Sep. 10, 2012 at 1:56 PM ET
Economics 101 says a massive dose of easy money is supposed to be a reliable cure for a sluggish economy. For the first time in decades, the prescription isn’t working, to the rising frustration of central bankers in the U.S. and Europe.
Four years and more than $2 trillion after the Federal Reserve opened the money spigots following the financial collapse of 2008, the U.S. economy remains stuck in the mud.
Fed Chairman Ben Bernanke, in a widely-watched speech last month in Jackson Hole, Wyo., defended the central bank’s past decisions to churn out record-breaking volumes of cash -- a process known as “quantitative easing” -- saying the policy had prevented a much more painful recession. Bernanke also left little doubt that more money may be coming, as early as this week’s regular Fed policy meeting.
"It is important to achieve further progress, particularly in the labor market," Bernanke said. "The Federal Reserve will provide additional policy accommodation as needed."
Maintaining steady job growth is half of the Fed’s so-called “dual mandate,” the other being inflation control. Based on Friday's monthly jobs report, showing fewer than 100,000 new hires in August, the Fed has a lot more work to do.
All of which has Wall Street convinced it’s a pretty sure bet that the Fed is about to fire up its money machine once more, forcing cash into the system by buying hundreds of billions of dollars’ worth of bonds.
“That employment report kind of nailed it,” said Michelle Girard, RBS senior economist. “The Fed laid out the criteria: we need to see a sustained and substantial improvement. And that labor report didn’t show it. So the Fed is going to have to make good on their intentions.”
But roads paved with good intentions don’t always lead to good places. Though investors have bid up stocks on the theory that another massive wave of cash has to go somewhere, there’s widening doubt that another money flood will boost growth or create more jobs.
“What central banks everywhere are doing is trying to make sure people are not focused on the world breaking apart,” said Dinakar Singh, CEO of TPG-Axon Capital. “Ultimately I don't think lower rates make that much difference anymore. There aren't that many people left that haven't borrowed money -- companies or people -- but would if rates were lower. “
On top of another massive money drop, the Fed may extend its stated promise to keep interest rates ultra-low further into the future. Some market watchers, and a few Fed policy makers, have expressed concerns those moves could do more harm than good.
Even as low rates have failed to spur growth, they’re penalizing savers. Insurance and pension funds have been hit hard by record low returns needed to fund long-term obligations. And, at some point, the Fed will have to start selling its massive holdings in bonds, forcing rates higher and producing a drag on growth. Discussions about that "exit strategy," frequent following the Fed's first round of bond-buying, have all but disappeared from recent Fed deliberations.
Europe’s central bank, meanwhile, is also embarking on its second round of bond buying to try to head off a deepening recession. But the ECB's easy money efforts appear to have had even less impact on the eurozone crisis than its American counterpart.
Central bankers there face a different, and thornier, set of problems. So far, they’ve been badly hampered by restrictions on their mandate preventing them from intervening to help bail out specific countries in trouble.
They’ve also been hamstrung by politics, as wealthier northern nations led by Germany have opposed the kind of big-money stimulus pioneered by the Fed.
Further action could be hampered by a German high court ruling expected this week on the constitutionality of a key bailout fund. No matter which way the court rules, central bankers in Germany’s Bundesbank -- along with millions of that country’s voters -- will likely oppose further ECB proposals to flood the continent with money, much of it coming from Germany.
“The Bundesbank is now becoming the voice increasingly of conservative Germany,” said Jim O'Neill, chairman of Goldman Sachs Asset Management. “It’s the early stages of heading toward what ultimately will be some referendum in Germany on a closer euro in which Germany, as part of its DNA has to support the others.”
ECB intervention to drive down interest rates could worsen the crisis by protecting free-spending governments from the financial market punishment needed to enforce tighter budget controls.
“Its massive support may well discourage profligate governments from meeting their fiscal objectives,” said David Rosenberg, chief economist at Gluskin Shiff. ”Italy is already backsliding on this front.”
Central bankers in China, trying to revive a slumping economy by pumping more money into the system, face yet another set of problems this time around. Following a series of monthly data showing China’s once-hot growth winding down, Beijing last week announced a series of new infrastructure projects to try to reverse the downturn.
But the measures are much more limited than the massive stimulus undertaken following the 2008 collapse. That spending spree left China with more roads, bridges, airports and rail lines than it needs. Now, as growth has slowed again, inventories of raw materials and finished goods are piling up.
Additional government lending and spending risks igniting another round of the kind of consumer inflation that swept through China in 2010, forcing up food prices and inflating a rapidly expanding real estate bubble.
Chinese consumer price inflation appears to be moving higher again, bumping up to annual rate of 2.0 percent last month from 1.8 percent in July, and is likely to rise above 3 percent early next year, according to Mark Williams, chief Asia economist at Capital Insight.
“This won’t prevent further stimulus if the economy remains very weak, but it does make large policy moves less likely,” he said.
Faced with an ongoing global slowdown, though, central bankers around the world are loathe to do nothing. Despite the limited impact of dumping more money into the economy, even easy-money skeptics at the Fed will likely go along with another round, according to Neal Soss CSFB chief economist.
“Even those who doubt the efficacy of monetary policy under current circumstances may well feel obliged not to disappoint financial markets,” he said. “First, do no harm.“
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