As the vote on Obamacare approached in 2010 — a year when the budget deficit was a staggering $1.3 trillion — the Democratic majority ignored the opposition’s concerns about the costs and unintended consequences of restructuring the entire health care system. It was also the year that Federal Reserve Chairman Ben S. Bernanke rolled out Phase Two of his controversial policy known as quantitative easing — QE, for short.
As Mr. Bernanke explained, the purpose of QE was to help the private economy. The Fed would buy long-term bonds with its newly printed dollars for the purpose of raising the price and lowering the yields of those bonds. By pushing rates down, QE would drive investors into equities in search of higher yields. This supposedly creates a “wealth effect” whereby the 10 percent of Americans who own about 80 percent of the stocks would spend more, invest more and create opportunity for the other 90 percent.
QE may have started out with that objective, but after four years of failure to spur job growth, which has also been accompanied by a widening gap between the rich and the poor and the piling up of $5-trillion-plus of new federal debt, it’s apparent that QE’s purpose has morphed. By manipulating and maintaining interest rates at abnormally low levels, QE has also become the great enabler of Washington’s spending and its appetite to buy votes and gain centralized power.
In 1977, the Federal Reserve added a second mandate of full employment to its original, single directive of maintaining price stability. With QE, the Bernanke Fed has effectively taken on a third role: supplying cheap financing for Washington’s chronic, dysfunctional deficit spending of hundreds of billions, even trillions of dollars, that exceed tax revenues.
The scope of the regulatory state — enlarged by the two signature policies of President Obama and the Democrats, Obamacare and Dodd-Frank — has dampened business expansion and entrepreneurial risk-taking and the tax revenues that would follow. After nearly five years, it seems apparent that no amount of easy-money monetary policy can overcome wayward regulatory and fiscal policies.
The fiscal policies of Mr. Obama and monetary policies of Mr. Bernanke are at cross-purposes. Like a driver with the left foot on the brake pedal and the right foot on the accelerator, the result is a ruined economic drive train. In this case, such contradictory policies have prolonged the 2008 recession, with the lowest labor-force participation rates in 35 years and with true unemployment rates north of 12 percent. Only a domestic energy boom that has nothing to do with Mr. Obama’s leadership disguises the reality.
While QE’s hot money has helped fuel the stock market to record highs, significant private wealth remains sidelined over concern about QE-induced systemic risk stemming from $17 trillion of federal debt — a sum exceeding national gross domestic product. There’s significant chatter about a “black swan” event that could trigger another financial market panic.
In 1987, when the economy was healthier than today’s, the stock market dropped 22 percent in one day — a 3,500-point equivalent at today’s levels. In the 1990s, the Treasury bond market dropped 4 percent in one day on several occasions. Today, a 4 percent drop in 10-year Treasury bond prices would wipe out all the equity capital of the Federal Reserve — if its $4 trillion portfolio of government and mortgage bonds were marked to market.
Taking the QE punch bowl away won’t be easy. The new Fed chairman-in-waiting, Janet Yellen, should explain her views on unwinding QE before her upcoming confirmation vote.
As the nation’s chief banker, she will have a primary duty to help reduce systemic risk by promoting responsible debt management and a sound dollar. Congress needs to be reminded that the S&P downgrade of U.S. sovereign debt in August 2011 was but a warning of imminent trouble if spending and entitlement-program reform are not addressed.
The media loves scandals, yet the biggest one of all goes largely unreported. That is this: The very elected officials who have taken an oath of office to protect the country are tempting fate in an almost reckless way. Our enemies and rivals surely understand the trajectory of growing debt service and entitlement costs in the United States mean less money available for defense, crippling America’s superpower status and hastening its retreat from the world. Let’s hope new leadership at the Fed can do its part to help redirect national priorities.
Scott S. Powell is an economist and senior fellow at the Discovery Institute in Seattle.