Sent: 18-09-2012 13:51:02
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Fed policies to spur asset prices
The launch of another round of quantitative easing by the US Federal Reserve will boost asset values but doubts will persist about whether the Fed can engineer a seamless transition between its market interventions and a sustainable recovery in US domestic economic activity.
The US Federal Reserve has concluded that the momentum of US economic activity is fading. The pace of growth is insufficient to reduce unemployment to any material extent.
At the same time, Fed chairman Bernanke is unable to rely on the executive or legislative arms of government to pull their weight. He is simply the only game in town if the pace of economic activity is to pick up.
More than that, the rate of growth could be set to sink lower over the next few months as US politicians first jockey for election and then deal their way out of the imminent tax rises and spending cuts which have been built into the system because they have fluffed their chances to stabilise their fiscal balances in the past.
The US government is at the heart of the employment problem in another way. Government cutbacks in this cycle have retarded the overall expansion of employment.
Since the Second World War, the number of government employees had increased over the three years following the end of each of the 10 recessions in the US with only one exception. The exception was the recession that ended in July 1980 but was followed very quickly by another downturn that began in July 1981 and finished in November 1982. Even so, three years on from the end of this second recession, government employment had risen by over 4%.
In other words, government employment in the USA has typically supported a recovery in economic activity. Not so in this cycle. Three years on from a recession which finished in June 2009, government employment is 2.8% lower. Meanwhile, private sector employment has risen by 2.9%.
This private sector growth outcome is more than three times the pace of growth coming out of the 2001 recession and only slightly lower than the 3.9% gain coming out of the recession that ended in 1991.
Fewer government employees and less government spending on goods and services are another wet blanket on the enthusiasm of the private sector. Not only is the Fed trying to compensate for a range of international financial market circumstances but is also battling decisions among many governments in the USA to pare their budgets.
The Fed cannot act directly against these pressures. Buying financial assets is, if it works, an indirect way in which to help boost employment, at best.
The Fed will be hoping to have two effects. One will be through the housing market. Purchasing mortgage backed securities will help to reduce already low funding costs and, at the margin, might boost demand. There is a backlog of inventory to clear so that higher demand will only translate into construction activity with a lag of currently unknown duration.
As always, monetary policy is a little like a blind man trying to make his way to a door across an unfamiliar room. As he is feeling his way, he is never sure how much further he has to go. He might do some damage getting to the door but will recognise the door as soon as he comes across it. In this case, the door is an increase in the rate of real output growth.
The second effect of the infusion of additional liquidity by the Fed will be higher equity prices. This will bolster the wealth and confidence of households. Past a point, it might encourage them to spend more. Again, where this point is remains unclear.
Higher equity prices would normally make raising capital less expensive and encourage investment. However, access to capital among companies with already strong balance sheets has not been a constraint in this cycle so that higher equity prices will be less likely to boost corporate spending.
The Fed has tried to show its commitment to the task by not placing any upper limit on the total size of the $40 billion a month asset purchase programme it is initiating. By eschewing a ceiling it is trying to reinforce the sense that it will find the door.
Of one thing we can be relatively certain. There is a strong connection between the growth in the supply of money and the speculative flow of funds into a range of asset markets.
The European monetary authorities are also set to begin a more aggressive asset buying programme. Theirs differs from that of the Fed insofar as they will try to sterilise the monetary effects of their purchases.
Nonetheless, the combined activities on both sides of the Atlantic could spur greater speculative and investment interest in commodity and other asset prices.
The adrenalin surge will keep us moving but only for so long. In this sense, the key issue for investors depending on more favourable outcomes in the real economy will be how long it will take for the blind man to make his way to the other side of the room. Is he just a step or two away now? Or, in making his way across the room, is there still furniture to trip over and family heirlooms to smash into?
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