by Peter Schiff
The Fed's failure
today to announce some sort of tapering of its QE program, despite the
consensus of an overwhelming percentage of economists who expected action, once
again reveals the degree to which mainstream analysts have overestimated the
strength of our current economy. The Fed understands, as the market seems not to,
that the current "recovery" could not survive without continuation of
massive monetary stimulus. Mainstream economists have mistaken the symptoms of
the Fed's monetary expansion, most notably rising stock and real estate prices,
as signs of real and sustainable growth. But the current asset price bubbles
have nothing to do with the real economy. To the contrary, they are setting up
for a painful correction that will likely be worse than the one we experienced
five years ago.
Given the strong
anticipation for a taper announcement, today's relief rally should come as no
surprise. However, the Fed's inaction should be perceived by many as an
admission that the economy is fundamentally weak. Once that possibility takes
hold, today's euphoria is likely to dissipate. Perhaps the Fed's inaction may
cause many to wonder if the economy is not as strong as they believed. This
could ultimately lead to an even bigger sell off than what we would have seen
today if the Fed had come through with a taper announcement.
A major factor in the
current "recovery" is the confidence that has been created by rising
stock and real estate prices. On Wall Street confidence can become a
self-fulfilling prophecy. If the Fed were to make its fears more explicit
that confidence could drift away. As a result, I believe that they chose a path
of continuous obfuscation. But in so doing they lost control of the message.
The Fed knows that the
appearance of economic health would evaporate if stimulus were withdrawn. But
like Jack Nicholson in A Few Good Men, it also knows that the markets
can't handle the truth. Over the past year Ben Bernanke and other
top Fed officials have tried mightily to communicate to the markets that no
decisions had been made on the future and timing of QE reductions and that its
moves would depend on the data. On many occasions they even hedged the
automatic nature of their data triggers and moved the goal posts that
supposedly guided their policy. But as a result of this continuous
obfuscation, the Fed lost control of its message.
Despite its efforts
toward vagueness, the markets nevertheless made definite conclusions. In addition
to the overwhelming consensus of economists who had predicted a taper
announcement for today, many even offered precise measures of how big the taper
would be (median forecasts were that bond purchases would be trimmed by between
$10 and $15 billion per month). As the Fed had not dashed these expectations
strongly enough, today's non-event comes as a surprise to most. However, as I
have mentioned many times in the past, the Fed has checked into a monetary
Roach Motel. Getting out will be infinitely harder than getting in. In fact it
will be likely impossible to get out without tipping the country back into
recession.
If stock and home
prices continue to rise, and if the unemployment picture appears to brighten as
a result of a shrinking workforce, the Fed may have an increasingly difficult
time explaining why they are failing to cut back on a policy that many
mistakenly assume is no longer needed. Look for the rhetorical pretzels to get
ever more complex and the goalposts that would trigger an action to become
completely mobile.
But the reality is
that the economy will never regain true health as long as the stimulus is being
delivered. Despite trillions already administered, the workforce is shrinking,
energy usage is down, the trade balance is weakening, savings are down,
inflation is showing up in inconvenient places, debt is up, and wages are
flat. So while QE has succeeded in hiding the truth, it hasn't
accomplished anything of substance. Unfortunately, the Fed is only interested
in the headlines.
We also must
understand that even if the Fed were to deliver a small reduction in bond
purchases, such a move would change nothing. The Fed would still be adding
continuously to its enormous balance sheet while presenting no credible plans
to actually withdraw the liquidity. As I have pointed out many times, it simply
can't do so without pushing the economy back into recession. Although this
would be the right thing to do, you can rest assured that it won't happen.
We should also recall
where this all began. When QE1 was first launched Bernanke talked about an
exit strategy. At the time I maintained the Fed had no exit strategy as it
had checked into a monetary Roach Motel. But now questions about an exit
strategy have been replaced by much more delicate taper talk. But easing up on
the accelerator without ever hitting the brakes will not stop the car or turn
it around.
Bernanke has
maintained that his purchases of government bonds should not be considered
"debt monetization" because the Fed intends to only hold the bonds
temporarily. In recent years however talk of actively selling bonds in the
portfolio have given way to more passive plans to simply hold the bonds to
maturity. But this is a convenient fiction. When the bonds mature, the Fed will
have little choice but to roll the principal back into Treasury debt, as
private bond buyers could not easily absorb the added selling that would be
required to repay the Fed in cash. Judged by his own criteria then, Bernanke is
now an admitted debt monetizer.
Following this
playbook, the Fed will likely maintain the pretense that tapering is a near
term possibility and that it has a credible plan on the shelf to bring an end
to QE. In reality the Fed is stalling for time and hoping that the economy
will inexplicably roar back to life. Unfortunately, hope is not a strategy.
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