Financial FAQs

As we all know by now, Fed Chairman Bernanke seems to have abruptly switched sides in the stimulus debate. He said the purchases of $85 billion in bonds and mortgage securities could begin to be ‘tapered’ by the end of the year, if unemployment continues to fall—maybe to 7 percent.

Of course stock and bond prices plunged as they did 3 weeks ago, when he first mentioned the possibility, because there are few indications that employment will improve that much, and inflation reverse its downward plunge. Many, such as Nobelist Paul Krugman, believe he is wrong in making that pronouncement at the latest FOMC meeting and press conference afterward.

“My (initial) reaction is, this is not good. They might get away with it, but there’s also a serious chance that this will end up looking like a historic mistake. Bear in mind, first, that the US economy is still deep in the hole, which is especially obvious if you look at employment rather than unemployment:”

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Graph: St Louis Fed

“Aging of the population accounts for some but not much of the fall in the employment ratio; the fact is that we are still a very long way from acceptable employment levels,” said Krugman. “Meanwhile, inflation remains below the Fed’s target. Maybe the Fed believes that the situation will improve — but as everyone points out, the Fed has been consistently over-optimistic since the crisis began. And for now the economy still needs all the help it can get.”

So why is Bernanke suddenly so optimistic about growth? Bond guru Bill Gross, for one, thinks the markets are misreading Bernanke, because Bernanke said at the same press conference that inflation now at 1.1 or 1.4 percent (depending on which indicator is used) has to approach its 2-2.5 percent target range, and unemployment has to come down to 6.5 percent from its 7.6 percent rate before the Fed will stop its QE3 purchase of securities.

So this tells us the importance of low interest rates during this recovery, when household incomes are still stagnant, mainly due to almost no growth in wages and salaries—the income earned by most households (therefore consumers), as I said in my last column.

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Graph: Trading Economics

Meanwhile, inflation is still declining, not a good sign, so Bernanke must be attempting to manage expectations that economic growth is more robust that we know at present. I.e., he wants us to believe that in fact the economy is recovering faster than at present. I hope he is right in seeing better growth in the tea leaves the rest of us don’t see.

He might be right. Real estate at least is showing a better recovery. Existing-home sales rose 4.2 percent in May to a seasonally adjusted annual rate of 5.18 million — the highest rate since November 2009, when a buyer tax credit deadline approached — pointing to a continuing recovery, the National Association of Realtors reported Thursday. Sales of existing homes in May were 12.9 percent higher than during the same period in the prior year.

Harlan Green © 2013

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