The True Cost of the Current Federal Reserve Easy Money Stance

True Cost of the Current Federal ReserveFederal Reserve Chairman Ben Bernanke testified in front of Congress and faced a barrage of questions and criticisms regarding the central bank’s monetary policy initiative.

There are a growing number of critics voicing their concerns over the current monetary policy path set forth by the Federal Reserve. These critics aren’t only independent analysts such as myself, (I have been writing articles on the topic for some time now, including the article  “Current Monetary Policy Unsustainable”), but economists who have worked closely with the Federal Reserve in the past.

The Federal Reserve chairman stated in his testimony to Congress, “Keeping long-term interest rates low has helped spark a recovery in the housing market and has led to increased sales and production of automobiles and other durable goods.” (Source: “Bernanke Affirms Bond Buying,” Wall Street Journal, February 26, 2013.)

Is he correct? Over the short term, the answer is yes, since the Federal Reserve has begun its aggressive monetary policy plan, home prices have gone up and car sales are strong once again. The real question is: what are the costs of accumulating $2.8 trillion of Treasury debt and mortgage-backed securities?

The real issue I have is the belief in fixing a burst bubble with yet another inflated stimulus plan. The previous high level of home prices was artificial and not sustainable. The resulting housing crash was inevitable, as all of the factors that went into creating the bubble were not structurally sound.

With the Federal Reserve pumping out monetary policy at full throttle, home prices are sure to move upward over the short term, but the long-term implications can be quite severe.

The assumption that the Federal Reserve makes is that monetary policy can be reduced in a stable manner. First of all, the Federal Reserve has a history of having a very poor record of forecasting anything. Of course, it’s not its fault since forecasting the future is impossible. Yet monetary policy hinges on being able to predict several years out.

The markets will move at a much faster pace than the Federal Reserve, or any other central bank, can ever properly calculate. While the Federal Reserve might make adjustments to monetary policy, we will see the markets move in a much harsher manner.

While the Federal Reserve chairman did state that the members of the central bank are paying attention to the potential costs of their monetary policy actions, I believe they are relying on a false sense of confidence.

Actions taken by the market will be far more severe, in my opinion, than what the Federal Reserve calculates. The truth is that this monetary policy plan by the Federal Reserve is unprecedented, and no one can accurately predict the full extent of its potential side effects.

The goal of the Federal Reserve should not be to create an environment through monetary policy so that home prices can exceed the last decade’s levels. Those levels were artificially created in the first place. What we need are structural reforms, which monetary policy cannot provide.

Washington politicians might point the finger at the Federal Reserve, gaining political points, but they should really be pointing at themselves. I have stated many times before that the ineptitude of Washington politicians is staggering. The American public has continued to lose faith in the ability of Washington. Now negative sentiment towards the Federal Reserve and the potential damage that the current aggressive monetary policy actions could result in is growing.

While over the short term, the current monetary policy actions have helped certain sectors of the U.S. economy, I believe the Federal Reserve will not be able to smoothly reverse course. Usually, when monetary policy begins to tighten, the markets don’t react well at all. I foresee a time of extreme volatility, as the Federal Reserve tries to extract itself from the excessive course of action it is undertaking with current monetary policy.

The signal that the Federal Reserve might begin to tighten monetary policy could come as early as the fall. In that case, if the stock market remains at elevated levels, we could see a severe correction. Easy monetary policy pushes up all asset prices, including equities, home prices, and commodities like gold. However, once the spigot is turned off, the air will deflate among all asset classes and investors will rush for the exits.

The post The True Cost of the Current Federal Reserve Easy Money Stance appeared first on Investment Contrarians.

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