SERIOUS MONEY: THE WORLD'S monetary authorities are back on the offensive and both the European Central Bank (ECB) and the People's Bank of China (PBOC) grabbed the headlines last week, as they increased interest rates in an effort to combat rising inflationary pressures.
The ECB raised overnight interest rates by 25 basis points to 1¼ per cent with the hawkish tone of the subsequent press conference suggesting further hikes are in the pipeline; in Beijing, the PBOC increased interest rates by 25 basis points to 6.31 per cent – the fourth move since last September and the second this calendar year.
Meanwhile, the US Federal Reserve remains on the sidelines and argues that increases in the inflation rate arising from the surge in food and energy prices should prove transitory. Its lack of concern with the uptick in goods price inflation may well prove justified, as slack in the labour market is likely to keep wages in check.
However, the Fed’s ultra-accommodative monetary policies could ultimately threaten both economic and financial stability due to a surge in speculative activity across a variety of asset markets.
Fed chairman Ben Bernanke has been quick to deem the central bank’s quantitative easing (QE) policies a success, based on the sharp rise in stock prices.
It is true the major equity market indices jumped by more than 36 per cent during the first round of QE and by a further 25 per cent since the launch of QE2, but valuations are now in dangerous territory by any reliable measure and the much hoped-for kick-start to investment and consumption has proved largely elusive.
Although corporate profits have jumped to within touching distance of an all-time record over the past two calendar years, the resulting large cash balances, combined with the lower cost of capital arising from QE2, has not translated to a notable increase in the capital stock due to a dearth of productive investment opportunities in the US.
Furthermore, more than half of the increase in domestic profits is attributable to the financial sector, which has seen its share of earnings increase by more than 12 percentage points to 28 per cent. The investment share of GDP net of depreciation remains low, as the financialisation of the economy continues.
Higher share prices have not only failed to produce a positive investment effect, but the wealth effect upon household consumption has also been largely absent.
This is not difficult to appreciate when one considers that the top 10 per cent of wealthiest American households own more than 80 per cent of all common stock held by households. The typical household owns little or no stock, which means the surge in equity prices has little if any impact on their balance sheets.
The fact is that the primary asset held by the typical American household is their home. Indeed, the bottom 90 per cent account for 54 per cent of all housing equity and as a result, the wealth effect arising from a change in house prices is estimated to be at least twice as large as that arising from a change in equity prices.
In this regard, the Federal Reserve has not proved so successful, as mortgage rates have jumped by more than half a percentage point since the launch of QE2 and house prices have resumed their downward slide with no bottom in sight.
Although Bernanke likes to take credit for the rise in stock prices, he seems less keen to assume any responsibility for the surge in commodity prices. Indeed, a recent report by the San Francisco Fed concludes that quantitative easing has had no discernable impact on commodity prices.
It is undoubtedly true that numerous supply and demand factors contribute to price movements in commodity prices, but the notion that the Federal Reserve has played no role seems a stretch.
First, commodities are priced in dollars and the trade-weighted dollar has dropped by almost 9 per cent since the launch of QE2, which has almost certainly provided impetus to the commodity story. Second, quantitative easing has also contributed to an increase in inflation expectations. In this regard, an obvious beneficiary from the perspective of investors and speculators is the commodity arena.
The recent surge in both food and energy prices has erased in its entirety the two- percentage point lift to nominal income growth arising from the recent tax cuts. Just as higher stock prices do little for the average American, the recent jump in commodity prices has proved far more punishing.
Spending on food and energy accounts for almost 17 per cent of the lowest-income households’ personal consumption expenditures, or roughly eight percentage points more than the comparable figure for the highest-income households. It is hardly surprising in this context that consumer confidence has plummeted.
The Federal Reserve’s ultra- accommodative monetary policies are fuelling undesired speculation in a variety of asset markets that is already proving costly to the average American. Those policies are undoubtedly misguided.
charliefell.com
