David Stockman's warning that the Federal Reserve's quantitative easing is steering the world's largest economy toward a crash is at odds with record stock prices, unprecedented corporate earnings and nine quarters of job growth, former fiscal and monetary policy makers said.
Stockman, who served as budget director for President Ronald Reagan, wrote in a March 31 opinion piece in the New York Times that Fed policies in the aftermath of the financial crisis flooded equity markets with cash while weakening the “Main Street economy” and creating an “unsustainable bubble.”
That doesn't square with soaring U.S. stock prices and company profits that have emboldened investors. Bond buying that pushed the Fed's balance sheet to a record $3.21 trillion and other unprecedented actions by Chairman Ben S. Bernanke “saved the world,” David Blanchflower, a former Bank of England policy maker, said in response to Stockman's assertions.
“The reason that stocks have erased all their losses is entirely because of QE,” said Blanchflower, who teaches at Dartmouth College in Hanover, New Hampshire, and served on the BOE's Monetary Policy Committee from 2006 to 2009. “To argue that that's independent of the actions of the Fed shows no understanding of what the Fed is doing and what they did.”
The Standard & Poor's 500 Index has soared 131 percent since March 2009, surpassing its previous record last month, as profits surged and the Fed pumped more than $2.3 trillion into the economy through monetary easing. The rally represents the biggest bull market since the eight-year advance that added 302 percent through 1998, data compiled by Bloomberg show.
“You look at the market and you certainly don't get the message that the sky is falling,” said Jared Bernstein, former chief economist to Vice President Joe Biden and a senior fellow at the Center on Budget and Policy Priorities in Washington. “Recent gains in the stock market are explained by very high corporate profits and very low interest rates.”
Earnings for S&P 500 companies have risen for three years and are forecast to reach a record $109.30 a share this year, compared with $61.79 (SPX) in 2009, data compiled by Bloomberg show.
Bernanke and his colleagues on the Federal Open Market Committee, who have held interest rates near zero since December 2008, last month pledged to press on with $85 billion in monthly bond buying even as some Fed officials called for scaling back the record stimulus. The FOMC has said it will continue buying until the job market improves “substantially.”
The FOMC plans to continue its purchases of $40 billion of mortgage bonds and $45 billion of Treasuries each month. Policy makers have said they will keep the main interest rate near zero as long as unemployment remains above 6.5 percent and the outlook for inflation doesn't exceed 2.5 percent.
Stockman, 66, was a Republican congressman from Michigan before he rose to prominence during the early 1980s in the Reagan administration while pushing supply-side economics, which holds that income-tax cuts would boost economic growth and raise more revenue for the government.
Stockman quickly turned on supply-side economics. He said the benefits would only “trickle down” to the non-wealthy and that the tax plan “was always a Trojan horse” for accomplishing the primary goal. That objective was bringing down the top income-tax rate to 50 percent from 70 percent.
He resigned as budget director in 1985 and published a book criticizing the Reagan administration.
Stockman wrote in his New York Times op-ed that the U.S. economy is in a bubble inflated by “phony money” from the Fed and will begin to falter within a few years.
“When it bursts, there will be no new round of bailouts like the ones the banks got in 2008,” wrote Stockman, a former senior managing director at Blackstone Group LP. “Instead, America will descend into an era of zero-sum austerity and virulent political conflict.”
Among the culprits Stockman blamed for what he termed a “state-wreck” are President Franklin Roosevelt for weakening the gold standard in 1933 and President Richard Nixon for removing the convertibility of dollars to gold.
Stanford University professor John Taylor said that he had a “strong issue with the broad sweep” of Stockman's op-ed because it didn't account for “great improvements in the policies and performance” in the last three decades of U.S. economic history. Stockman's pessimism is “a wrong lesson to take away,” Taylor said.
Still, the Fed's record balance sheet is a “big overhang that needs to be corrected” because it creates risks that outweigh the benefits of the unprecedented easing, Taylor said.
“There are dangers, there's no question about it,” said Taylor, who served as a Treasury undersecretary in Republican President George W. Bush's administration and supported Republican presidential candidate Mitt Romney last year.
The economy grew at an 0.4 percent annual rate in the fourth quarter, up from an earlier estimate of 0.1 percent, according to the Commerce Department. Growth will be 1.9 percent this year, according to the median of 81 economist estimates in a March 8-13 Bloomberg survey.
The labor market improved in February as automakers, builders and retailers pushed the jobless rate to a four-year low, defying concerns that budget battles in Washington would harm the economic expansion. Labor Department figures showed employment rose 236,000 while the unemployment rate declined to 7.7 percent from 7.9 percent.
Alice Rivlin, who served as vice chairman of the Fed Board and budget director for President Bill Clinton, said she doesn't agree that “we made all these mistakes since 1933 and nothing good has happened” in the past 80 years.
“It's not the way I view the economy at all,” said Rivlin, now a senior fellow at the Brookings Institution in Washington. “I'm much more impressed with the resilience with the economy in the face of a lot of shocks and right now we have good prospects for growth if we don't mess it up.”
Since the Lehman Brothers Holdings Inc. bankruptcy in September 2008, the Fed has more than tripled the size of its balance sheet, in the process becoming the largest holder of U.S. government debt, owning about $1.8 trillion in Treasuries, displacing China (HOLDCH), which owns about $1.3 trillion.
Stockman said in his op-ed that when the Fed “even hints at shrinking its balance sheet, it will elicit a tidal wave of sell orders” in the bond market.
Mark Thoma, a professor of economics at the University of Oregon, said he doesn't see markets anticipating turbulence, and that the Fed has the tools it needs to slow its purchases. The central bank's policy is working through long-term interest rates, exchange rates and asset market values, he said.
“If you look at long-term bond rates or inflation expectations or any of the things that the market would use to signal that it's worried, you really don't see it,” Thoma said. “They can back off of this if they need without any kind of catastrophic collapse that he's talking about.”
The Fed's purchases have depressed yields on U.S. 10-year notes, the benchmark lending measure from everything from home and auto loans to corporate bonds. Yields have averaged 2.7 percent since the first easing efforts were announced in November 2008, below the 4.71 percent average in the decade before.
Over the past year yields have fallen even further, averaging 1.76 percent, less than half the average of the decade before the financial crisis, even as U.S marketable debt has ballooned to $11.3 trillion, nearly three times the $4.53 trillion at the start of 2008.
Yields on 10-year notes would be as much as 125 basis points higher without quantitative easing, according to Zach Pandl, an interest-rate strategist in Minneapolis at Columbia Management Investment Advisers LLC, which oversees $331 billion.