S. funds hire private sector investment professionals to manage their portfolios. That hardly makes them perfect, but at least they have a history of responding in standard ways to market (and more recently, government and central bank) signals.

The GPIF’s portfolio, by contrast, is run by government bureaucrats. Moreover, they’re bureaucrats from the Japanese government, whose devotion to free markets has been historically difficult to spot. I’m someone who actually thinks that Tokyo has a good record of intervening in the economy, especially in manufacturing. But that doesn’t mean I have much confidence in it as a stock- or sector-picker – which of course is a different animal altogether from identifying approaches to nurture the long-term development of industries. Moreover, why would anyone hewing to the conventional wisdom about Japan’s allegedly disastrous penchant for “picking losers” believe that its leaders will now suddenly start making decisions that improve the efficiency of their own economy, let alone economies anywhere else?

The second less-than-obvious set of implications of Japan’s new policies concerns trade flows and trade policy. As widely recognized, the extra BOJ bond-buying has already brought the yen to roughly seven-year lows versus the U.S. dollar. The question Washington needs to ask is why it’s still pursuing a Trans-Pacific Partnership trade deal when the biggest economy involved in the talks so far outside the United States, which already has a strong record of protectionism, has just moved to cheapen the price of its exports and raise the price of its imports – and all for reasons having nothing to do with market forces?

Further, this latest instance of Japanese currency manipulation will likely affect trade flows more than Fed easing ever could – even if ZIRP and QE haven’t been accompanied by a stronger, not weaker dollar. For as defenders of this Japanese exchange-protectionism keep ignoring, the BOJ isn’t simply mimicking the Fed because monetary easing policies in a mercantile, production and export-led economy like Japan’s will always have fundamentally different – and inevitably more protectionist – effects than easing policies in a consumption- and import-focused economy like America’s.

Finally, even though Washington reportedly is more determined than ever to ignore foreign currency devaluations in the mistaken belief that its leading, and slow-growing, trade partners deserve such help, the much weaker yen is likeliest to spur similar moves – or the introduction of other beggar-thy-neighbor measures – in other mercantile, export-led economies in Asia, notably Korea and China.

Without a meaningful U.S. response – meaning a sharp turnabout in import- and deficit-friendly American trade policies – the inevitable results will be an even bigger U.S. trade shortfall, a consequently weaker American recovery, and reflation of the global imbalances that played such a prominent role in triggering the financial crisis to begin with. Unless, finally, this time, for reasons no one has yet identified, it really is different?