Ben Bernanke, Chairman of the Federal Reserve, testified before Congress today and said that unemployment could remain elevated for quite a while. Moreover, he said that he needs to see “a sustained period of stronger job creation” before he considers the recovery firmly established. That sounds like it will be quite a while before the Chairman considers the recovery firmly established.
In August, 2010, when the Federal Reserve announced its second round of QE2 (Quantitative Easing full definition below), the US Treasury 10 year Note yielded 2.6%. It is now six months later and the yield on the US Treasury 10 year Note has risen to 3.7%. Mortgage rates and other borrowing costs have increased. Over the same period, the dollar has fallen about 5.5%, oil is up 16%, and gold is up 11.8%.
On Tuesday I was a speaker at the Lyons Companies 2011 Economic Forecast at the University of Delaware with Dr. Jeffrey Lacker, President of the Federal Reserve Bank of Richmond. Dr. Lacker said the he could see 4% GDP growth for 2011 and that QE2 should be reassessed. Lacker was upbeat and constructive on the economy. He is considered a “hawk” by Fed watchers, which means he is always perched, watching for and ready to attack signs of inflation. With stock indexes up over 24% since August, along with the aforementioned commodity price increases, it may be that Lacker’s hawkish radar is beginning to sound the alert. (Here is a link to my CNBC appearance discussing Lacker’s remarks.)
In a speech later on Tuesday, Dallas Fed President Richard Fisher said, "...The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we are pushing the envelope with the current round of Treasury purchases. I would be very wary of expanding our balance sheet further; indeed, given current economic and financial conditions, it is hard for me to envision a scenario where I would not use my voting position this year to formally dissent should the FOMC recommend another tranche of monetary accommodation. And I expect I will be at the forefront of the effort to trim back our Treasury holdings and tighten policy at the earliest sign that inflationary pressures are moving beyond the commodity markets and into the general price stream. I am a veteran of the Carter administration and know how easily prices can spin out of control and how cruelly markets can exact their revenge. I would not want to relive that experience. But here is the essential fact I want to emphasize and have you think about today: The Fed could not monetize the debt if the debt were not being created by Congress in the first place..."
While we are very happy that these responsible “hawks” are shrieking their cries of warning, we continue to worry about the viability of the consumer on whose back this economic recovery rests. Consumers have considerable debt, are underemployed, and are enduring an ongoing decline in home prices. These three things make us question the chipper optimism and capacity of the consumer to soldier on.
The doomsday projections of a US financial collapse will not come to pass in my opinion. I believe that either responsible leadership from government officials will lead us to a sustainable and responsible course or that a crisis will force responsible change upon us. I hope that responsible leaders will act responsibly, but I worry over our investment portfolios if change is crisis wrought. Therefore, we continue to invest in defensive companies that we believe will endure better than most. Earnings growth, strong balance sheets, good cash flow, and low debt are qualities we favor. Shares of these companies have not been exciting, but short term thrills are not part of our investment discipline.
(*Note: Quantitative Easing: When interest rates are close to zero there is another way of affecting the price of money: Quantitative Easing (QE). The aim is still to bring down interest rates faced by companies and households and the most important step in QE is that the central bank creates new money for use in an economy. From FT Lexicon )
Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.