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Washington Examiner

 

How The Fed Has Juiced The Stock Market

March 05, 2013

By Diana Furchtgott-Roth

The stock market market may be hitting record highs, but Carnegie Mellon economics professor Allan Meltzer is worried.

"We’re in the biggest mess we’ve been in since the 1930s," he told me when I visited him in Pittsburgh last month. "We’ve never had a more problematic future."

As America’s foremost expert in monetary policy, Meltzer, my former colleague at the American Enterprise Institute for eight years, should know. At age 85, he’s the author of the three-volume "A History of the Federal Reserve." For more than 25 years, he was the chairman of the Shadow Open Market Committee, a group that critiques Federal Reserve policies.

One reason the stock market is rising is that the Fed’s loose monetary policy -- quantitative easing, purchases of bonds -- is resulting in record-low interest rates, so investors are taking risks to get higher yields.

The Fed spends $85 billion each month purchasing Treasury bonds and mortgage-backed securities. That’s the amount of the entire sequester for fiscal 2013.

Older people, many of whom rely on income from savings and investments, are moving into riskier assets, such as the stock market, in order to be able keep up their standards of living. Many have no choice.

Low interest rates discourage savings and encourage people to take high risks, as well as dampening bank lending. This does not lead to a healthy economy. It ends in tears and regrets.

When interest rates rise, as they will have to at some point, the value of these risky investments will decline, and these older investors will be hurt.

Plus, interest payments on the public debt will rise, increasing the budget deficit, which has been a trillion dollars a year for the past four years.

The question is, how high will interest rates have to go to head off future inflation? No one knows, and the Fed isn’t inclined to start raising rates any time soon, as Fed Chairman Ben Bernanke told House and Senate committees earlier this week.

Bernanke’s position is that the economy is weak and unemployment is too high, and so he will keep interest rates at near-zero levels. But interest rates at zero have disadvantages too.

Governments by nature are more concerned about what happens today than what happens in the future, Meltzer told me. So there is little pressure on the Fed to unwind its positions and raise rates.

Meltzer recalls only one economic recovery as slow as this one, and that’s the recovery of 1938, under President Franklin Delano Roosevelt. Roosevelt attacked business, and continued to do so until the onset of World War II. Then he needed economic expansion, and stopped the anti-business rhetoric and actions. Many business owners are convinced that President Obama is similarly hostile to business.

"I don’t see any bright spots of importance," he told me. "Just dead ends."

What would Meltzer do? If it were up to him, he would reduce tax rates, put the Fed’s mortgage debt into a lockbox to preserve its balance sheet, and then gradually start raising rates. During the Reagan recovery, interest rates were between 5 percent and 7 percent after adjusting for inflation. Commodity prices declined, helping to move the economy to a stronger growth path. Now interest rates are negative.

No chance of a more sensible policy now, though. Bernanke will keep the Fed to its current path, and his potential replacement, Janet Yellen, is likely to prime the pump even faster.

Many believe that Fed actions can allow the government to continue indefinitely with deficit spending, raising stock market values. But Meltzer, a student of history, says "no way."

Original Source: http://washingtonexaminer.com/diana-furchtgott-roth-how-the-fed-has-juiced-the-stock-market/article/2523305

 

 
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