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There is an
ongoing three way debate between those who believe the Fed should do more to
strengthen the recovery, those who believe that the recovery is strong enough
to continue on its own, and those who believe that the economy has been so
fundamentally altered by the recession that no amount of stimulus can succeed
in pushing unemployment down to pre-crash levels. As usual, they all have it
wrong (although some are more wrong than others).
The false
conclusions are being made by the likes of bond king Bill Gross, who has
suggested that the economic fundamentals have changed. They argue that a
"new normal" is now in place that sets an 8% unemployment rate as a
floor below which we will never fall. This is absurd. America can once again
prosper if we put our trust in first principles and let the free markets
work. Unfortunately, that is not happening. Government is taking an ever
greater role in our economy where its efforts will continue to stifle
economic growth. A close second in cluelessness comes from those who believe
that we are currently on the road to a real recovery. I'm not sure what
economy they are looking at, but in just about every important metric, we
continue to be essentially comatose.
More accurate
are the opinions of those who believe that without a more serious
intervention from the Fed, which can only mean another round of quantitative
easing (QE III), the current quasi-recovery will soon fade and the tides of
recession will overtake us once again. They are correct. And even though this
time the water will be rougher and deeper than it was four years ago, it does
not mean that the Fed will do the economy any good by breaking out its heavy
artillery once again.
In his widely
anticipated speech at Jackson Hole last week, Fed Chairman Ben Bernanke
sounded a supremely optimistic note: "It seems clear, based on this experience,
that such (easing) policies can be effective, and that, in their absence, the
2007-09 recession would have been deeper and the current recovery would have
been slower than has actually occurred."
The simple
truth however, is that our economy has a disease that all the quantitative
easing in the world can't cure. And while the wrong medicine may make us
appear healthier in the short term, we will continue to deteriorate beneath
the surface. Not only should the Fed not provide additional QE, but it should
remove the accommodation currently in place. Although these moves would most
certainly send us back into recession, it would simultaneously provide a
needed course correction that would put us finally on the road to a
sustainable recovery.
The recession
the Fed is trying so desperately to prevent must be allowed to run its course
so that the economy that we have developed over the last decade, the one that
is overly reliant on low interest rates, borrowing and consumer spending, can
finally restructure itself into something healthier. By enabling this
diseased economy to overstay its welcome, QE does more harm than good. To
recover for the long haul, the market must be allowed to correct the
misallocations of resources that resulted from prior stimulus. Additional
stimulus inhibits this process, and exacerbates the size of the
misallocations the markets must eventually correct.
In the
interim, any GDP growth or employment gains that result from stimulus
actually compounds the difficulty in restructuring the economy. Any jobs
created as a result of cheap monetary stimulus are jobs that won't be able to
survive absent that support. They will require a continual misallocation of
resources in order to survive. Unfortunately, these jobs must ultimately be
lost before a real recovery can actually begin.
Holding rates
of interest far below market levels (which is the goal of stimulus) alters
patterns of consumption, savings, and investment. Fed intervention
short-circuits the market driven process that resolves misallocations. The
more stimulus that is provided, the harder market forces must work to try to
restore equilibrium. As the misallocations grow over time, the efficacy of
monetary measures diminishes. In the end, the market will overwhelm the Fed.
The only question is how long it will take.
The Fed is
trying to build skyscrapers on a bad foundation. Each subsequent structure it
builds not only collapses, but also weakens the foundation that much more.
The result is that subsequent structures collapse at increasingly lower
heights and require more effort to build. Instead of trying to build, the Fed
could concentrate on repairing the underlying foundation. That might delay
construction, but in the end the buildings will be much sturdier.
Because the
Fed has kept interest rates too low for too long, Americans have saved too
little and borrowed too much; consumed too much and produced too little; and
imported too much and exported too little. Too much of our labor is devoted
to the service sectors and not enough to goods production. Too much capital
goes to Wall Street speculators and not enough to Main Street entrepreneurs.
We built too many homes but not enough factories. We have developed too many
shopping centers, and not enough natural resources. The list of Fed induced
misallocations goes on.
By trying to
preserve the jobs associated with this old economy, the Fed prevents the
market from creating the ones we actually need. Unfortunately no one seems to
understand that, and we continue to chase blindly after failed economic
models. Look for such misunderstanding to be on high display this week in
Charlotte as Democrats gather to call for even greater intervention to
perpetuate a failed economic model.
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