The stock market reacts to some issues like those panicked by the boy calling “wolf.”
That wolf is to be loosed in October when the Federal Reserve puts to rest its quantitative easing policy that has flourished since the economic crisis in 2008.
Quantitative easing (QE) is an unconventional monetary policy used to stimulate the economy when standard policy has become ineffective.
The central bank typically buys short-term government bonds to lower short-term market interest rates. When short-term interest rates have reached or are close to zero, this method can no longer work. QE can be extended by purchasing assets of longer maturity government bonds, thereby lowering longer-term interest rates further out on the yield curve.
Central banks state the newly created money is used to buy government bonds or other financial assets, whereas the term ‘printing money’ usually implies that newly created money is used to directly finance government deficits or pay off government debt – also known as monetizing the government debt.
A recent brief response to a mere mention of QE tells the story.
Since first closing at 62.76 on Feb. 16, 1885, the Dow Jones Industrial Average increased steadily, reaching a record high July 16, 2014, closing at 17,138.20.
After word leaked of the Fed’s plan to end QE3, stocks dipped immediately by .06% and yields on 10-year bonds went up .12% briefly. The market has been erratic in the 16,000 level since.
It is more than the $4.5 trillion quantitative easing the Fed has pumped in the economy. The Fed’s near-zero interest rate is even more worrisome, because it stacked investment for the stock markets.
The rich got richer because they had capital and access to Fed money. The stock market was like a roulette wheel fixed to pay off on nearly every spin of the wheel. The house – taxpayers, most elderly and those invested in money markets – in this game were the losers because their assets were devalued as the money supply grew and low interest rates failed to keep up with inflation.
There are several economic theories. Currently, John Maynard Keynes’ are most commonly applied by our government.
The Fed has tried to achieve its macroeconomic goals of price stability, sustainable economic growth, and high employment in part by influencing the size of the money supply.
During the late 1960s, Milton Friedman, 1976 Nobel Prize winner in economic sciences, promoted – and I became an advocate because of his columns in Newsweek – an alternative macroeconomic policy known as “monetarism.”
He theorized a “natural rate of unemployment” exists and governments could increase employment above this rate only at the risk of causing inflation to accelerate. He extolled the virtues of a free market economic system with minimal intervention.
This column in 2008 questioning the initial $700 billion bailout and marriage of the Treasury and Federal Bank under the Bush administration to free up money for banks and other “too big to fail” businesses. Congress couldn’t pass the bill quick enough, but first had to add several special interest ornaments.
It also is obvious those floating all of these rescue plans have no better idea on the odds for success than you and I do. It is typical Washington D.C. thinking: If you throw enough money at a problem, you might find something that works.
By increasing the supply of money – the number of dollars in circulation – the government inflates the value and decreases the purchasing power of those new dollars. It also devalues our assets – homes, pensions and investments – because they were purchased with higher value dollars.
Just because you can print all the money you want does not mean you can spend your way out of every problem.”
The Fed is going to turn off its money machine in October. Many of the same issues are with us, but a new one is how investors react and its effect on the stock market. Opinions gleaned from websites include:
Henry Blodget, editor in chief of Business Insider, opined June 30, 2014:
“For the last five years, the Fed has been frantically pumping money into Wall Street, keeping interest rates low to encourage hedge funds and other investors to borrow and speculate. This free money, and the resulting speculation, has helped drive stocks to their current very expensive levels.” (Berkshire Hathaway, Warren Buffet’s holding, hit $200,000 a share last week.).
Blodget is concerned about stock prices and thinks stocks will likely deliver lousy returns over the next 7-10 years because of price, profit margins and Fed tightening.
Robert Rubin, former treasury secretary under Clinton, is concerned about the Fed absorbing reserves in the banking system. “Uncertainties could be far greater with the vast increases that have taken place in the balance sheet of the Fed,” which is now worth more than $4 trillion, up from pre-crisis levels around $800 billion, according to Rubin.
Princeton professor Alan Blinder, former Fed vice chairman, told financial insiders, “The Fed is not going to stay at near-zero interest rates as the economy strengthens.”
In June, the Fed began cutting its purchase of Treasury and mortgage-backed securities by $10 billion a month each meeting from a peak of $85 billion. It added $35 billion of bonds in July, $25 billion in August and September and a final $15 billion in October.
Fed officials said the end of tapering issue will have no bearing on the timing of the first rate hike. The Fed said that rates would remain near zero for a “considerable time” after it ends bond purchases.
Friedman made the following comments, appropriate to this column:
“One of the great mistakes is to judge policies and programs by their intentions rather than their results.”
“Nothing is so permanent as a temporary government program.”