Will the Fed Bring Us QE3 Soon?

07/26/2012 9:00 am EST


Robert McTeer

Distinguished Fellow, National Center for Policy Analysis

Former Dallas Fed president Robert McTeer discusses how the Fed's Open Market Committee wants to avoid moves that could be interpreted as politically motivated ahead of the US election. He also shares his views on the Eurozone's future, and his perspective on a slowdown in Chinese GDP rates.

Kate Stalter: Today, I am pleased to be speaking with Robert McTeer, former President of the Federal Reserve Bank of Dallas, also a member of the FOMC. He is currently with the National Center for Policy Analysis, where he blogs at their Web site.

Bob, you'll be speaking at the upcoming World MoneyShow Shanghai in September. Members of our international audience are very curious about economic conditions and policy in the US. Perhaps we can start with that today: Your view of some of the economic and monetary policy issues here at home.

Robert McTeer: Well, our recovery, such as it is, has been going on for over three years. It has never been strong, and it has been getting weaker in the last several months.

We've gone from weak to weaker. The last two GDP numbers we had were 3% and 1.9%, but those exaggerate the strength, because inventory accumulation was an important part of that growth. So it was really below that.

We are expecting a first estimate of the second quarter in a few days, and people have been marking down their guesses to under 2%. In addition, we have had three consecutive very weak job growth numbers for the last three months, and we have also had three consecutive negative numbers on retail sales. So, things are weak and getting weaker.

Now, for investors, you don't buy GDP. What you buy are companies. And during this period, a lot of companies have strengthened their balance sheets, have become more liquid, they have shed debt, and got more productive. So the weak economy doesn't necessarily translate into bad investment opportunities.

Of course, the wild card there is what is going on in the rest of the world, particularly Europe. It seems like if we could ever get that albatross off our neck, the investment climate would be much, much better.

With regard to policy and whether the Fed might do more, it's kind of interesting. If you watch the financial shows on TV, most of the commentators say, "Don't do more, it's not needed, didn't do much good in the first place." But the markets themselves seem to want more, because every time Bernanke says something that suggests there might be more coming, the market rallies. And every time he suggests there might not, it swoons. So there is that dichotomy.

I think recently it has gone-and I have no inside information-but I think it has gone from the Fed might do more if things weaken further, to the Fed will likely do more unless things strengthen. So that is a subtle change.

We've got, in a few days, another employment number coming up, and we've got a GDP number coming up. And my guess is that, if those aren't stronger than people expect, there will be some announcement of some additional easing on the part of the Fed.

Kate Stalter: One of the big questions that I've heard quite a bit about in the media recently, Bob, is the idea of any further Fed action as we get in closer proximity to the election-and of course, whether or not that might be interpreted as politicizing events in one way or another. What is your view on that?

Robert McTeer: Well, as a former member of the FOMC for 14 years, I can confirm that the Fed is reluctant to do anything very...political. It never wants to do anything political, but it likes to lay low as an important election approaches, and certainly doesn't want to become part of a campaign rhetoric.

On the other hand, if it works out that the economy just clearly needs the Fed to do something, it would be irresponsible for them to say, "Well, we ought to be doing something, but we won't because of the elections in two or three months."

Kate Stalter: Is it the case, perhaps, that the market is looking to the Fed to do too much? As you alluded to, we have incredible price swings on the major indexes depending on what Ben Bernanke says or doesn't say.

Robert McTeer: They are depending on the Fed to do too much, because fiscal policy isn't doing anything.

It would be much better if the Fed could sort of rest and let the Congress go to work in solving some our fiscal problems. As you know, we've got this fiscal cliff coming up where the Bush tax cuts will expire and other tax cuts will expire, and at the same time, there will be a large automatic reduction-a fairly arbitrary reduction-in spending.

So economic policy has been a one-pony show so far. It has been the Fed, and the fiscal authorities have been AWOL. It would be much better if the Fed could sit back and let fiscal policy move to the floor.

Kate Stalter: Well, let's move over to another problem area, which is Europe. As we speak today, markets are moving on news that Greece may need some further debt restructuring-moving to the downside. Talk a little bit about what you see as some of the constraints that the Eurozone is facing with regard to its currency, the ECB, and other factors.

Robert McTeer: Well, of course, the basic fundamental problem is there are 17 countries now that share a single currency. And they share a single central bank, which means that no country really has a central bank, or a currency that can help with the adjustment.

They had rules for entry into the euro area, anticipating that they would need to sort of move along the same path fiscally. They had a rule that they shouldn't have budget deficits over 3% of GDP. They had a rule that their accumulated debt shouldn't be above 60% of GDP.

Unfortunately, they didn't follow the rules. Very few countries over the years have stayed with that, and, in particular, Greece.

What triggered this whole European crisis two or three years ago is that a new government in Greece announced that the previous government had been fudging the numbers, and instead of its deficit being 3% of GDP, it was 13% of GDP. And everybody sort of seemed to believe-I think probably correctly-that the Greek finances were a mess, that the Greek people were notorious for not paying their taxes, and the Greek government was notorious for giving generous wages and pension benefits, and so forth, to a bloated bureaucracy working for the government.

