RealClearMarkets

The Fed's QE Makes Life Difficult

How quantitative easing is helping investors but hurting households

Despite the recent Wall Street volatility, stocks remain well above their dismal lows from the spring of 2009. The resurgence of the stock market, which began with Ben Bernanke's first of two experimental forays into quantitative easing, has vexed many Main Street Americans who hear talk about recovery, but do not see it in their daily lives. Bernanke's programs have been temporarily goosing stock prices, but have consequently inflated the prices of just about everything else, placing a heavy burden on middle-class Americans. To address the current market turmoil, he may very well unveil a third round of debt monetization and cheap credit this week in Jackson Hole. Such an announcement may once again boost investor confidence (i.e. stock prices), but it will bring only pain to the middle-class.

It is assumed that improvements in the general economy benefit all the participants of that economy. A rising tide lifts all boats. While this phrase has historically been a truth for stock markets, under today's conditions it is pure fallacy. The actual net effect of the stock markets' return to growth shows that this rising tide lifts only a wealthy few.

It is no surprise that, after the Federal Reserve (Fed) ballooned its balance sheet from $900 billion in August 2008 to over $2.8 trillion today, stock prices have soared. This decade has already seen the effects of bubblicious Fed intervention following the then unprecedented 1 percent interest rate policy under Alan Greenspan. After its fuel artificially pumped housing prices and the short-run stock run-up from 2003 to 2007, they both came crashing down. The Fed is once again up to its old tricks-pushing the limits of the unprecedented. Ben Bernanke has trumped the "Greenspan Put" by dropping interest rates to zero and, for the first time in the Fed's history, buying private assets with freshly printed money.

The result is the same: inflated asset prices. Stock prices have risen, but so too have the prices of commodities like gold, corn, sugar, orange juice, cotton, coffee and gasoline. And they have risen at a startling pace. From the beginning of the Fed's first quantitative easing program through last week, the CRB CCI index, which measures the price of a diverse basket of commodities, is up more than 80 percent. Over the same period, large cap stocks as measured by the S&P 500 Index are up just over 50 percent. Prices for corn, sugar, cotton, and crude oil have all more than doubled.

This is not to say that Wall Street is enjoying the high life. Stocks are not trading much higher than levels seen 10 years ago. Financial institutions are bleeding staff and selling off businesses. And the temporary juice provided by quantitative easing is wearing off, revealing a less stable financial sector than many had hoped. In short, the Street is not exactly a fun place to be at the moment.

The reality is that the purchasing power of the dollar is falling as the Fed directs money artificially toward stocks, bonds, and commodities. Since 2002, when Greenspan first brought interest rates below 2 percent on their way to 1 percent, the dollar has lost 39 percent of its value against a weighted basket of currencies. Over this same period, gold has risen more than 500 percent, and continues to rise. The average American has not at all benefited during this time, as personal incomes have not only stagnated, but have declined. Employment has done nothing but fall.

Because most Americans are not heavily invested in the stock market, they do not benefit from rising stock prices that are artificially pumped up by government intervention and are not fundamentally reflective of real domestic economic conditions. In today's centrally funded environment, higher cost pressures from the rising price of goods like food, clothing, and gasoline more than outstrip the benefits average Americans gain from higher stock prices. The Fed targeting asset prices expands the net worth of the top earners, while the combination of rising expenses, a depreciated dollar, and falling real wages consumes the savings and pinches the budgets of middle-class Americans. Unless one is in the top 20 percent of income earners in this country, current Fed policy is a detriment.

Those in that top 20 percent own more than 90 percent of all stock market wealth, and the Fed has targeted these assets to stave off deflation, a sort of progressive policy of trickle-down economics. But the result has been anything but mutually beneficial to all participants in the U.S. economy: the bottom 80 percent of Americans have seen higher costs offsetting any presumed gains from a rising stock market.

The median value of total stock holdings by median households (those with income between $39,400 and $63,900 per year) was $4,400 in 2009, according to Fed data. For those earning between $63,900 and $103,100, the median value of holdings was $10,000. Relative to rising commodities expenses, these stock portfolios are too small to keep pace. Any benefits individuals in these income brackets have seen via stock market gains over the past three years have been washed out due to rising costs from Fed intervention.

As the trend continues, middle-class Americans get squeezed out and pushed to the lower end - their standard of living all the while declining. The top 20 percent, on the other hand, absorb any rise in food, clothing, or gasoline, and more than welcome the outsized gains to their overall wealth.

