S. Balakrishnan

The Fed soldiers on.

At its meeting this week, it retreated from an earlier decision to wind down its securities portfolio acquired at the height of the financial crisis. The portfolio comprises both Treasury and non-Treasury paper and is the legacy of the Fed having to act as banker to the private sector in the worst periods of 2008 and 2009.

Bond redemptions and loan amortisations should have normally shrunk the portfolio gradually, but the Fed doesn't have that luxury in the deteriorating economic situation. It will continue with ‘quantitative easing', reinvesting maturing principal in dated Treasuries, thereby maintaining the portfolio size.

There's barely any dissent – in fact total silence prevails even among the ‘inflation hawks' among economists. They have good reason to stay quiet. America's inflation is zero and we could, possibly, see prices falling. The near zero interest rate policy of the Fed (the post-meeting statement assures it will be so for an ‘extended period') is defeated if deflation reigns.

It was good news for Treasuries whose yields continued their downward course of the past weeks. Ten years are around 2.7 per cent and two years only 0.5 per cent. The feared ‘bond vigilantes', who drive up yields when they whiff loose monetary and fiscal policies, are themselves buying bonds – so certain are they that persistent economic weakness will pull yields even further down.

It's Keynes' classic ‘liquidity trap' – confidence of businesses and consumers is so low that there's no impulse to invest or spend. On the other hand, companies are slimming down and slashing fixed costs to a permanently lower base.

‘Jobless growth' is the name given to an economic recovery which doesn't create enough employment. For years, America is suffering from the syndrome of fewer ‘quality' jobs for the mass of people without Ivy League degrees or special skills. Recent experience suggests that general economic well-being is disconnected, i.e., entirely different, from the performance of the stock market.

What are the consequences? More concentration of income and wealth – in effect a two -tiered economy in which the brunt of recessions and job lossses is borne by the unfortunate majority outside the top income and wealth quartiles. The ‘new normal' describing modest growth and anaemic employment must be widened to include the (implied) economic insecurity of a large section of the population.

All these issues are, of course, outside the deliberations of the Federal Reserve.

With Obama ‘psyched' out of action on a stimulus package to engineer an economic turnaround, not only by the Republicans but also his own economic advisers, Fed or no Fed, difficult days are ahead for America.

(This article was published in the Business Line print edition dated August 13, 2010)
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