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Stephen Roach Warns The Fed's Fixation With Markets Is "A Potentially Deadly Trap"

Tyler Durden's picture




 

Authored by Stephen Roach, originally posted at Project Syndicate,

As the US Federal Reserve attempts to exit from its unconventional monetary policy, it is grappling with the disparity between the policy’s success in preventing economic disaster and its failure to foster a robust recovery. To the extent that this disconnect has led to mounting financial-market excesses, the exit will be all the more problematic for markets – and for America’s market-fixated monetary authority.

The Fed’s current quandary is rooted in a radical change in the art and practice of central banking. Conventional monetary policies, designed to fulfill the Fed’s dual mandate of price stability and full employment, are ill-equipped to cope with the systemic risks of asset and credit bubbles, to say nothing of the balance-sheet recessions that ensue after such bubbles burst. This became painfully apparent in recent years, as central banks, confronted by the global financial crisis of 2008-2009, turned to unconventional policies – in particular, massive liquidity injections through quantitative easing (QE).

The theory behind this move – as espoused by Ben Bernanke, first as an academic, then as a Fed governor, and eventually as Fed Chairman – is that operating on the quantity dimension of the credit cycle is the functional equivalent of acting on the price side of the equation. That supposition liberated the Fed from fear of the dreaded “zero bound” that it was approaching in 2003-2004, when, in response to the collapse of the equity bubble, it lowered its benchmark policy rate to 1%. If the Fed ran out of basis points, the argument went, it would still have plenty of tools at its disposal for supporting and guiding the real economy.

But this argument’s intellectual foundations – first laid out in a 2002 paper by 13 members of the Fed’s Washington, DC, research staff – are shaky, at best.

The paper’s seemingly innocuous title, “Preventing Deflation: Lessons from Japan’s Experience in the 1990s,” makes the fundamental assertion that Japan’s struggles were rooted in a serious policy blunder: the Bank of Japan’s failure to recognize soon enough and act strongly enough on the peril of incipient deflation. (Not coincidentally, this view coincided with a similar conclusion professed by Bernanke in a scathing attack on the BOJ in the late 1990s.) The implication was clear: substantial monetary and fiscal stimulus is critical for economies that risk approaching the zero bound.

Any doubt as to what form that “substantial stimulus” might take were dispelled a few months later, when then-Fed Governor Bernanke delivered a speech stressing the need for a central bank to deploy unconventional measures to mitigate deflationary risks in an economy that was approaching the zero bound. Such measures could include buying up public debt, providing subsidized credit to banks, targeting longer-term interest rates, or even intervening to reduce the dollar’s value in foreign-exchange markets.

A few years later, the global financial crisis erupted, and these statements, once idle conjecture, became the basis for an urgent action plan. But one vital caveat was lost in the commotion: What works during a crisis will not necessarily provide sufficient traction for the post-crisis recovery – especially if the crisis has left the real economy mired in a balance-sheet recession. Indeed, given that such recessions clog the monetary-policy transmission mechanism, neither conventional interest-rate adjustments nor unconventional liquidity injections have much impact in the wake of a crisis, when deleveraging and balance-sheet repair are urgent.

That is certainly the case in the US today. QE may have been a resounding success in some ways – namely, arresting the riskiest phase of the crisis. But it did little to revive household consumption, which accounts for about 70% of the US economy. In fact, since early 2008, annualized growth in real consumer expenditure has averaged a mere 1.3% – the most anemic period of consumption growth on record.

This is corroborated by a glaring shortfall in the “GDP dividend” from Fed liquidity injections. Though $3.6 trillion of incremental liquidity has been added to the Fed’s balance sheet since late 2008, nominal GDP was up by just $2.5 trillion from the third quarter of 2008 to the second quarter of this year. As John Maynard Keynes famously pointed out after the Great Depression, when an economy is locked in a “liquidity trap,” with low interest rates unable to induce investment or consumption, attempting to use monetary policy to spur demand is like pushing on a string.

