by Mitch Kokai
Senior Political Analyst, John Locke Foundation
If you think it was a good idea for the Federal Reserve to stimulate the American economy, Thomas Donlan asks you in his latest Barron’s column to consider what will happen when the Fed decides to put the brakes on artificial stimulus.
The Fed now occupies the commanding heights of the U.S. economy and doesn’t know how to withdraw. Money markets, bond markets, and stock markets chafe under the thumb of the Fed’s zero-interest-rate policy, known as ZIRP. Values in all three are dependent on the Fed’s continuing to supply free money through quantitative easing, known prosaically as QE.
These have become essential to American finance as we now know it. We have no general but the Fed, no strategy but hanging on.
Wall Street is not an army; it is a mob that sells bonds and stocks and dollars whenever somebody looks up from his array of computer-display screens and asks, “Tell me how this ends.” When Bernanke or some other central banker starts to explain, the mob’s fingers start to move on computer keyboards and markets tank, as happened last week and on May 22, and will probably happen each time Bernanke speaks about trimming or tapering or reducing QE and ZIRP.
For it’s plain to see how this ends—or rather, how it doesn’t end. Under the relentless pressure of free money, the U.S. unemployment rate gradually falls toward the goal of 6.5%. The Fed slows and then stops buying Treasury debt and starts selling its accumulated hoard. Money comes out of the real economy. Interest rates rise, and unemployment rises again. Bernanke’s successor declares the nth stage of quantitative easing and continues to ZIRP the economy for a few more months. Repeat ad libitum, ad nauseam.
As long as the Fed holds responsibility for the economy, the recovery will be fragile. And as long as the recovery is fragile and incomplete, the Fed’s monetary policy will be responsible for boosting the economy.
What’s needed is a new strategy—an escape from planet ZIRP. It will be at least as difficult to manage as the escape from Iraq.