Global markets were roiled last week by Ben Bernanke's comments on the Federal Reserve's tapering forecasts of monthly bond purchases, known as Quantitative Easing (QE). U.S. and Asian stocks (outside of Japan) posted their biggest weekly loss since 2011, and the UK's FTSE 100 capped its worst weekly run in 13 months. Commentary and debates from some of the most talented brains in economics reveal a myriad of differing opinions surrounding orthodox and unorthodox monetary policy, but one fact we can be certain about -- QE cannot last forever.
There are many schools of thought concerning the effectiveness of Bernanke's reactive monetary policy. If you regard the Fed's monthly purchases of $45Bn in U.S. treasuries and $40Bn in mortgage-backed securities as the mechanism that has 'jump-started' U.S. growth -- then this weeks reaction in global markets would suggest Wall Street isn't confident the economic engine is quite ready to run on its own.
QE in principle is supposed to reduce business and individual borrowing costs (and therefore increase lending by banks); debase the dollar (making exports more attractive); and prop up stock markets. Conveniently it also enables the US to service its $16.4T debt mountain at record low rates. Most noticeably in the economy, it should stimulate long-lived investments such as housing, not just construction, but house prices that make the consumer feel wealthier and more likely to spend. And let's not forget that the short-term interest rate has been pegged at near zero since 2008 and is likely to remain at record lows until 2015.
So are Wall Street's jitters justified? Recent key economic indicators should suggest not. U.S. unemployment has reduced from 10% in October 2009 to 7.6% in May 2013; building permits were the highest in April since June 2008; consumer confidence has climbed to the highest level in 5 years; home prices have advanced by the most in seven years; U.S. indices (whilst retreating in June) hit all time highs in May 2013; and GDP is at its highest since 2010 with the Federal Open Market Committee (FOMC) estimating a further rise to 3.5% in 2014. Fairly compelling, especially when you consider the results are set against a backdrop of austerity through sequestration and increased taxes that will lob an anticipated 1.5% off growth in 2013.
But gauging to what extent QE is responsible for this recent upbeat data, and therefore what toll reducing monthly purchases may take on recovery, is complex to decipher - making the case for tapering and timings, equally as problematic. According to Fed Reserve Bank of St Louis President James Bullard, Bernanke's tapering intent was 'inappropriately timed', and the Fed Chairman should have waited for 'tangible signs that the economy was recovering'.
To Bernanke's credit, the FOMC has, from December 2012, overtly declared an unemployment rate of 6.5% (achievable on latest predictions by mid-2014) as the key indicator that would signify an appropriate end to purchases. Transparency, however, on both short-term interest rates, policy objectives and tapering timelines doesn't seem to be reassuring the markets. The reaction from stocks last week would imply that QE is entering a new phase that Bernanke may have under-estimated or overlooked -- an paradigm of addiction rather than dependency.
Surging bond yields and rising interest payments on U.S. debt are compounding the symptoms of addiction. Reducing debt to GDP ratios may calm the markets in the longer-term, but that will take time and as we have observed over the pond in Europe -- the markets move much quicker than fiscal or monetary policy.
The scale at which QE has been conducted was always going to generate shocks when the time came to reversing policy. Moreover, there was never going to be a defining moment to announce the scaling back $85Bn in bond purchases. Wall Street's reaction to Bernanke's comments suggests that the enormity of the addiction problem is not fully understood. Cold turkey to some degree is inevitable, but ensuring the economy's immune system can withstand the process before it commences is vital. Maybe the most significant task is to acknowledge there is an addiction issue in the first place -- then at least the Fed might stand a fighting chance of identifying the correct antidote, how much of it is needed, and when the course of treatment should start.
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