Posted by Shyam Moondra
This Thursday, the Federal Reserve Board (FED) is likely to announce a new Quantitative Easing program (QE3) through which they will infuse liquidity into the monetary system, inducing investors to go after more risky assets rather than park their money in fixed-income instruments that they consider as safe haven in the present uncertain environment. The earlier similar programs (QE1 and QE2) have had some positive effect on economy but they provided only a temporary lift. What if the FED takes a different approach this time?
Here is a recap of where things stand right now:
• The stock prices are historically low with S&P 500 PE hovering at around little over 15. At the last market peak, it was over 30. When the market goes up, the investors feel wealthy and more secured about the future. That leads to their increased spending which fuels the economy.
• The housing prices are improving, but they are still very depressed from their historic averages. Higher housing prices have the same wealth effect as higher stock prices; homeowners start borrowing against home equity which leads to increased spending that boosts the economy.
• The corporations have the best balance sheets in a generation, hoarding cash of the order of $3 trillion. They are ready to invest in capital projects and hire more workers, but two things are holding them back: gridlock in the Congress that creates uncertainty (and corporations hate uncertainty) and tepid consumer spending.
• Having lost tons of money in the 2008-2009 market crash, the investors have parked their cash in government securities that pay almost no interest and corporate bonds that are barely keeping up with inflation. So what we have is a fixed-income bubble that would eventually burst, as all bubbles do.
Given the above facts, this is what we can do to increase the rate of economic recovery and speed up job creation:
• The voters need to take a decisive action in November and give control of all three government entities, the White House, the Senate, and the House of Representatives, to the same party so we can finally get rid of gridlock. Under Obama, we have made progress in terms of job creation from the depth of severe recession left by the former President George W. Bush (4.5 million new jobs created in the last 30 months compared with 2.6 million jobs lost in the final year of the Bush presidency). Obama has demonstrated that he is the absolute champion of the middle-class (that accounts for 70% of consumer spending) and protector of Medicare and Social Security safety-net programs. Therefore, the voters should put Democrats in charge of all three parts of the government. In the past, the voters preferred a divided government to have checks-and-balances and to avoid ideological domination by any single political party. However, in the current circumstances, getting rid of gridlock is much more important than worrying about ideological domination. In the absence of gridlock, the government will be able to swiftly move on tax reforms and adopt a long-term balanced plan to reduce federal budget deficit and debt.
• The FED has been buying treasuries and mortgage-based securities to infuse more liquidity into the system with the hope that investors would go for more risky assets such as equities. The FED actions have had limited success in achieving their goals and these actions have largely benefited the financial sector which is in much better shape today than it was in 2008. Therefore, may be the FED should buy equities instead of treasuries and mortgage-based securities to encourage the investors to move their money from less risky instruments to more risky equities. The previous government investment in equities by the Treasury Department under the bailout program TARP (e.g., in auto companies and financial companies) has produced good returns for the taxpayers; FED’s equity purchases now when the market prices are relatively low should prove to be profitable for the taxpayers as well as beneficial for the overall economy. The FED purchases of equities (they could buy the stocks in various indices such as Dow Jones, S&P 500, NASDAQ) will move the stock market up and create wealth. By the same token, the FED should snap up foreclosed properties (rather than buy mortgage-based securities that benefit only the banks) to reduce supply of homes and thus give a boost to the housing prices, thereby creating the wealth factor on that front as well. The Congress would have to revise the Federal Reserve Act authorizing the FED to buy equities and foreclosed properties and also increase funding for the FED so that it will have the necessary resources to effectively execute the plan of investing in equities and foreclosed properties.
• The FED has stated that it will keep interest rates close to zero at least through 2015. The idea was to nudge investors away from fixed-income securities and towards more risky assets and encourage corporations and consumers to borrow and spend. Unfortunately, the low interest rates are not having an appreciable stimulative effect on economy; corporations don't need to borrow much because of their huge cash pile and consumers are reluctant to borrow because they don't feel secured in the current economic environment with high unemployment rate. Also, the potential home buyers are putting off their real estate purchases thinking that interest rates will remain low for some time so it's better to just wait for lower real estate prices. Therefore, the FED’s low interest rate policy is actually having unintended negative impact on economy. May be the time has come for the FED to try a different tack and start increasing interest rates and force these waiting potential homeowners to start buying homes now which will have a big impact on job growth. Higher interest rates will also increase the spreads for banks that will allow them to make fatter profits and thus become financially more stronger than they are now.
Since the 2008 recession, we have had the slowest recovery on record. It’s time the voters and FED try different approaches to improve economy and create lots of jobs faster.
