Federal Reserve Chairman, Ben Bernanke, has given a clear indication of how he intends to proceed with monetary policy in the event that economic indicators fail to suggest that a recovery is under way. He has conveyed the impression that the Federal Reserve will take whatever steps are necessary and proper to carry out its mission.
The Fed has thus far prevented economic armageddon by providing unfathomable amounts of money into an already diluted system. They have bolstered the banking sector by buying mortgage assets in a so-called quantitative easing. Readers may recall that the Fed pushed overnight rates to near zero in December 2008 by announcing that they were buying nearly $2 trillion in mortgage-backed securities, the so called “toxic assets”. Further aggressive Fed action has kept interest rates at near record lows for the better part of 2 years now. However, rates on long-term U.S. government debt rose after the Chairman made his remarks at a conference sponsored by the Boston Federal Reserve Bank. The nation’s commercial banks have taken this opportunity to pile Treasury bonds onto their balance sheets in an effort to improve their solvency. They have also increased their loan loss reserves during this period of increased loan defaults. And for all of the easing by the Fed, hoarding cash seems to be the one activity the entire nation is engaged in. It seems as fast as a person or an entity gets its hands on a dollar it is locked up and preserved for the proverbial rainy day. This loss of velocity make dollars quite dear. The subsequent loss of business activity leaves many American businesses struggling to survive. So how exactly is the overall economy doing?
According to the United States Commerce Department the climate is improving. They recently issued a revised estimate of second-quarter growth. It showed Gross Domestic Product expanding at an annual rate of 1.6 percent. Although far from a buoyant reading, apparently productivity as measured by the government policy makers is showing some signs of improvement. I use that qualification because most
small business owners would disagree. It seems the first seeds of recovery have been aimed at large corporate owners.
Further information is garnered from measures of consumer sentiment which also showed positive increases during the month of August. This was an especially welcome change after a protracted period of declining consumer sentiment, and when consumers are not positive on future prospects, they freeze their spending, exacerbating the velocity problems mentioned before. All of these indicators taken together may suggest that the slightest sparks of a recovery have in fact been kindled. However, one thing is sorely lacking in this nascent recovery. American are screaming for jobs. They are also screaming at their elected officials for jobs. Overall, this suggests that the Fed will continue to stimulate the markets with easy money until the sparks become the raging fires of inflation. There are three ways that the Fed can accomplish this task with current tools. First, by expanding their frenzied purchase of long-term government backed securities. So far this action has proven effective at reducing long term interest rates and overall growth in 2011.
Conditions Uncertainty about new regulations on businesses is causing a freeze on hiring and expansion. As these conditions clarify, expect job growth to accelerate. With the midterm elections around the corner, polls are showing that Americans harbor a lack of confidence in President Obama’s handling of the economy. The question of how to encourage private sector hiring has been the subject of much debate. A survey last month of more than 1,000 chief financial officers by Duke University and CFO magazine, showed that nearly 60 percent of those executives do not expect to bring their employment back to pre- recession levels until 2012 or later. These same executives are projecting a 12 percent rise in earnings and a 9 percent boost in capital spending over the next fiscal year. When analyzingthereasonswhy companies are being so cautious, uncertainty seems to be the most compelling factor. Executives aren’t sure whether the economy can and will sustain a strong recovery. As a result they put expansion plans on hold. If consumer spending remains anemic then there isn’t much incentive for companies to ramp up production or hiring. Only time will tell what lies ahead..borrowing costs.
They can also expand the program to include other non-governmental debt instruments thereby spreading the benefit across all asset classes. Secondly, the Fed could also modify the language in its statements to indicate that short-term interest rates will remain low for a longer period than is currently expected. By sending such a clear signal to the investment community, they might encourage more of them to take on additional risk in such an environment. This might also lead to additional hiring and more jobs. Third, by lowering the reserve requirement that the commercial banks must keep, or lower the rate of interest that the Fed pays to these banks on reserves that they keep within the Federal Reserve System. Lowering the rates paid on deposits would providebankswithanincentiveto increase their lending instead of leaving excess reserves with the Fed. This would provide for some expansion in money and credit, but that could also create inflation. Despite the weaker data seen recently, the circumstances appear to support the financial situations that will become more supportive of economic growth, in part because a concerted effort by policy makers in Europe has reduced default fears surrounding the debt of the European nations and the commercial banking system in the Euro community. Absent any significant action by the Fed, banks seem to be more than willing to lend. However, consumers are paying down debt and building reserves, operating at odds with each other’s interest. Businesses also appear likely to invest at an accelerated pace in the coming year. This is reflected in the fact that corporate America is hoarding an unprecedented quantity of current money. To date, this balance sheet building by corporations has stymied economic activity. A clear signal that conditions have improved will spur these companies to begin hiring and expand their mergers and acquisitions. These non bank corporations have roughly $2 trillion in cash, compared to $1.5 trillion before the beginning of the recession. Moving forward we anticipate major firms reporting impressive earnings. This will encourage even more money to flow into these firms’ treasuries.