Sunday, September 22, 2013

On the Wealth Effect, Monetary Morphine and Transitional Issues

When the U.S. Federal Reserve said it would not reduce its stimulus efforts, at least in the short term, many investors were very surprised.  This news triggered strong positive moves in equities, commodities and interest rate sensitive assets, while driving a strong move down in the value of the U.S. dollar on Wednesday (markets pulled back by Friday).  Note: These stimulus efforts, called Quantitative Easing, have been controversial and have expanded the Federal Reserve’s balance sheet from less than $1 trillion before the Great Recession to over $3.6 trillion today (some people refer to this process as printing money).  This stimulus activity sought to stabilize the economy and create a “Wealth Effect” - where people would feel richer, increase their spending and drive economic growth.

While real estate and stock prices have improved in recent years, data released by the U.S. Census Department last week revealed that the Wealth Effect is likely benefiting only a small portion of U.S. citizens.  For example, median household income was stable during 2012 at $51,017, but this amount is down 8.3% since 2007, and slightly lower than what households made in 1989 ($51,681 in current dollars).  Also during 2012, 15% of the population (46.5 million people) was at or below the poverty level.  This is an increase of 2.5% since 2007.

Reacting to the news, Congressman Kevin Brady, Chairman of Congress’ Joint Economic Committee said, “Those [Federal Reserve asset] purchases may have helped juice profits on Wall Street, but they have done little, if anything, to help struggling families on Main Street. In fact, this heavy dose of ‘monetary morphine’ may have actually slowed the economy’s healing process.”
  • During October 2010, Chairman Ben Bernanke said, “there are clearly many challenges in communicating and conducting monetary policy in a low-inflation environment, including the uncertainties associated with the use of nonconventional policy tools."  While these tools have provided some economic value, the recovery process has taken longer than expected.
  • With the Federal Reserve's leadership in transition, Janet Yellen may be the front-runner but a smooth transition is not assured.
  • Given weaker than expected economic fundamentals, the investment environment may encounter increased volatility.

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