This approach also has serious financial-market consequences. Having more than doubled since its crisis-induced trough, the US equity market – not to mention its amply rewarded upper-income shareholders – has been the principal beneficiary of the Fed’s unconventional policy gambit. The same is true for a variety of once-risky fixed-income instruments – from high-yield corporate “junk” bonds to sovereign debt in crisis-torn Europe.

The operative view in central-banking circles has been that the so-called “wealth effect” – when asset appreciation spurs real economic activity – would square the circle for a lagging post-crisis recovery. The persistently anemic recovery and its attendant headwinds in the US labor market belie this assumption.

Nonetheless, the Fed remains fixated on financial-market feedback – and thus ensnared in a potentially deadly trap. Fearful of market disruptions, the Fed has embraced a slow-motion exit from QE. By splitting hairs over the meaning of the words “considerable time” in describing the expected timeline for policy normalization, Fed Chair Janet Yellen is falling into the same trap. Such a fruitless debate borrows a page from the Bernanke-Greenspan incremental normalization script of 2004-2006. Sadly, we know all too well how that story ended.

 

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Fri, 11/14/2014 - 14:23 | 5449051 km4
km4's picture

Here's another deadly trap for US economy...

More and more Americans are outside the labor force entirely. Who are they?

Nov 14, 2014

http://www.pewresearch.org/fact-tank/2014/11/14/more-and-more-americans-...

According to the October jobs report, more than 92 million Americans — 37% of the civilian population aged 16 and over — are neither employed nor unemployed, but fall in the category of “not in the labor force.” That means they aren’t working now but haven’t looked for work recently enough to be counted as unemployed. While that’s not quite a record — figures have been a bit higher earlier this year — the share of folks not in the labor force remains near all-time highs.

Fri, 11/14/2014 - 14:32 | 5449079 OW My Balls
Fri, 11/14/2014 - 15:22 | 5449149 Pinto Currency
Pinto Currency's picture

 

 

 

Not possible that printing a higher stock market can be a trap.

Breaking windows creates wealth and so does QE printing the stock market higher.

Mr. Roach: your article is not news and has been visible to the central banks since day-1. 

What then is the stock ramp driven by QE?  Beneficiaries: the banks are recapitalized with the Fed holding junk, 2) insiders have gotten out of the stock market at higher prices vs. 2008.

Fri, 11/14/2014 - 14:42 | 5449122 Aeternus
Aeternus's picture

Unemployment doesn't exist, it's a conspiracy theory.

http://www.infowars.com/video-apache-helicopter-harasses-gun-owners/

Fri, 11/14/2014 - 14:57 | 5449190 slaughterer
slaughterer's picture

Anything negative about Central Banks, ZH will print.  Anything positive about Precious Metals, ZH will print.  Does this perspective make money?  

Fri, 11/14/2014 - 15:06 | 5449229 donsluck
donsluck's picture

ZH makes money from ads. The rest is mission statement.

Fri, 11/14/2014 - 17:22 | 5449788 Deacon Frost
Deacon Frost's picture

Using your logic, this would have to be true for all web sites, no matter their proclivities.

Fri, 11/14/2014 - 17:38 | 5449853 Clowns on Acid
Clowns on Acid's picture

You make your own money .. this ain;'t the place for day traders, buy and hold IRA's or early news on M&A's. Read 'em and weep.   

Fri, 11/14/2014 - 19:56 | 5450248 Savyindallas
Savyindallas's picture

It will  - likely very soon. 

Fri, 11/14/2014 - 15:02 | 5449210 Bloppy
Bloppy's picture

Almost no one is worried at this point- total complacency reigns

 

CNBC: home of ANGRY bulls

http://tinyurl.com/qb44mtq

Fri, 11/14/2014 - 16:27 | 5449568 island
island's picture

Roach notes: "The persistently anemic recovery and its attendant headwinds in the US labor market belie this assumption."

The masters in D.C. are ignorant and self-serving.  Instead of caring about John and Jane Q. Public, they engage in smoke and mirrors messages, distorted " official figures," deceit, and corruption.

Unfortunately, there is zip "the small people" can do.  We have past the point of no return.  Wealth and power have become too concentrated.  This will have to be played out over the long term.

