Fort Apache, the Fed

09/21/2011 10:13 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Don’t expect miracles from the central bank today with the rest of the federal government AWOL, writes senior editor Igor Greenwald.

Back in the days before the economy got grounded, the mission of the Federal Reserve used to be to engineer “soft landings.”

There were a few of those in the 1980s and 90s, but nothing but a couple of crashes since, and now weeds cover the tarmac.

These days—whatever the Fed’s ambitions—its foremost achievable goal is to look busy. In that sense, the two-day meeting concluding today should deliver.

Looking busy isn’t easy when the car you once drove is sitting in a ditch with two flat tires, a shot transmission, and a back seat full of guys yelling at you to slow down, dammit.

But the Fed’s a resourceful lot, when it comes to the symbolic gesture.

Federal Reserve Chairman Ben Bernanke is calling plays from a playbook he read aloud not once but twice in July, in his semiannual monetary policy report to Congress.

Should the economy worsen, he then said, as it subsequently did, “One option would be to provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels.”

The Fed checked off that box last month, when it all but ruled out rate hikes for the next two years.

What’s left? Here’s Bernanke in July: “Another approach would be to initiate more securities purchases or to increase the average maturity of our holdings. The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally.”

Everything other than the “more securities purchases” part has been mooted as a move the Fed might make this week—and even that is hardly out of the question, whatever Republicans in Congress might think.

That’s because a mere two months ago, Bernanke could still reference recent Fed forecasts calling for economic growth of 2.8% this year and 3.5% in 2012, figures that now read like science fiction.

As of early August, “the projection for real GDP growth in the second half of 2011 and in 2012 was marked down notably,” according to the Fed meeting minutes, which spared us the ugliness of the actual figures.

But that was last month. This month, the 56 economists surveyed by The Wall Street Journal have dialed down their 2011 expectations to an average of 1.5%, which would still require a healthy year-end growth spurt currently nowhere in evidence. The consensus for 2012 is down to 2.4%, and surely that’s back-loaded as well.

You don’t need to be Dr. Copper to diagnose this: Europe has embraced austerity, deficit-ridden US state and local governments have had no other choice, and federal stimulus has given way to budget-cutting as well.

People are hoarding so much electronic cash that banks are looking for ways to discourage deposits, having long ago run out of creditworthy borrowers looking to expand.

Gold vaults are running out of space to store the bullion bid ever higher by the scared investor class. Corporate America is planning the next round of layoffs.

This does not look like a private sector ready to pick up the slack as governments go on a diet. As a result, consumer and managerial confidence has curdled, and could get worse as hiring freezes up, while the European debt crisis fans financial panic.

It’s folly to think that the Fed can reverse any of this by denying banks 0.25% on excess reserves, or by swapping some short-term notes for ten-year paper, or by buying more paper so that banks end up with more money no one is clamoring to borrow.

Because at the so-called zero-bound of interest rates, the transmission mechanism by which cheap credit turns into economic growth seems to get broken. The Fed can swap all the assets it wants with money-center banks, but can’t seem to get its money to the populace that will spend it.

It turns out that Bernanke, so frequently derided as “Helicopter Ben,” really doesn’t have a pilot’s license, much less clearance for takeoff from Congress. Speaking recently in Minneapolis, the Fed chief could only lament “the prospect of an increasing fiscal drag…in the face of an already sluggish recovery.”

As for the Fed, it “will certainly do all that it can,” he promised. Which, as it turns out, is not all that much for all the demonic powers ascribed to the Fed’s palliative bond purchases.

Fed fatigue has clearly set in, so that anything but a wild-eyed money-printing pledge is likely to disappoint those who have not yet sworn off stocks.

I still believe that, as I wrote after the August meeting, this Fed will fight. But it doesn’t have a silver bullet, and even the rubber ones are in short supply.

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