Current Monetary Policy Unsustainable
The current Federal Reserve monetary policy initiative is truly historic in proportion. Not only has the Federal Reserve held interest rates at extremely low levels for an extended period of time, it has also embarked on an asset-purchasing program in the amount of $85.0 billion per month.
Clearly, this type of monetary policy program is unsustainable. While many people have been warning of the dangers, an interesting paper that will be presented at the upcoming U.S. Monetary Policy Forum will state similar concerns; however, what’s fascinating is who the authors are.
Amongst the four economists, one is a former Federal Reserve governor, Fredric Mishkin; two are former Federal Reserve economists, David Greenlaw and Peter Hooper; and the fourth author is James Hamilton, an economics professor at the University of California whose work has been used by Federal Reserve Chairman Ben Bernanke to justify certain monetary policy initiatives. (Source: Zumbrun, J., “Economists Warn Fed Risks Losing Control Amid Budget Deficits,” Bloomberg, February 22, 2013.)
These economists certainly have the kind of background, knowledge, and experience that can’t be ignored. Their assertion is that the explosion in the Federal Reserve’s balance sheet, in addition to the unsustainable fiscal policies, could result in a loss of control over the monetary policy system.
With the Congressional Budget Office (CBO) estimating at current projections for revenues and expenses, the government will run budget deficits of approximately $700 billion for the next 10 years. This type of irresponsible management of fiscal policy by Washington is inexcusable.
While the Federal Reserve is attempting to reduce the unemployment rate through monetary policy, Washington’s inability to get its fiscal house in order is creating an extremely dangerous situation over the long term. Monetary policy action by the Federal Reserve was never meant to be used as a solution to a lack of fiscal discipline by Washington.
These economists are extremely knowledgeable about the Federal Reserve system and what the limits are for monetary policy. Their concerns that the current path of monetary policy will create long-term problems should not be ignored by the current Federal Reserve.
As I have stated in the past, the extreme measures currently being taken by the Federal Reserve might make sense over a very limited period of time—during a crisis or an emergency. However, using monetary policy in lieu of structural reforms via fiscal policy is not a long-term sustainable answer. Too often, politicians in Washington have relied upon the Federal Reserve’s easy monetary policy stance to essentially help them get reelected.
It is rare to see a politician speak the truth. The current fiscal path is not sustainable. Much work needs to be done, with significant reforms to our fiscal system if America is to be financially viable over the next several decades.
Naturally, a worry for investors is inflation. A popular investment over the past few years has been Treasury inflation-protected securities. However, the price has run up significantly. Of course, if inflation was to be ignited, all asset classes will go up and the currency will go down—that is the normal course of action.
There are several investments to avoid and to invest in if the Federal Reserve was to continue its monetary policy initiative for an extended period of time. I would not invest in long-term U.S. Treasuries, as inflation will erode the yield; and eventually, when the Federal Reserve discontinues its asset purchase program, these long-term Treasuries will most likely decline in value.
Investing in various assets should provide protection against inflation. This includes commodities such as gold, in addition to stocks and real estate. I would also look to hedge my currency exposure by looking to other nations that are not running similar fiscal imbalances.
The year 2013 will be extremely important. At this point, it is difficult to predict exactly if the Federal Reserve’s monetary policy initiatives will kick-start the U.S. economy by the second-half of the year. If that occurs, we will see additional discussions of a reduction in monetary policy liquidity by the Federal Reserve. However, if the U.S. economy is not able to sustain its own momentum, I think there will be a substantial increase in volatility across many markets.