Mark Twain once said, To a man with a hammer,
everything looks like a nail. To the Federal Reserve
an institution employing an army of economists and
academics everything looks like an economic problem that
needs to be quantitatively eased. As a result, the Fed is
killing the economy.
Sir Alan Greenspan, who after he left the Fed suddenly
turned into a rational and comprehensible person, said during a
recent appearance on The Charlie Rose Show that businesses
dont want to invest because they are concerned about the
future. I agree.
Ironically, by intervening in the free market and
arbitrarily setting short- and long-term interest rates at
insanely low levels, the Fed is responsible for this
uncertainty, enabling and propagating speculation not
investing and eroding confidence about the future.
Usually, in investing, liquid capital turns illiquid when it is
committed to a higher, more productive long-term use. The
ability to forecast aftertax cash flows and discount rates is
key here. Speculators, however, are indifferent to what asset
they hold (junk or quality). Their time horizon is much
shorter, and they are just looking for a greater fool on whom
they can unload their stuff. The next tick in price is the only
variable that matters to them.
Speculators are the ones driving stock prices up (and down)
in the short run, but they leave as quickly as they arrive. It
is the investors who stick around, but because of Fed chairman
Ben Bernanke, they are choosing not to come.
The Fed and others are measuring the health of our economy
by the wrong statistic: unemployment. Its a political
number that everyone pays very close attention to, but
its not as important to the economy as it appears to be.
Although 9 percent unemployment is high statistically, most of
the inability to find work is in low-paying sectors.
Unemployment among people with bachelors degrees was just
5.4 percent last year, according to the Bureau of Labor
Statistics, while unemployment among those who dont have
a high school diploma was almost 15 percent. Workers with a
bachelors degree make almost three times more than those
who dont graduate from high school. Thus the economic
impact of unemployment is a lot less pronounced than the
headline number may indicate.
Dont get me wrong: I feel for all the people who
dont have jobs. But the Fed and the government are trying
to fix a problem that only time can solve. The bulk of current
unemployment is structural; it is not caused by too little
money in the economy or interest rates being too high
the Fed took care of that, and it didnt make a
Focusing on the wrong statistic and using the
governments balance sheet (that is, debt) to cure the
incurable is dangerous. The statistic that the Fed should focus
on is the one it worries about the least, as it feels it can
control it yes, interest rates. They are more important
for our economy than unemployment. As our debt grows, interest
payments are becoming a greater portion of the federal budget;
thus our budget deficits will become more
interest-rate-sensitive, which in turn will impact tax rates.
The housing market is tethered to interest rates as well.
Having taken short- and long-term interest rates to all-time
lows, the Fed has not been able to lift the housing market
we simply got too addicted to low interest rates.
However, if interest rates go up to levels we have not seen in
a few decades, they will tank the housing market.
The Fed is desperately trying to mess with interest rates
through quantitative easing, but at some point it may lose
control over them. Recently, we saw yields of Italian bonds
jump to 6 percent and Italy is a first-world nation. The
market is more powerful than the Fed and not stupid. It will
not let the U.S. government borrow at first-world rates while
behaving as a third-world country (like the ones we used to
preach to about how to run their government finances). ?Also,
China and Japan, the largest foreign holders of ?U.S.
Treasuries, have their own sets of problems and may have a lot
less demand for our less-than-excellent debt in the future.
Until the U.S. hits the wall, we are not willing to take the
needed pain: significant budget cuts across the board (we
simply cannot afford the government we have) and some higher
taxes. Unfortunately, we are so impressed with the Ivy League
vocabulary the Fed heads use, and so scared that our economy
will cease to exist without the Feds help, that we play
along. But our economy really needs to get off Fed (and
government) steroids and start functioning on its own. However,
judging from Bernankes latest testimony to Congress, that
is not likely to happen, as the Fed will use the U.S. economy
as a laboratory for untested measures, which will go down in
history as QE3. Prepare for higher interest rates and higher
Vitaliy Katsenelson (firstname.lastname@example.org) is CIO at Investment
Management Associates in Denver and author of The Little
Book of Sideways Markets.