The Fed’s stimulus is off to a flying start – but will it last? Maley

Global asset prices soared overnight as investors world-wide embraced the oldest investment tip on Wall Street: ‘Don’t Fight The Fed’.

And right now, the US central bank wants higher asset prices. Ben Bernanke, the boss of US Federal Reserve, left no doubt in an opinion piece he wrote for the Washington Post that the central bank wants to push asset prices higher.

In the piece, Bernanke explains that the Fed is not satisfied with the state of the US economy. The country’s unemployment rate is close to 10 per cent and large numbers of people can only find part-time work. And inflation is too low.

As a result, when the Fed’s all-important monetary policy committee, the FOMC, met earlier this week, it decided that more monetary stimulus was necessary. But because short-term US interest rates are already about as low as they can go, the FOMC decided to push long-term interest rates lower by buying $US600 billion of longer-term treasuries.

Bernanke was certain that this policy would be successful. He pointed out that stock prices have climbed, and long-term interest rates have fallen since he first started hinting that the Fed was about to embark on a new bond-buying program.

Even more importantly for investors, Bernanke spelled out exactly why the US central bank believes that higher share prices are crucial to the US economic recovery. “Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending,” he wrote.

And the Fed is hoping that this additional spending from the newly-confident US consumer will mean that US businesses see more demand for their products and services, and this will encourage them to increase their investment and hire more workers.

As Bernanke put it: “Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Critics of the Fed’s latest bond-buying warn that the Fed’s policy of pumping in additional liquidity to spur a share market rally is doomed to failure.

They point out that debt-laden US consumers have been too badly stung by previous share market slumps to have much faith in the latest rally. Households, fearful of high levels of unemployment and deeply aware of the plunge in the value of their most valuable asset – the family home – are cutting back on their spending and trying to whittle down their debt. As a result, consumer spending is likely to remain weak, even if Bernanke ignites a spectacular surge in the share market.

Others warn that investors, emboldened by the Fed, are likely to happily go along, creating bigger and bigger global bubbles in shares, bonds, commodities, gold and oil. Eventually, however, they’ll realise that the Fed has not managed to solve the underlying problems of the US economy. At that point, there’ll be a massive collapse in asset values.

This article first appeared on Business Spectator.