Crossing the Line

“Such supplementary interventions [by the State], which are justified by urgent reasons touching the common good, must be as brief as possible, so as to avoid removing permanently from society and business systems the functions which are properly theirs, and so as to avoid enlarging excessively the sphere of State intervention to the detriment of both economic and civil freedom.” – Walter Bagehot

As the quote above mentions very clearly the State intervention is required but it is required for short bursts.  Thinking back to the beginning of the Great Recession, Federal Reserve intervention was needed to prevent a complete collapse of the financial system.  The Federal Reserve acted quickly and effectively and staved off the crisis.  Since that time they have remained involved in the economic “recovery” and it is their belief that unless they remain fully invested that the economy will crater.

The question is have they crossed the line?  The line I refer to is the line between required involvement to rescue the economy for common good or permanently removing systems and functions that are properly seated in the private sector.  This is critical to the long term viability of the general economy and is the reason that I continue to remain skeptical of the current market movements.

The question therefore is whether continued activity will continue to stimulate or whether it is just kicking a tin can up a very steep hill.  Take Greece for example.  They need to borrow money to stave off a default but no-one will lend them any money other than the ECB who ultimately underwrites the debt that Greece owes.  So effectively the ECB who is owed the money is lending more so that the insolvent country can continue to service their debt.  This is unsustainable in the long run unless there is a structural change to either the debt or the Greek government or both.

Looking at the Federal Reserve, saving the financial system was definitely a necessity.  Continuing to pour money into poor investments is not.  The second use of funds was done under the guise of stimulating the economy.  Bernanke who schooled himself on the Great Depression feels that the cause of the Great Depression was in large part due to the Federal Reserve cutting off funding too early.  He is determined not to repeat past mistakes and so has kept the foot hard on the gas-peddle for an extended period.  The result is a now mountain of debt and little in the way of success.  More importantly is that the economy now seems wedded to more money printing to survive and the ills of the past have not been corrected but have been glossed over with more money.

In my view the later portions of the so called quantitative easing have wasted an opportunity.  That opportunity was at their doorstep in the time of severe crisis but was squandered and now we have created a level of debt that has become a burden to the economy and is stripping away market opportunities that should be filled by the private sector. 

Furthermore the market is very fickle and at some point the low level of interest rates could spiral as it has done in Europe.  If this happens our current trillion dollar budget deficits will look small and trying to borrow your way out of that hole will not happen.   As I have argued before I believe that interest rates will remain low for longer than anyone expects but it certainly appears that we are squandering an opportunity to structurally fix the problem while these interest rates remain low by thinking that the only solution to the problem is to print money.  This is not the solution but is going to cause great problems in the future.  However in the meantime Wall Street celebrates any time they hear of more quantitative easing and this is a worry in and of itself as the Federal Reserve pats itself on the back each time the market goes up.

Their thought is that if the rich get richer (through asset appreciation) that the income will trickle down to those that do not have a job (through job creation from the rich) but this is not happening as unemployment remains stubbornly high.  In fact while there is a strong correlation between the stock market and job growth I would argue that job growth creates a strong market and not the other way around, however our leaders in their infinite wisdom believe otherwise.  Hold onto your hats as this will be a bumpy ride.