From Ambrose at the Telegraph:
Post-monetarist Fed is sleepwalking into a trap (technical)
Is the Fed is about to make a major policy error?
The FOMC thinks it can taper its $85bn monthly bond purchases without tightening monetary policy. It hopes to wind down QE stimulus while at the same time offsetting this by holding down long-term interest rates by mere rhetoric, or "forward guidance".
That was the basic message from the Fed Minutes – apart from the general confusion, and lack of conviction that anything really works, as Tim Duy from Fed Watch says here.
This sort of smooth exit is possible only if you believe in the "creditist" doctrines of Fed chief Ben Bernanke, an outlook that has somehow become orthodoxy in the US and is broadly shared by the markets.
Bernanke seems to work from the assumption that the interest rate is the only thing that matters, as you would expect since he made his name at Princeton studying the "credit channel" causes of depressions.
What if Bernanke is basically wrong? What if the monetarists – Cassel, Hawtrey, Fisher, Keynes (yes, even Keynes), Friedman, et al – were right all along that what also matters, and perhaps matters most, is the quantity of money effect: that buying bonds and other assets from the non-bank sector boosts broad money (M3 these days) and kick starts the expansionary cycle by other means?
If the monetarists are closer to the mark – and they were right to warn about the dangers of ballooning M3 money up to 2007, and collapsing M3 growth from early 2008 onwards – the Fed may be about to tighten much more than it realises or intends.
Those emerging markets with big current account deficits (Fragile Five) will be the first in the firing line when the storm hits. The OECD warned this week that the taper tantrum in May-June may just be a foretaste. It warns of "virulent episodes" to come.
As I wrote in my column this morning, ex-Treasury Secretary Larry Summers may be right to worry about a deep "secular stagnation", with the US and the world trapped in a bad equilibrium that needs permanent bubbles just to keep the game going.
Whether you think the US is fully recovering depends where you stand on the ladder. The workforce actually shrank by 755,000 in October. This is one of the biggest one-month falls since the start of the Long Slump. The labour participation rate for men dropped to 69.2pc, the lowest since data began in 1948. Don't tell me that this is all structural.
His preference is a big blast of fiscal stimulus. My modest proposal is to deploy QE in an entirely different way, injecting stimulus directly into the veins of the economy by building roads, railways, smart grids, and enough houses to drive down the home price to income ratio (at least in the UK)....MORE