Ben Bernanke’s encore
It is not the risk of tapering that investors should worry about but asymmetric policy stance on part of the US Fed
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Now that the much dreaded “tapering” is out of the way, financial markets have realized that they were dreading a phantom dragon in the last few months. On the day the US Fed announced that it would buy “only” $75 billion of bonds (treasury securities and mortgage-backed securities), US stock indices made new highs. This episode confirms, if such a confirmation were needed, that financial markets are only capable of identifying the last risk or the last bubble. In truth, if financial markets can identify a threat ex-ante, then it is unlikely to be a threat. Bubbles burst because of risks that markets had not anticipated and had not priced in.
Since financial markets had reacted nervously to the threat of tapering during the summer months, the Fed had gone out of its way to reassure markets that it will keep monetary policy accommodative for longer than warranted and excessively so. There was one dissenter at the Federal Open Market Committee meeting who did not want the Fed to initiate even this mild tapering. The usual dissident, Esther George, fell in line presumably because she thinks that reducing the bond purchases by $10 billion per month removes the risk of excessive and prolonged policy accommodation. Groupthink is an affliction that no group is exempt from.
Technocrats are expected to take the long view while politicians are more responsive to the political cycle that comes once every four to five years. But, technocrats too have caught the short-term bug. Their horizons have shrunk too. Perhaps, their horizons are now limited to their tenure. They pursue personal popularity and not enduringly sound policies. Some academics in the US think that bubbles are required for maintaining the pretence of economic growth. The actions of the Federal Reserve suggest that it accepts the premise unquestioningly. Hence, monetary policy appears to be actively fostering bubbles. All talk of improvement in the labour market undergirding policy is just that. Both the intermediate and end goals are creation of bubbles. Never mind that the consequences of a burst-bubble erase all the employment and growth gains that bubbles seemingly cause. Further, it does not matter that the economy not only gives up its gains of the previous expansion but also loses some of its innate ability to generate future economic growth.
The Federal Reserve held out a laborious and painstaking assurance last week at its policy meeting that ultra-accommodative monetary policy would be maintained well into the so-called economic expansion (“The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2%, especially if projected inflation continues to run below the Committee’s 2% longer-run goal.”). That is the real risk for investors in 2014.
The risk of tapering is now history but one that ought to concern investors for the next year but isn’t is asymmetric policy response from global central banks. They still think they can clean up after a bubble bursts but they do not want to lean against one—to borrow William Whites’ phraseology. This is what they did in 2003-04.
Alan Greenspan took seriously the threat of deflation because his favourite measure of inflation—the core Personal Consumption Expenditure deflator—had dropped below 1%. He bought insurance against deflation by cutting the Federal funds rate to 1% and holding it there for one year. In the end, it turned out to be a false alarm. Low rates in the US prompted low rates everywhere else and triggered real estate bubbles globally. They played catch-up in 2006-07 verbally and otherwise. The rest of the world paid the price, in 2007-08, for his error of judgement, compounded further and later by his successor Ben Bernanke.
Fast forward to 2012. Bernanke opted to insure himself against a meltdown in the euro zone with his third round of quantitative easing. In 2013, he has resorted to issuing unconditional promises of ultra-easy policy well into the future. These have pushed the S&P 500 to a record high and the new slogan for investment strategists is 2014 in (or, by) 2014. Once again, the non-existent threat of deflation has policymakers running scared into the hands of bubble trouble.
Therefore, it is not the risk of the Fed tapering that investors should worry about but asymmetric policy stance on the part of the Federal Reserve leading to a belated and aggressive catch-up inducing nasty corrections in asset markets. Despite the consequences of his policy actions in 2005-07, Bernanke has set up an encore with the small difference that the brickbats would accrue to Janet Yellen. That is just as well since she is more likely to follow more faithfully in his footsteps than Bernanke did on Greenspan’s.
V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at email@example.com.
To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk