Recently, the Federal Reserve issued a statement in which the members of the committee downgraded their description of the expansion of economic activity in the US from "moderate" to "modest" and reiterated their intention of keeping the zero interest-rate policy in effect for "a considerable time." They also kept in place their ongoing quantitative easing policy, known as QE3 (sometimes nicknamed "Q-Eternity").
While the stock market response to this ongoing dovish sentiment from the Fed has been generally positive, we believe that the continuation of what were originally billed as "emergency measures" to address the 2008-2009 financial panic is unhealthy for the economy and the markets.
We have written many times previously that the Fed should not be attempting to "steer" the economy. Most recently, we discussed this problem in a blog post published towards the end of June, which contained links to the many previous posts which warn against the dangers of Fed "over-steering."
Even if the Fed does not decide to get out of the business of trying to steer the economy, we also believe that continuing to steer the economy as if it is in the middle of a major financial panic is inappropriate and potentially dangerous, just as it would be inappropriate and dangerous to drive your car as if you were always in the middle of an action movie car chase rather than simply going to work or going out to get coffee.
We have written about this problem before as well, such as in this post from last year entitled "Growing the economy, part 1: Get off a 'war footing' with monetary policy." We know that central planners and policy-makers generally like to act as though we're always in the middle of an existential crisis (like a war): witness the "War on Poverty" and the "War on Drugs." Such a mentality can induce the people to accept greater levels of intrusion into their lives from the governing bodies. However, if such behavior is used all the time, it becomes a serious distraction to the normal, healthy functioning of individuals and businesses who are just going about their business and leading their lives.
At the risk of adding one too many metaphors, it's like the story of the "Boy who cried wolf." After a while, the farmers got tired of dropping whatever they were doing and running to save the little boy's sheep from a wolf that wasn't really there. All that running around took them away from their own business of the day.
While some would argue that the US economy has been in need of life support since 2008-2009, and that in such dire straits an endless "emergency status" is appropriate, we believe that the economic numbers have shown and continue to show steady, if painfully slow, economic growth. We would also point to the analysis of professional economists whom we respect, such as Brian Wesbury, who argue that monetary policy gimmicks are not the way to grow the economy, and don't address the real issues that have been stunting economic growth in the US.
In a recent note published on July 31, Mr. Wesbury wrote:
As we have written many times before, QE3 is simply adding to the already enormous excess reserves in the banking system, not dealing with the underlying cause of economic weakness, including growth in government, excessive regulation, and expectations of higher future tax rates.
Mr. Wesbury has coined the term "plow-horse economy" for the slow but steady progress that the economy has been making since 2009, and recent economic data such as the latest ISM manufacturing number and data showing continued gains in employment rates appear to support such a description. The main reason the "plow horse" is not moving faster is that government has been weighing it down with additional regulation and costs, and these cannot be addressed with monetary policy from the Fed.
In fact, inappropriate "emergency" monetary policy actually acts as another load that weighs down the plow horse. As another economist, Scott Grannis, writes in a post published on August 1 and entitled "A decent manufacturing report trumps QE," recent economic data:
casts serious doubt on the assumption that many observers have made that the Fed has been artificially lowering interest rates and in the process distorting the capital markets and artificially stimulating the economy. As I've asserted for a long time, the Fed's QE program has been designed not to stimulate the economy but to accommodate the world's intense demand for money and cash equivalents. And not only has monetary policy not been stimulative, but fiscal policy has been acting like a headwind to growth, since its emphasis has been on redistribution, huge new regulatory burdens (e.g., Dodd-Frank, Obamacare), and higher taxes. In short, what we are seeing is that the economy has been growing in spite of monetary and fiscal policy, not because of it.
We believe these are very important insights from economists to whom investors should pay close attention. Their analysis supports the assertions we make above that the Fed's continued zero-interest-rate policy and quantitative easing are inappropriate "oversteering" and that the sooner these policies end, the better.
Investors should also note that many stock market participants wrongly believe that the Fed's ongoing "emergency measures" are a good idea. When those policies are finally removed, there may well be some serious negative reactions in the stock market. However, we believe that any tantrums the market throws when the Fed finally ends these inappropriate policies will be outweighed by the longer-term benefits of getting these policies out of the way of real growth.