Ben Bernanke, Chairman of the Federal Reserve (Fed), gave a speech on Monday that sent the equity markets skyward. He announced to the world that he is going to keep the peddle down and the presses rolling: loose monetary policy is here to stay. The markets applauded, but should they?
There is another way to interpret what Bernanke is telling us: The economy is still in trouble. We have been hit with a lot of encouraging news over the last few weeks, especially with improving unemployment numbers. However, the Fed is concerned that these recent gains may not be sustainable. Unfortunately, we would have to agree.
Europe’s problems are not going away even if the media decides not to report on them when there are other more exciting things to cover. In Europe once again there are calls to increase the ever-growing bailout fund, and once again Germany is saying, “Wait a minute.” Italian and Spanish yields are creeping back up. Although the new Italian government led by Mario Monti has introduced some brave, and needed, reforms of the Italian labor market, those reforms are being resisted by the powerful trade unions. If Italy cannot overcome that resistance it will likely follow the path of their neighbor, Greece, with much greater consequence to the rest of the world.
China’s growth is slowing perhaps more than we realized. We have been very hesitant to jump on the anti-China bandwagon, but there are certainly signs that the world’s economic growth machine is slowing down. China is in the middle of an economic transition. Factory wages have grown dramatically and have encouraged a shift from China being simply being a cheap source of manufacturing for the developed world, to becoming a self-sustaining, consumer-driven economy. This maturing process may come with some growing pains.
Then of course there is the Middle East. What is going to happen between Iran and its neighbors is anyone’s guess, but we deal in the world of probabilities and a military conflict of some sort seems like a fairly strong probability. That will not go over well with oil prices, and if the already high price of oil spikes from current levels, all economic recoveries could be off.
This is the world Bernanke sees. Unfortunately keeping monetary policy loose will not help with most of the risks. This, however, is the problem with the Fed’s dual mandate of stable money and economic growth for low unemployment. The Fed must realize that since the end of the financial crisis its policies have not been effective, but what choice do they have as long as their mandate is to promote growth? It is increasingly clear that the problems our economy faces cannot be solved through monetary policy alone.
Markets cheer the news that money will continue to be printed, but this knee jerk reaction could quickly move the other way when investors start to understand what Bernanke and the Fed are really saying. They are saying that despite all their efforts things are not getting better. That is not a bullish message.
Over the past month the market bulls have been saying that the U.S. economy is picking up and that we can be a catalyst for global growth once more. Bernanke just told us that isn’t going to happen, and we think investors should listen.
Chuck Osborne, CFA
Managing Director
