So the Fed announces QE3: Operation Twist and the market tanks. I think it’s a little unfair to say the market drop was in direct response to the size and characteristics of the Fed’s next round of quantitative easing: after all, we are still significantly higher than recent lows on the DOW and S&P 500. Suffice to say the market reaction could have been significantly worse.
The Gist of the Ben Bernanke Twist
The long and short (you’re going to hate me for that pun) of Bernanke’s Operation Twist is effectively purchasing long bonds while selling short term bonds (follow the actual Fed POMO open market operations). If you’re scratching your head and thinking, “What does it matter that they’re buying long bonds and selling essentially the same amount of short bonds?” you are asking yourself the right question. The easiest answer is the Fed is trying to squeeze long term borrowing rates just a little lower. They believe that doing so will improve credit borrowing rates for average folk (encouraging a few more large ticket / debt financed purchases) by businesses and consumers.
Doing so should have the impact of stimulating a small amount of GDP. The problem is rates are already as low as consumers could possibly want them (and buying interest remains sputtering – July car sales up, August down – July housing sales down, August up). Perhaps the Fed is hoping that businesses will get off the sidelines and re-finance or expand, driving some economic activity. I remain pessimistic about both cases: businesses MAY borrow more and invest in capital goods… but this trend has not increased employment. Investment in capital goods of late has been done in replacement of labor. On the consumer side, folks are effectively holding out as long as they can before making purchases. It won’t be until more communities see a concrete bottom in the housing market before prospective buyers will take on another mortgage. So many mortgages and home purchases went bad the last go-around it will be a long time before some folks take another chance on such a large portion of their wealth/equity capital.
Don’t Blame the Fed or Bernanke
You read the headline: don’t blame Chairman Bernanke or the Fed for the lack of progress on the economic and job front. The Fed (a dissenting Fed at that) has fired (and is committed to continue firing) every last bullet they have to push economic growth. The problem the Fed has at this time is that silver bullets (US Congress spending) are needed to fill the massive debt void caused by the housing debt collapse. The Fed neither creates nor removes money from the physical and electronic money supply. Currency in circulation is controlled by the Congress (via deficit spending), and right now there is not enough to go around to pay the debts government, businesses, and households have accumulated. The Fed only manages what is in circulation and realistically can have little impact on economic growth.
Why Have the Fed at All?
One outcome of the present economic crisis is the evaporated mystique that surrounded the Fed. There was a time when dollar bills may have just as easily read: “In Greenspan We Trust.” I think nearly all citizens with a modest interest in the economy understand that the Fed is powerless to expand the economy given historically low rates have proven inadequate to restore healthy growth to GDP. The power of the Fed we can see remains useful in times of expansion and in instances where inflation is a risk – but they have no silver bullets when massive debt bubbles implode. Paging John Boehner… hulllooo?