Stephen Roach: Fed’s Asset Purchases Are A ‘Charade’
Stephen Roach makes some good points in the Bloomberg Television interview from September 14th below. He talks mostly about China in a tete-a-tete with Gordon Chang later in the broadcast. Don’t miss that. But on the US at the beginning of the clip, Roach’s basic question is whether the Fed’s trying to add stimulus on “the quantity dimension” as opposed to by cutting rates i.e. affecting price will have a positive impact. Roach says the answer is no.
This is the question I have also been asking – especially since the added reserves from this stimulus do not permit more lending. Loans create reserves, not the other way around. And my answer is similar:
The Fed’s Chairman, Ben Bernanke, has repeatedly said he believes inflationary pressures are subdued. So he believes more needs to be done to promote full employment. I agree.
But what can the Fed do? Usually the Fed lowers interest rates to stimulate the economy. But, the Fed has said the federal funds rate will be effectively 0 percent through late 2014. So the Fed has resorted to less proven, less effective means like buying up Treasury bonds or informing bond markets that it intends to keep the federal funds rate at 0 percent for longer. This won’t cut it.
So Bernanke has told Congress the Fed cannot do it alone, without interfering in fiscal policy by making specific recommendations. Congress needs to do more to bring down the unemployment rate, the broadest measure of which is 15.3 percent. But Congress has failed to live up to its responsibilities. Exasperated with political gridlock on Capitol Hill, everyone has turned to the Fed as economic savior. But the Fed is not going to save us because it can’t.
That doesn’t mean it can’t try, right? Isn’t that what QE3’s all about? Bernanke wants to be able to say – especially if the US economy falters and lapses into a Japanese-like state – that he did everything possible, especially because a lot of people have been saying just the opposite about him. So the Fed is throwing the kitchen sink at the problem by:
- lengthening maturities of its bond portfolio
- buying mortgage bonds instead of treasuries
- not limiting the QE program to quantity or by date
- and by extending its zero rate policy back out to three years where it was in 2011
That sounds pretty aggressive two months before a presidential election if you asked me.
Let’s be clear though. QE is not the Fed’s first choice policy tool. As Roach said, the Fed would like to focus on price i.e. yield but Fed Funds can’t go any lower. Or as I like to say: “All of these ideas are largely untested fallback options because the Fed Funds rate has reached the zero lower bound. If the Fed Funds rate were 5%, then the Fed would simply cut rates to stimulate the economy. However, over the last two recessions the Fed has cut rates so much that it now can cut no more and must try other untested policies to fulfill its constitutionally-enacted mandate of supporting full employment.”
Will it work? I know a lot of people tell you it would or it could. But I don’t see how it can. QE is just an asset swap. The Fed creates reserves and swaps them for existing financial assets. It drains the private sector of those assets and adds an equivalent amount of reserves. It’s not creating the preconditions for more lending since loans create reserves.
Sure, the Fed could alter private portfolio preference and get people into serious risk-on mode. In fact, it’s already doing that. But is that what we want? Isn’t that what got us into this mess in the first place? Video below.