From ‘Taper Tantrum’ & ‘Token Taper’ to ‘Taper Tomorrow’: Fed Policy in Crisis
This past week the US central bank, the Federal Reserve (Fed), opted not to change its current 3rd Quantitative Easing (QE) policy providing $85 billion a month in bond purchases from bankers and investors. The Fed’s QE3 policy has been in effect for about a year, injecting in excess of $1 trillion in subsidized money into the US and global economy. Since QEs began in 2009, the total injection will have exceeded $4 trillion by the end of this year.
Consensus was strong in recent weeks that the Fed would at least slightly reduce that $85 billion, by a token $5-$10 billion a month. That would have provided a mild, second signal it would begin reducing its $85 billion a month money injection.
Last May-June 2013, the Fed’s chairman, Ben Bernanke, initially signaled to the markets the Fed might soon start ‘reducing QE. That set off what has been called the ‘taper tantrum’ by investors. Almost immediately in response to the Fed’s suggestion, rates on bonds in the US began to escalate, including mortgage rates, corporate bond rates and US Treasury bonds—all of which surged by more than a full 1% in a matter of weeks.
The outcome of the rapid rate rise was the tepid US housing market recovery almost stalled, stock and bond prices began to tank, and investment into ‘emerging markets’—where much of the total $4 trillion in QEs since 2009 has gone—began to reverse and flow back from abroad to the US and Europe. Emerging markets’ currencies in turn began to decline, the global currency war ratcheted up another notch, and capital flight from those economies to the west accelerated.
Faced with the ‘taper tantrum’ by global high net worth investors and their institutions—aka ‘the markets’—the Fed and Bernanke quickly changed their tune by early July, reassuring investors and speculators that s significant retraction of QE3’s $85 billion wasn’t really their intention. The ‘markets’ quickly sighed with relief and stock, bond, property, and other financial asset prices rose again.
As part of its so-called ‘forward guidance’ policy—notifying markets of its future intentions—the Fed in August took another shot, this time more cautiously, at trying to extricate itself once again from its massive, five year, $4 trillion QE program.
The extrication has become increasingly necessary, since QEs—together with the Fed’s accompanying policy of ‘zero bound’ interest rates—have been force-feeding financial asset bubbles globally—threatening to destabilize the global money system. Simultaneously, it has become no less clear that these dual Fed policies have become increasingly ‘inefficient’—that is, while feeding financial speculation and asset bubbles they have not resulted in much real investment in goods and services.
As more and more reports and articles have begun to show, as QE continues to grow and financial asset market prices rise, the growth of real investment in goods and services continue to slow. According to one report, only 15% of financial flows since 2009 are now going into real investment in goods and services, according to a recent article in the global news daily, the Financial Times, this past September 20.
However, the Fed’s second ‘forward guidance’ second suggestion to taper in August led to still more capital flight and currency declines in emerging markets. At the same time, by late summer in the US, a number of economic indicators began to show that the US economic recovery is not as strong as the press hype has been suggesting. Even the Fed itself has been lowering its own forecast for the US economy, from 2.5% earlier in 2013 down, most recently, to 2% GDP growth. (That downward revised forecast was not the first. In fact, the Fed has consistently reduced its US economic forecasts for the past three years, from an originally predicted 4.3% annual GDP growth).
Given the obvious concern with Fed monetary policies’ growing ‘inefficiency’ stimulating the real economy and the growing effects of QE and zero rates feeding financial speculation and bubbles, the Fed last week on September 16, shook markets and investors by deciding not to ‘taper’ at all for the moment, suspending its August implied ‘token taper’ of $5 or $10 billion a month.
To recap these Fed events over the summer: in a matter of just a few months the Fed has shifted from responding to the ‘Taper Tantrum’ to the ‘Token Taper’ retreat. This has left its policy of ‘forward guidance’—i.e. signaling its intentions to the markets—in a shambles. In recent days, several Fed board governors have returned to suggesting a third time that a reduction of the $85 billion will occur before year end, and perhaps even start in October—i.e. what might be called a ‘Taper Tomorrow’.
