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More Easing? The Fed Must Listen to Main Street

The question "where is the Fed coming from?" is not only economically rhetorical, but geographic.

United States Federal Reserve
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United States Federal Reserve

Much has been made of the division between Wall Street and Main Street and the differing attitudes towards another round of central banks buying assets to boost the money supply - known as Quantitative Easing or QE2. Debates continue to rage about the efficacy and legacy of the last round of asset buying.

But the consensus is that the “shock and awe” tactics employed by the Federal Open Market Committee in March 2009 marked the nadir of the financial markets.

Still, unemployment in the US has remained stubbornly high, as the alarming rate of job losses was driven by both cyclical and structural factors.

Many column inches have been devoted to the likely impact that any such further action would have, and how much QE2 is currently priced in to the markets. Many FOMC members (whether voting or non-voting) could still be swayed as to the merits of more easing.

It appears that such debates have encountered something of an economic stalemate. It's arguable that beyond the narrow parameters of a “normal” economic cycle, one can forget the dry economic textbook arguments and return to plain English.

The key issue is now one of “psychological crowding out” (fear of higher taxes) rather than “economic crowding out,” when it comes to small businesses making fresh investments.

One question that is occupying the thoughts of all governments and central bankers in the West is how best to revive what Keynes termed "animal spirits," the natural inclination for humans to take on risk to better their personal economic prospects.

The list below is not a definitive guide to the Fed presidents’ attitude to another round of easing, but is drawn from publicly available information at the time of writing. The key factor that stands out is that those who appear to be most in favor of quantitative easing come from coastal areas and are arguably more sympathetic to the functioning of financial markets (Wall Street) than those based in areas of the US that depend on industries (Main Street).

The current split is as follows:

Federal Reserve Bank Presidents

Boston – Eric Rosengren
FOR

New York – William Dudley
FOR

Philadelphia – Charles Plosser
AGAINST

Cleveland – Sandra Pianalto
CAUTIOUS

Richmond – Jeffrey Lacker
CAUTIOUS

Atlanta – Dennis Lockhart
NOT KEEN

Chicago – Charles Evans
NOT KEEN

St. Louis – James Bullard
CAUTIOUS

Minneapolis – Narayana Kocherlakota
CAUTIOUS

Kansas- Thomas Hoenig
AGAINST

Dallas – Richard Fisher
AGAINST

San Francisco – John Moore (Interim while Janet Yellen is replaced)
FOR

Once the dry terminology of economics is cast aside, one is reminded that the world’s great economists from centuries of yore operated mainly in the spheres of sociology and psychology. Adam Smith and the profit motive were not rooted in equations, for example.

So, you should treat with caution those who believe that quantitative easing will kick-start psychology by boosting asset prices, which in turn will boost those "animal spirits."

Dallas Fed President Richard Fisher said “when the Federal Reserve buys Treasurys to drive down yields, it adds money to the financial system. In sharp contrast to the depths of the Panic of 2008, when liquidity had evaporated and we stepped into the breach to revive it, today there is abundant liquidity in our economy."

"Credit availability remains a challenge for small businesses, but only 4 percent of small businesses surveyed by the National Federation of Independent Business reported financing as their top business problem," Fisher said.

In other words, to the outside observer, it would appear that those in favor of large scale QE are approaching the problem from the wrong way around. A healthy economy, boasting growing employment and wages, in a positive credit cycle, will (all things being equal), enjoy rising asset prices as a beneficial side effect of sustainable economic growth.

The FOMC, under the leadership of Ben Bernanke, is trying to “fool” the economy into participants believing that all is well by boosting asset prices, thus giving the symptoms of a healthy economy, without the US economy exhibiting meaningful underlying health.

The QE “dissenters” recognize that while there remains a structural mismatch between job vacancies and the skills available from the workforce (exacerbated by the lack of mobility of the workforce, 24 percent of which has negative equity on their mortgages), boosting asset prices does not solve the problem.

To paraphrase the owner of a small business, “I don’t need more credit, I need more customers.”

The risks of further QE are clear.

Firstly, any further speculative flows of cash risk flowing into the “anti-dollar” trade; gold and commodities. Higher commodity prices act as a deflationary tax on the hard-pressed American citizen’s non-discretionary expenditure. Secondly, investors are rubbing their hands with glee at the prospects of more “hot money” - money that comes from short-term speculating funds - flowing into emerging markets. Governments from Asia to Latin America are not amused at having to deflect unwanted "hot money."

Basically, the Fed’s attempts to reflate asset prices amounts to the tail wagging the dog.

Higher asset prices will not reverse the deleveraging process, and as far as the “Asian Tigers” go, tweaking a tiger’s tail is known to be fraught with danger.

Those who preach from behind podiums on coastal universities, and are too close to the concerns of Wall Street, should instead take a walk down Main Street. Perhaps then, the divisions among the FOMC would narrow and pragmatism would trump economic theory.