Wall Street, with its overwhelming preponderance of Republican voters, might have had the common courtesy to feign some excitement about Mitt Romney’s big speech last night. But for most investors the only big speech this week is the lecture on monetary theory to be delivered by Ben Bernanke today at Jackson Hole.
It is a mystery why the markets look forward with such excitement to a tedious and predictable restatement of Mr Bernanke’s boundless confidence in the power of monetary policy to stimulate growth and create employment. After all, experience has shown that the Fed simply does not have these magical powers. Almost nobody outside the Fed genuinely believes that another round of quantitative easing, or another promise to hold interest rates at zero until the Last Trumpet, will do anything to accelerate economic growth. The evidence of the past three years has been pretty conclusive on when QE works and when it does not. QE1 was a genuine emergency measure that proved extremely effective in preventing a meltdown of the US banking system and the resulting depression. The same was true of the first round of QE in Britain. By contrast, QE2 and Operation Twist produced no discernible economic benefits. If anything, the Fed’s activities have made matters worse by fuelling oil and food inflation, thereby squeezing real incomes and undermining consumer and business confidence. In fact, the only significant gainers have been bond investors and banks, plus a few macro hedge funds. (This is perhaps why Wall Street is more obsessed than ever with Fed watching, even though monetary policy is much less powerful once interest rates hit the zero bound.)
Additional QE today would be especially counterproductive. The US economy is no longer threatened by deflation, recession or a housing slump. In fact the biggest economic danger is the jump in oil prices – up 27% since the end of June. This is largely because of the speculation about more QE that was inspired by a series of Fed statements from early July onwards, when the probability of QE3 shot up to 70%, according to the regular Reuters survey of Fed-watchers. This oil price surge is already bigger than the 19% increase that occurred between late January and early March, contributing to the spring slowdown. Unless this oil price movement is quickly reversed or at least arrested, another slowdown is likely in the fourth quarter.
Why then are most investors so confident that Bernanke will hint strongly at more QE today, with a formal announcement at the next FOMC meeting on September 13? The main reason is that Bernanke has become a QE addict. He wants more and more QE, almost regardless of economic conditions. Like an alcoholic who needs several stiff drinks before he can face a party, Bernanke needs several hundred billion of bond purchases under his belt before he can face a congressional hearing or a press conference. He simply refuses to recognise the links between QE, surging oil prices and weakening consumer spending and employment. On the contrary, the Fed chief probably considers the recent fall in consumer and business confidence as a further justification for QE – and the more the economy weakens, the more QE he wants. That, at least, has been his attitude in the past. But perhaps Bernanke will surprise the world today. Maybe he will not promise more QE3. He might even acknowledge that, as economic conditions normalise and oil prices inflate, QE can become dangerously counterproductive. If Bernanke did that, Jackson Hole really would be a “big speech”.
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