As the Federal Reserve is set to end its quantitative easing bond-buying program this week, a veteran Fed watcher is warning the U.S. central bank increasingly demonstrates it has no answers to today’s economic challenges, leaving a severe market sell-off as the sole means of righting the economy.
The Federal Open Market Committee (FOMC) is set to formally conclude its $15 billion a month asset-purchase program when it meets in Washington Tuesday and Wednesday.
That meeting comes on the heels of another economic gathering in Washington—this time by officials of the IMF and World Bank, who earlier this month “were able to agree on one important thing,” says American Enterprise Institute resident scholar John Makin: namely, that “the global economy, especially in Europe but also in Asia and the United States, is slowing again, and outright deflation is drawing ever closer.” Makin has long warned about the risk of deflation, which he sees as the key global economic threat.
Now writing ahead of the FOMC meeting, Makin notes that the anticipated withdrawal of stimulus would occur at a time of increased market volatility which he believes has Fed officials scared, with spillover effects in a private economy that is increasingly losing confidence in policymakers.
“The Fed’s rising nervousness has been illustrated by a tendency toward rapidly shifting views among Fed leadership,” writes Makin in the monetary policy analysis.
“Fed Vice Chairman Stanley Fischer went from an Oct. 9 assessment that the Fed could begin tightening around mid-2015 — or perhaps a little earlier than the ever-shifting consensus — to an opposite, outright risk-on call on Oct. 11, saying that if the global economy continued to weaken, the Fed would further delay its move to higher rates.”
St. Louis Federal Reserve President James Bullard went further than suggesting putting tapering on hold, suggesting the possibility of a fourth round of quantitative easing (QE) in the face of a weakening global economy.
Makin laments that these comments followed a major market sell-off, despite the fact that the global economy has been declining for a half a year.
Indeed, despite shoots of growth such as occurred in the second quarter, U.S. GDP seems incapable of escaping its new normal 2% growth trend.
And that torpid pace is rapid-fire in comparison to the European economy, where outright deflation and a potential third postcrisis recession looms.
What Makin finds especially discouraging is that policymakers like European Central Bank President Mario Draghi are pushing for a European QE2 despite his view that that has already been tried and failed in the U.S., where it has not even blunted disinflation, let alone spurred growth.
Indeed, a particularly aggressive monetary stimulus program in Japan provides a particularly poignant example of the limits of easy money. There, the promise of Abenomics has fizzeled with second-quarter growth falling to a -7.1% pace.
He credits that dismal performance in part to “Japan’s bad 1997 habit of burying any green growth shoots with a solid dose of tax increases of uncertain timing and degree.
Beyond the U.S., Europe and Japan, Makin notes that the IMF has cut growth forecasts for China and emerging markets, and asks if the world’s economic policy makers have a Plan B.
Surveying the world, Makin argues that fiscal policy is largely contractionary and monetary policy consistently oriented toward tapering — the same policies that have so far failed to foster economic growth.
Indeed, Makin asks what alternative options policymakers could offer were the economy to weaken further or, worse, if deflation were to get hold of the economy.
Since the Fed and other central banks offer no new measures beyond a delay in hiking interest rates, Makin argues that businesses and households are coming to doubt officials’ ability to improve the economy, thus leading to further economic decline and increased market volatility.
“If the Fed overdithers or markets simply adopt more firmly the view that monetary policy is impotent while volatility spikes and risk assets are sold, what, if anything, is the antidote to weaker growth? If policy really is just supporting an unsupportable asset bubble, the incipient danger of a bursting rises daily,” he writes.
Making sees evidence of this decline in confidence in what he calls a “freezing” of global economic activity in which “most business managers far prefer cost cutting to capacity expansion as a means to preserve profit margins.”
As he puts it, “if managers think that the Fed and other policymakers do not know how to fix the economy, then how should they know themselves? Why should they invest to expand capacity in the face of persistently weak demand? Better to hold off on real investment until we all see either a more convincingly durable recovery or a capitulation,” by which he means an economic cratering that offers greater clarity about “what needs building and what does not.”
The free-market-oriented scholar says policymakers across the globe offer no ideas for growth. Even the IMF’s push for infrastructure spending meets with rejection from deficit-obsessed politicians in the U.S., Europe and Japan. Far less likely are proposals for tax cuts or structural reform, which Makin describes as not presently viable, and even risky in today’s environment.
“Rather,” Makin laments, “we continue to watch and wait until something gives, perhaps driven by the emergence of a substantial sell-off in markets — the aftermath of which somehow clears the decks for a return to higher levels of investment.”
The AEI scholar concludes that the sharp correction that may lie ahead may be the only thing that avails to get politicans to consider the removal of “growth-crushing policies.”
— Check out ‘Nasty Surprises’ in Store for Economy: AEI’s Makin on ThinkAdvisor.