Under the spell of QE’s mirage: Samson Okalow

Rock, meet hard place

(Photo: Pete Turner/Getty)

(Photo: Pete Turner/Getty)

As a result of the U.S. Federal Reserve’s Sept. 18 decision not to commence tapering, a biblical number of analysts and economists had to eat crow last week. Almost to a man/woman, they predicted tapering because they had put their faith in a talked up economy that was said to be improving. The problem was they were looking at the wrong economy.

By now it should be clear that in the era of quantitative easing, there are in fact two economies. There is the economy reflected by the world of stocks, bonds and abstractions of real estate and then there is the real economy. In the former, the idea is to make as much money as possible from rising asset prices (or, if you like, falling asset prices for the shorters out there). In the latter the idea is that people trade their labour for money they then use to buy goods and services, the activity of which creates a kind of virtuous circle that generates something tangible for everyone. What the analysts and economists have done is confuse the former for the latter in seeing the relentless upward march of asset valuations as a sign of “economic recovery.” Right up to the last minute on Sept. 17 the certainty reached comical levels of self-delusion.

But as Fed chair Ben Bernanke said at the press conference, tapering would begin only “If the data confirm our basic outlook.”

So what does that data look like?

Is unemployment on the mend? Not particularly. Officially the rate in the U.S. is 7.3%, down from a high in Oct. 2009 of 10%. But too much of that is due to people dropping out of the workforce altogether (because the job market is *that* good): now at 63.2%, the labour force participation rate has been catapulted all the way back to that which last prevailed in 1978. In fact, the true unemployment rate could be as high as 9.5%.


Moreover, the rate of job creation, which averaged 183,000 per month in 2012 and so far 180,000 in 2013, doesn’t do much more than absorb monthly new entrants into the workforce. It scarcely puts a dent in the losses of about 8 million attributable to the crisis of 2008. At the current growth rate, it will take until 2019 to recover the lost jobs. To keep the current unemployment rate flat, the Federal Reserve Bank of Chicago in July estimated that 80,000 new jobs need to be created each month. For a statistical look at how deep the hole is and how long it will take to climb out based on a given monthly job creation number, try the “jobs gap” tool by the Hamilton Project or this calculator from the Federal Reserve Bank of Atlanta.

For those who have jobs, what has the Fed seen in terms of wages? Since 2000, wages have been stagnant or in decline for a majority of workers, a trend now accelerated since 2007. According to the latest U.S. Census Bureau figures, median household income for non-elderly households rose 1% between 2011 and 2012. Unfortunately, that’s in the context of incomes having slipped 11.6% from 2000 to 2012, and 9.3% since 2007. In 2000, income was US$64,853 and now stands at US$57,353. This isn’t an encouraging trend given that consumer spending is 70% of U.S. GDP.

Is the Fed looking at housing, the averred bedrock of the economy? Again, too much of it is a mirage. Growth is coming disproportionately at the hands of all-cash speculators (flippers) and equity or hedge funds using artificially cheap money to convert properties into rentals, possibly hoping to IPO them for a big pay day. There also appears to be a segment of buyers who are simply trying to get in ahead of interest rate increases. But first-time homebuyers, who are a significant indicator of strength in the housing sector, are disappearing from the market in dramatic fashion.

Data from the National Association of Realtors indicate the number of first-time home buyers as a percentage of the market averaged 39% from 2001-2007, and 42.8% from 2008-2012. But so far in 2013 (Jan.-Aug.), that number has plunged to an average 29% per month. Given that the remainder of the year includes the slowest selling season, that average is not likely to improve much and may worsen.

This makes sense given two factors: one is the hit household formation took during the financial crisis. Among the key 18-34 demographic, the rate declined by 5.5% between 2007 and 2011, “accounting for almost three-quarters of the overall shortfall [2.6 million] in household formation over the period,” according to the Federal Reserve Bank of Cleveland. In turn this is coupled with the fact that what job growth has come has been concentrated in the low-wage service sector, which has a negative feedback effect on household formation. You can’t buy a home if you’re making little or no money. In fact, you’ll be lucky to move out of your parents’ house.


As for the plethora of other indicators over which many investors obsess—such as PMI, new orders and shipments, inventories, housing starts, etc.—they yo-yo from month to month, but typically within a narrow bound that excites one moment and disappoints the next.

The fact of the matter is quarterly GDP growth hasn’t often crested the 2% threshold during the post-recession era and 2013 has actually slowed down somewhat from 2012. (The long-term average growth rate since records started being kept has been a little over 3%.)


Moreover, the post-recession GDP growth rate currently stands at 2.2%, compared to a 4.4% average for the previous seven recessions dating back to 1960. And this is with the aid of a Herculean $3 trillion injection over a half decade. That’s not recovery, that’s disaster.


If this is what the objective numbers look like, how is anyone interpreting this as a state of affairs that would lead the Fed to taper? They must be looking at different data, indeed.

Don’t mistake these observations for a call for continued QE because they’re not. The Fed has utterly boxed itself into a corner and how it gets out is anyone’s guess. But here’s the newsflash, folks: What you’re seeing in the market isn’t real. It isn’t real people getting real raises or income who then go out and buy real products and services. Instead, you’re seeing the predictable effect of artificially suppressed interest rates coupled with “free” money being poured into an investment and banking system through the primary dealer banks.

Thus desperate for yield, asset valuations are bid up only in the context of that largesse. Take that funding away and the market settles back into something more closely aligned with the underlying reality—the one of high unemployment/underemployment, high oil prices, stagnant middle- and lower-class incomes, unprecedented wealth concentration in the upper class, demolished savers, under-investment in capital, and an ongoing transition to a low-wage service economy hard-pressed to service debt.

As its actions prove, the Fed is well aware of this despite its routinely over-optimistic and always incorrect predictions, which is why there is no taper. The green-shoots predictions and pronouncements are simply meant to talk up the market and make everyone “feel” richer in the hopes of igniting the so-called confidence fairy. Essentially, it’s the psychological component of the supply-side trickle-down theory and it, too, evidently does not work.