Traditionally Wall Street and Main Street have been joined at the hip, but the recent trends are defying that notion. It's true that when stock prices climb, all owners of stocks see gains respective to the amount of their ownership, but only when underlying economic fundamentals warrant the gain do all parties truly become better off. Rising stock prices that are reflective of real growth and innovation materializing in rising incomes, job growth, and increased purchasing power benefit all Americans regardless of the wealth ownership inequality in this country.

This mutual, cross-class benefit was most readily seen in the twenty-year bull market that began in 1980 (minus the last few years of the tech-bubble, of course). In the 80's and 90's, there were high net worth households that far exceeded many in the middle and lower classes. However, the rise in stock prices at that time was much different, and actually did benefit all participants of the economy since the entire period saw an overall deflationary trend in the price of commodities, and median incomes over this period rose by 21 percent.

The differences between then and now could not be more stark. Back then, it was hands-off for the Fed. Real growth, not dollar printing and asset purchases, produced actual wealth. In fact, the bull run began when then-Fed Chairman Paul Volker substantially raised interest rates in 1980. The decision to raise rates was initially followed by a recession, but then led to the greatest expansionary period in our nation's history. From August 1979 through August 1999, the S&P 500 rose an incredible 1,108 percent, while over the same period the CRB CCI Index declined 24 percent.

Overall, that twenty year bull run was characterized by innovation, entrepreneurialism, and real economic growth. Technological improvements enabling more efficient production in manufacturing and of commodities freed up human capital and money that led to innovation in finance, communication, technology, and medicine. In sharp contrast, the past decade has seen almost the reverse trend, with commodity prices far outstripping investment gains - particularly since quantitative easing started up in early 2009. From August 2001 through August 2011, the CRB CCI Index is up 217 percent, while the S&P 500 Index is up only a minuscule 4 percent.

Why Bernanke believes more quantitative easing and long-term zero interest rates are the solution is beyond comprehension. What's more is that, by telegraphing their every move, the Fed is directing banks and other potential lenders to speculate in commodities and stocks instead of issuing loans.

Through its programs, the Fed relies on a transmission mechanism (banks and, more notably, the Fed's primary dealers such as JP Morgan, Goldman Sachs, and Morgan Stanley) to make loans that would spur economic growth and create jobs. Bernanke has stated that interest rates will remain at zero for at least two more years, and that the Fed will continue to purchase assets as its balance sheet matures. The Fed may even expand its balance sheet through another easing program. This is leading banks and institutions that deal with the Fed to allocate money for speculative purposes, thus exacerbating the situation.

From fiscal year 2009 to fiscal year 2010, Goldman Sachs added $9.42 Billion in commodities to its total financial assets. Over the same period, JP Morgan added $19.09 Billion. These are 253 percent and 52 percent rises in commodity exposure, respectively, while total financial assets for both firms grew by only a little over 5 percent. Conversely, small business loan portfolios at FDIC-insured institutions declined by 4.2 percent over this same 2009-2010 period, according to the FDIC. From their peak in June 2008, total holdings of small business loans have declined 14.3 percent through the first quarter of 2011, a decline of $101 billion.

This is not how economies grow, but don't blame the banks for not lending. JP Morgan, Goldman Sachs, and others are doing exactly as they should, given the massive presence of the Fed in the marketplace. Look no further than to the sage economist David Hume for the explanation: "When any quantity of money is imported into a nation, it is not at first dispersed into many hands but is confined to the coffers of a few persons, who immediately seek to employ it to advantage." Under the Fed's current policies and direction, that advantage is in commodities and hot money assets - not slow growth vehicles like business loans and, God forbid, employment payrolls. And, those "few persons", i.e., the banks, will continue on like this until the Fed changes course. There is no incentive to do otherwise.

Every indication expressed in the speeches from Bernanke suggests the Fed won't change course anytime soon. In the latest government report, Q1 GDP for 2011 posted a paltry 0.4 percent gain, and Q2 is shaping up to be lackluster at best, with preliminary readings pointing to little more than 1 percent growth (a far cry from the projected growth rate of 3+percent). Employment numbers for this month show that the economy continues to falter with 9.1 percent unemployed. The market and pundits are now begging for another round of quantitative easing, and most likely, Bernanke will once again comply - after all, the only way quantitative easing can support markets is through continuous pumping of money into the system. Politicians will praise his genius, all while 80 percent of their constituents suffer under the Bernanke Fed's actions.

This commentary first appeared at RealClearMarkets on August 24, 2011: http://www.realclearmarkets.com/articles/2011/08/24/the_feds_qe_makes_life_difficult_99210.html

James Groth is Research Associate

Anthony Randazzo is Director of Economic Research






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