 

Fri, 11/14/2014 - 14:25 | 5449060 pendragon
pendragon's picture

slow news day?

Fri, 11/14/2014 - 14:33 | 5449085 Bell's 2 hearted
Bell's 2 hearted's picture

i wasted 4 minutes in that roach trap

Fri, 11/14/2014 - 14:46 | 5449138 NotApplicable
NotApplicable's picture

Stupid should hurt! ;-)

Fri, 11/14/2014 - 14:39 | 5449114 lordbyroniv
lordbyroniv's picture

Long Guillotines 

Fri, 11/14/2014 - 14:43 | 5449123 Youri Carma
Youri Carma's picture

"... the policy’s success in preventing economic disaster..." WRONG!

First off, they created the problem (derivatives). Secondly, it was a blatant bail-out for the banksters that should have failed in the first place and put out of business.

Fri, 11/14/2014 - 14:44 | 5449127 Bam_Man
Bam_Man's picture

"There's never just one Roach..."

Fri, 11/14/2014 - 14:46 | 5449137 rpboxster
rpboxster's picture

I only viewed to see if Admiral Ackbar has posted yet...haven't seen him in a few days and this is a lay-up

Fri, 11/14/2014 - 14:50 | 5449161 thatthingcanfly
thatthingcanfly's picture

Dude, I did the same thing! Where is he?

Fri, 11/14/2014 - 15:03 | 5449213 venturen
venturen's picture

The USSR had full employment once they accepted dictatorship! 

Fri, 11/14/2014 - 15:15 | 5449265 kahunabear
kahunabear's picture

Reeeeely? Wow, I hadn't thought of this. Thanks for the heads up, Steve-o!

Fri, 11/14/2014 - 16:19 | 5449557 saveUSsavers
saveUSsavers's picture

Global MSCI index up 39% in 3 years total, EARNINGS UP 3% IN TOTAL! (1%/yr) these financial terrorists should be in prison

Fri, 11/14/2014 - 17:27 | 5449809 breadonwaters
breadonwaters's picture

Hang on here a second.  What we have is a financial sector that captured the government, gambled like a drunk sailor and finally crashed as a result of its greed.  At that point, we should have said: "Too Bad, you're toast!"  and then taken our deserved lumps for letting it get so out of hand.

NOPE!  We didn't do that.  Instead, we propped up the offending gamblers, patted them on the back and let them loose with a 'get out of jail free' card.

Now we count the number of angels on the head of a pin, as the MFWIC stumble towards the inevitable fall.

Sorry if i don't take the numbers games too seriously.  The system doesn't work. We are in a self induced crisis and our leaders (sic) are merely dancing to the tune of their own incompetance, and greed.  The end will come, and from the smoke and ruin, we will begin again, somewhat chagrinned that we let it go too far.

Keep on Stackin.

Fri, 11/14/2014 - 17:30 | 5449824 breadonwaters
breadonwaters's picture

Sorry 'bout that chief.....MFWIC :   "Mother F**kers whats in charge".

Fri, 11/14/2014 - 17:36 | 5449844 Clowns on Acid
Clowns on Acid's picture

It's taken Stephen Roach this long (since 2009 - QE 2) to write this Master of the Obvious piece?

Mr Roach - Fuck Off. 

Fri, 11/14/2014 - 19:06 | 5450119 limacon
Fri, 11/14/2014 - 23:03 | 5450817 AdvancingTime
AdvancingTime's picture

The Federal Reserve has failed to take serious efforts in pushing the government to take the necessary reforms needed to move the economy forward. Policy makers aided by the media thrive at presenting simplistic answers that solve both economic and society’s problems with little or no effort required from the masses. What started as a program to support and prop up the economy has morphed into the main driver of economic data.

With the low interest rates that have propelled investors into high risk assets in search of a positive return on their money, and money being pumped into the system, the markets have become distorted and disconnected from the economy. The idea that investors will continue to pour money into the sky high equity market is flawed. More on this subject in the article below.

 http://brucewilds.blogspot.com/2014/06/exit-strategy-from-qe-remains-elusive.html

Do NOT follow this link or you will be banned from the site!