Trader’s Narrative

In today’s Washington Post Op-Ed, the Federal Reserve’s Chairman, Ben Bernanke, basically admits that the $600 billion quantitative easing program announced yesterday is meant to propel stock prices higher:

The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

The above bolded text is my own emphasis. So basically the Federal Reserve is adamant about forcing the US consumer to set upon the previous course of debt and credit gluttony based on the mirage of unsustainable equity and home prices. But their ultimate goal isn’t so much as to create a mirage economy but to kick start the stalled economy to gain the momentum necessary to set the US economy on a path of growth. Then they hope that real growth will take the place of their artificial one.

While the present course chosen by the Fed is one way to accomplish this, another, would be to address the structural and secular changes that have taken place. For example, the US consumer has changed their habit of consumption and is now set upon savings. Or take another example, their penchant for bonds instead of equities. And a housing recovery won’t be realistic until personal income rises and unemployment abates so that higher prices are sustainable.

Clearly, it is not in the long term interest of the average US consumer to simply put the economy back on the same track that it was before without addressing at a fundamental level why it went off the rails so spectacularly.

Having said that, we have to keep in mind that the Federal Reserve is extremely powerful. They aren’t omnipotent and Bernanke admits so much at the end of his Op-Ed. But they are certainly capable of accomplishing this.

And for those worried about the inevitable inflation (of hyperinflation) that such policies will create, Bernanke gives his assurance that this has been considered and the Federal Reserve stands ready to “unwind these policies at the appropriate time”. Now, doesn’t that make you feel better?