The Independent Market Observer

9/20/12 – I Will Gladly Pay You Tuesday for a Hamburger Today

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Sep 20, 2012 11:14:51 AM

and tagged Debt Crisis

Leave a comment

I was never a big fan of Popeye. The whole eating-your-spinach thing wasn’t what I was looking for as a small boy. The Federal Reserve (Fed), however, seems to be a fan of Popeye’s friend Wimpy, as the thrust of its recent policy has largely been to pay later for the hamburger we eat today.

The most recent quantitative easing (QE) program is a great example. Rather than just pushing off deleveraging for a while, the unlimited asset purchases—at least until the economy recovers—aim to stop it completely. If it were that simple, the problem would have been solved already.

But let’s think about what the Fed can do here. If it stimulates now, at some point—in theory—it will eventually have to de-stimulate by an equal amount to avoid unpleasant consequences. Stimulus is intended to create real growth; if it is accompanied by inflation in a deflationary period like the present, that can be considered a feature, not a bug. When growth recovers, however, that stimulus will have the power to kick off inflation in a big way, and the Fed will then have to make a choice: wind down the stimulus, take the punch bowl away, or face renewed inflation.

So, any stimulus today is merely borrowing growth from the future. This can be seen in the federal government’s attempts over the past couple of years to goose the auto and housing markets. Sure enough, auto and housing sales perked up while the stimulus measures lasted, then dropped back to and below previous levels after they expired. The stimulus incentives had not created growth; they had just made it happen sooner.

By setting interest rates, central banks help determine when consumption takes place; lower interest rates decrease the incentive to save, pushing consumption today, and higher interest rates increase the incentive to save, deferring consumption till later. QE is the next step available when interest rates are effectively at zero. But, just like with cutting interest rates, the incentive under QE is to consume now rather than later. In both cases, the total amount of consumption remains unchanged over time.

What does this mean for us today? The market seems to be telling us that stimulus by the European Central Bank and the Fed will actually kick-start resumed growth in demand. I don’t think so. To the extent that these measures create current demand, they will borrow it from the future—again.

This means that the current slow growth projected by the Fed has become a self-fulfilling prophecy based on its own actions. Furthermore, even if growth were to start to increase from the current 1.5 percent–2 percent to a more typical 3 percent–4 percent, at some point, the Fed would have to begin pulling the stimulus back, depressing the higher growth rate. An extended period of slow growth appears ever more likely.

The Fed is well aware of this and would argue (I think) that the present actions are necessary, in the absence of Congress taking appropriate action to reduce the uncertainty that is slowing growth. I agree with this, but we have to be aware that the bill will be coming due at some point, and we will be paying for this well past the time we have digested the hamburger.


Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®