Entering the final quarter of the year, Lacy Hunt and Van Hoisington (H&H) describe domestic and global economic conditions as extremely fragile. Across the globe, they note, countries are in outright recession, and in some instances where aggregate growth is holding above the zero line, manufacturing sectors are contracting. Of course, new government initiatives have been announced, particularly by central banks, in an attempt to counteract deteriorating economic conditions.
These latest programs in the U.S. and Europe are similar to previous efforts. While prices for risk assets have improved, governments have not been able to address underlying debt imbalances. Thus, nothing suggests that these latest actions do anything to change the extreme over-indebtedness of major global economies. To avoid recession in the U.S., the Federal Reserve embarked on open-ended quantitative easing (QE3). Importantly, in their view, the enactment of QE3 is a tacit admission by the Fed that earlier efforts failed, but this action will also fail to bring about stronger economic growth.
H&H go on to break down every branch that Bernanke rests his QE hat on from the Fed's inability to create demand, to the de minimus wealth effect, and most importantly the numerous unintended consequences of the Fed's actions.
Can all the trillions of dollars of reserves being added to the banking system move the economy forward enough to eventually create a higher level of aggregate spending? Our analysis of the aggregate demand curve and its determinants indicate they cannot. The unintended consequence of these Federal Reserve actions, however, is to actually slow economic activity.
The unintended consequences of QE3 could also serve to worsen and undermine global economic conditions already under considerable duress. When the Fed actions lead to higher food and fuel prices, the shock wave reverberates around the world, with many foreign economies being hit adversely. When prices of basic necessities rise, the greatest burden is on those with the lowest incomes since more of their budget is allocated to the basic necessities such as food and fuel. Thus, a jump in daily essentials has a more profound negative impact on living standards in economies with lower levels of real per capita income.
Three studies show that the impact of wealth on spending is miniscule—indeed, “nearly not observable.” How the Fed expects the U.S. to gain any economic traction from higher stock prices when rising commodity prices are curtailing real income and spending is puzzling.
The other element that is required for the Fed to shift the aggregate demand curve outward is the velocity or turnover of money over which they also have no control. During all of the Fed actions since 2008 the velocity of money has plummeted and now stands at a five decade low.
The consequence of the Fed’s lack of control over the money multiplier and velocity is apparent. The monetary base has surged 3.3 times in size since QE1. Nominal GDP, however, has grown only at an annual rate of 3%. This suggests they have not been able to shift the aggregate demand curve outward. Nor, with these constraints, will they be any more successful in shifting that curve under the present open-ended QE3.
Increased aggregate demand and thus rising inflation is not on the horizon.
Full H&H report below: