Bernanke’s dilemma
Aug 30, 2012
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Equity markets perked up last week when the newly released minutes of the US Federal Reserve’s August meeting strongly suggested that the Fed will soon launch a third round of quantitative easing (QE3), or money printing. QE involves electronically creating money and buying mortgage and government bonds with it. That injects money into the system and aims to lower long-term interest rates and thus fuel risk appetite, bolstering growth.
Fed chairman Ben Bernanke seems to be “frantically searching for another rabbit to pull out of the hat to give the lame recovery a bit more vigour”, says Alan Abelson in Barron’s. This task “probably took on fresh urgency with Mitt’s [Romney] vow last week to replace Ben… if and when he becomes president”.
So assuming QE3 does indeed arrive, can it help? Some printed money tends to leak into asset markets, but investors’ hopes of a boost to the economy have previously gone unfulfilled. Following QE1 and QE2, long-term rates have fallen to historic lows but there has been little impact on growth.
The basic problem is that simply making more money available doesn’t prompt consumers or business to borrow and thus get the economy moving. In a post-bubble environment, households tend to concentrate on paying their debt down. Businesses are either doing the same or reining in investment plans, thanks to the lacklustre consumer (and government) spending outlook.
Besides, as Capital Economics points out, “yet more purchases of US Treasuries ormortgage-backed securities by the Fed will do nothing to address the underlying economic and financial problems in the eurozone” or the weakness in the Chinese economy. Last week’s data from both regions “suggests economic activity, and hence the backdrop for corporate earnings will remain fragile for a while”.
Along with those key issues, the prospect of major automatic US spending cuts kicking in on 1 January, if a deeply divided Congress fails to avert them, also bodes ill for growth. Finally, given that stocks have already rallied strongly this year – the S&P 500 is close to a post-crisis high – any further doses of QE appears to have been factored in already. So don’t count on QE giving equities a lift. Given the discouraging backdrop, notes Lombard Street research’s Dario Perkins, “this is a brave time to embrace risk”.
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