What all this policy shifting signifies is, in the last several months, Fed monetary policy is perhaps beginning to unwind in more ways than one.
On the other hand, the Fed’s retreat from the ‘Tantrum’ and the ‘Token’ has left speculators, investors and banksters quite happy. The stock and bond markets surged in September once again, emerging market currencies recovered a little, and other financial markets moved once more to the upside—illustrating the tight positive correlation that has evident for four years now between financial asset inflation and Fed QE policies (and the equal lack of any correlation between QEs and the real economy).
To employ a metaphor, as a consequence of its ‘on-off’ QE policy the Fed is beginning to appear like the drunk driver stopped by police after appearing to ‘weave back and forth’ on the highway. It is being asked to hold its finger to its nose and walk a straight line, to give evidence if it is indeed drunk or not. And it’s not succeeding. Instead, its stumbling to either side of the line.
What the Fed’s ‘stop-go’, on and off, QE policy signifies in a broader sense is threefold:
First, that investors and banksters have become addicted to the QE, low interest and free money policies of the Fed that have been in effect the past five years. (see this writer’s March 7, 2012 article and prediction, ‘Are Capitalists Becoming Addicted to Free Money’, on his blog at jackrasmus.com). The mere suggestion of a QE retraction, even when token, results in financial asset price declines and rising interest rates. Banksters-investors simply want the free subsidies to continue and they expect that to happen. A ‘cold-turkey’ withdrawal of liquidity sends them into ‘financial fits’.
Moreover, each time the Fed retreats on its signal to taper, it makes the next attempt even more difficult as investors anticipate and become even more predisposed to quickly respond to counter any Fed suggested move. As the Fed repeatedly retreats, the financial bubbles continue, emerging markets’ problems of currency volatility and capital flight grow, China’s real estate market becomes more fragile as hot money inflows return from the west to Chinese ‘shadow’ banks, and US monetary policy becomes even less ‘efficient’ stimulating the real US economy.
Secondly, Fed recent stop-go policies suggest the real economy has become super-sensitive to interest rate hikes—just as it has become ‘super-Insensitive’ to interest rate reductions over the past five years. (In economists’ parlance, this is expressed as the economy having become ‘increasingly inelastic’ to interest rate declines—i.e. falling rates generating little real growth—while conversely becoming ‘increasingly elastic’—rising rates quickly slowing real growth—to interest rate hikes).
QE is showing the real economy is responding less and less positively to money supply injections and interest rate declines, while more and more negatively to money supply reductions and interest rate hikes. Furthermore, the Fed’s key policy of ‘forward guidance’—i.e. telling the markets what it plans to do in order to avoid severe volatility response by investors—is now unraveling as well. No one really knows what the Fed is going to do now, how it plans to do it, and when and at what rate it plans to begin doing it. In short, the Fed is losing control of the monetary tools by which it has been stabilizing the banking and financial system the past five years.
Thirdly, it all means it will be even more difficult for the Fed to ‘taper tomorrow’, which is apparently its latest message being delivered by select Fed governors. Emerging markets may react even more volatilely to the next taper iteration by the Fed, producing even more currency volatility, capital flight, and economic slowdown. More hot money will flow into China’s increasingly fragile local property markets via its growing ‘shadow’ bank network there. Financial asset bubbles, having returned in the interim, will pose an even greater risk of too rapid asset price contraction at some later date.
Apart from problems of feeding financial speculation, asset prices, and continuing financial bubbles, the US and global real economy will now become even more ‘super-sensitive’ to QE withdrawal and resulting interest rate hikes.
Dr. Jack Rasmus is the author of the 2012 book, ‘Obama’s Economy: Recovery for the Few’, Pluto press, and ‘Epic Recession: Prelude to Global Depression’, Pluto, 2010. He hosts the weekly radio show, ‘Alternative Visions’, on the Progressive Radio Network, blogs at jackrasmus.com. His website is: www.kyklosproductions.com and twitter handle, @drjackrasmus.