The government always spent more and promised more than it could deliver. This was very unfortunate, because when the crisis started in Greece and spread to other European countries, they all sort of got painted with that same Greek brush. There was the feeling that they were all fiscal messes, and that wasn't really quite the case.

Some of the countries-Spain, for example-were managed pretty well at the national level by the fiscal authorities. Their problem was they had a housing bubble burst, just like we did, that infected their banks, and then the government assisting their banks sort of got the contagion. And that was true of Ireland, probably Portugal as well. Italy had pretty good current finances but it had accumulated a lot of debt over the years, so it was vulnerable.

And so they all have to shrink-reduce their standard of living, so to speak, down to what is sustainable. Normally, a country can do that with the least pain by letting its currency depreciate, so that you don't have to cut wages and everything in the local currency, but you can let the local currency go down, relative to foreign currencies, and you can become more competitive that way.

Well, they don't have that option, since they are sharing the euro, unless they all go down together with a weaker euro, and the euro has been weakening. But it is not a good thing for the euro to weaken for the stronger countries like Germany and Austria and some of the other northern countries. It forces you into a one-size-fits-all situation, and one size increasingly does not fit all.

Since there are 17 governments involved, every time they have an emergency, the logistics of getting together-even if the 17 legislatures were all willing-are very complicated.

And, of course, most of the governments that have gone along with German-imposed austerity have fallen. Most of the Southern European governments have changed since this started. So it's easy to see why a politician wouldn't be too brave, because the cost of their bravery is to be thrown out of office.

Kate Stalter: That's a pretty bleak picture you're painting there, Bob. Do you have any thoughts on what the outcome of all of this might be?

Robert McTeer: I have become rather fatalistic. My hopes for the Europeans getting their house in order have gone dimmer. And I've started trying to rationalize that, as this goes on, maybe US financial institutions and US companies will increasingly disengage and disentangle themselves. So even if Europe doesn't improve very much, as we hope they will, the contagion with the US would become less.

Every morning when you get up and some of the news out of Europe causes the stock market to tank in the US, it is very discouraging. Of course, at the same time, there are weaknesses elsewhere in the world. So weakness spreads, and we're getting some weakness not only from Europe, but from places like Brazil, India, and even China.

Kate Stalter: Let's talk a little bit about China. I know there is quite a bit of discussion about a slowdown there. But even the projected slower rates are well above the best projections for the US. What do you see happening there?

Robert McTeer: Well, a couple of things to keep in mind about China's slowing:

First, it was government-imposed. The government tightened policy over an extended period of time, to try to cool the economy off, and to try to keep property bubbles from forming and things like that. To some extent, the slowing in China is a result of successful government policies, rather than something to be terribly worried about.

Now, the government has since reversed course and is offering some stimulus, so it is a delicate matter whether they are having a soft landing or a hard landing.

Now, the numbers over there: I think the latest GDP number was 7.6%, but China always reports its GDP numbers year-over-year, where we usually focus on quarter-to-quarter here. If you are on a downward slope and your last year was 7.6%, then your last quarter must have been considerably below 7.6%. I think it might have been around 7%.

Now, we would die for 7% growth, but the Chinese need that higher growth rate probably more than we do, because they still have a lot of people back on the farm, so to speak, that they have to absorb into their modernizing economy. Going down from over 10% to around 7% is not horrible, but it is significant.

Kate Stalter: It strikes me in this conversation today, Bob: There are not a whole lot of glimmers of good news for those who are trying to latch onto the silver lining here. Is there anything of a silver-lining nature that you see out there?

Robert McTeer: Well, let me think. The US has made a good bit of progress in lowering its debt. I'm talking about the population- consumer debt. Consumer debt, as a percentage of consumer income, has come down over the last few years, so the deleveraging has been going on.

The continued decline in manufacturing activity in the US has sort of bottomed out, and has gone up the last year or two. We have had a little bit of a resurgence in manufacturing, as a result of a fairly weak dollar against the rest of the world, and the fact that wages are going up in some of the low-wage countries, like China. So our debt situation is improving, and manufacturing is picking up a little bit.

Lately, it looks like there might be some life in the housing sector. It has been on the floor so long, we've just about forgotten about it, but it is showing some signs of life. If we start getting some growth there, that will be very helpful.

Also, there is hope in all the technological revolution that is going on in the energy industry. We finally are becoming less dependent on imports for our oil, and the technology in gas is very promising. So our international position, our balance of payments, is likely to improve considerably over the next few years. That has been the main reason they have been so lousy, is the high and rising price of imported energy, and that is sort of reversing.

Again, let me emphasize that for investors, macroeconomic issues are important-but you don't buy the GDP, as I said earlier. You buy companies. And if you can find companies that are taking advantage of a lot of these problems, or seem to have found a way around them, I think there are still some possibilities.

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