OK, so Bernanke’s plan worked: Now what?

Chairman of the Federal Reserve Ben Bernanke talks to Senators at the Senate Banking Committee on Capitol Hill in Washington February 17, 2011. REUTERS/Larry Downing

Nearly everything is going according to the plan Federal Reserve Chairman Ben Bernanke hatched six months ago.

During a speech in Jackson Hole, Wyo., on Aug. 27, Bernanke outlined an effort to spur economic growth, prevent prices from falling and push markets higher through the purchase of government bonds. Since then stocks have soared, the unemployment rate has dropped and Americans have started to spend more.

“It’s been a success,” says Bill Gross, who manages the world’s largest mutual fund at Pimco. Gross had skewered Bernanke’s attempt to boost the economy, comparing it to a Ponzi scheme. “It’s hard to dispute that since Jackson Hole the market is up around 25 percent.”

But the Fed’s $600 billion program to buy Treasurys ends in June. And investors like Gross are worried the stock and bond markets will fall without the Fed’s $75 billion monthly injection. “At the end of June, the biggest bond buyer steps away,” he says. “The markets could have a shock in store.”

And now there’s a different economic issue. Higher prices for food and energy have replaced a double-dip recession as the major concern for economists and investors. Bernanke begins two days of Congressional testimony Tuesday and is sure to face criticism that the bond-buying program known as quantitative easing is to blame.

On the surface, Bernanke’s speech in Jackson Hole was full of Fed-speak. But the language was clear to those in the audience at the Fed’s annual Board of Governors meeting in the Wyoming resort. “He was saying, ‘Whatever it takes we’re going to do,'” says Richard Hoey, chief economist at BNY Mellon. “It was a Rambo message.”

The move, which began in November, was unorthodox, but the logic was simple: Buying $600 billion in Treasurys would make borrowing cheaper and move investors out of low-yielding bonds into riskier investments like stocks. A rising stock market could then give Americans confidence in the economy and spur consumer spending, which leads to higher corporate profits.

A lot has happened in the markets and the economy since then — most of it good.

_The unemployment rate dropped to 9 percent in January, the most recent month for which data is available. It was 9.6 percent in August.

_The Consumer Price Index rose 0.4 percent in January and 1.6 percent over the previous year. Prices rose 0.2 percent last August from the month before and just 1.1 percent over the previous year.

_The Standard & Poor’s 500 stock index is up 27 percent since Aug. 26, the day before Bernanke’s speech, powered by stronger corporate profits and people moving their savings into stock funds.

_Consumer spending has climbed seven months in a row. In the last quarter of 2010, it grew at the fastest pace in three years. Spending rose 0.2 percent in January, according to data released Monday.

“Measured in the fairest possible way, and by just about every measure, QE2 has succeeded so far,” says Anthony Chan, chief economist at JPMorgan‘s wealth management unit. QE2 is market slang for the Fed’s quantitative easing program.

Long-term interest rates are the exception. They’ve been on a steady climb, until the recent turmoil in Egypt and Libya pulled them lower. The benchmark 10-year Treasury rate recently hit 3.50 percent. That’s up from 2.49 percent on Aug. 26. But rates fell after the Jackson Hole speech and then began rising on each bit of good news about the economy. Economists say that’s how it’s supposed to work. Interest rates typically rise during an economic recovery to compensate bond holders for the negative hit from inflation.

“When this stuff starts to work, interest rates go up,” Chan says. “Otherwise, it’s just not working.”

It’s another story if rates jump too quickly. “Obviously, higher rates can stop an economy dead in its tracks,” he says.

How could rising rates derail the Fed’s efforts? A common worry among investors is that the Fed proves too successful in pushing up prices and inflation gets out of control, leading to a spike in rates.

A similar but separate concern, Hoey says, is that people come to expect rampant inflation and begin preparing for it. Companies raise prices in anticipation. Investors ditch bonds en masse, interest rates jump and borrowing turns suddenly expensive.

“It has brought us closer to an unstable rise of inflation expectations,” he says. “There’s a risk of exceptional instability.”

Another danger: There will be nobody to replace the Fed when the program ends in June. “Who will buy when the fed stops buying?” Gross asks, rhetorically. “Who will take their place? Mutual funds like Pimco?”

That’s unlikely, he says, because investors have been pulling money out of bond funds. Other institutional investors, like insurances companies and banks, are beginning to put their money elsewhere. And even bond managers like Gross have been warning investors away from Treasurys for months. If rates rise too high and too quickly, they squelch the economic recovery and drive down stocks.

Jack Albin, chief investment officer at Harris Private Bank, worries that the U.S. could wind up with a similar experience to Japan’s. The Japanese central bank also managed to boost prices and spur economic growth through pushing money into financial markets starting in 2001. Bond yields began rising. But the benefits evaporated when the central bank pulled back.

“Maybe it was a problem of timing,” he says. “But once they took the quantitative easing programs off, the economy just sagged back to where it was before.”

Copyright © 2011 The Associated Press

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7 Responses to "OK, so Bernanke’s plan worked: Now what?"

  1. Almandine  March 1, 2011 at 11:05 am

    “But once they took the quantitative easing programs off, the economy just sagged back to where it was before.”

    And thus began the saga of QE3, after finding that the supposed improvements thought to result from QE2 were actually a mirage based on clever statistics and churned markets designed to entice the ever-gullible populace back into heightened indebetedness.

    The original porkulus, the too-big-to-fail bailouts, and QE1 couldn’t get it done, and without structural realignment of government specding, we will continue to throw good money after bad. At some point it will all be bad.

  2. bmclellan  March 1, 2011 at 11:15 am

    Ya gotta hand it to em Al, solid bullshit is easier to push than that soupy shit we’ve ” Ben ” left to swim in.
    We should be happy to keep a penny on the dollar they whine,
    while they take 99. Hack !

  3. woody188  March 1, 2011 at 1:27 pm

    WTF AP? Ben’s been wrong at every turn. First, he claimed there wasn’t a recession. Then he claimed the housing slump was limited to only a few markets. Next he claimed there wasn’t any systemic risk even while Lehman and Sterns were collapsing. Then he claimed inflation was tame. Finally he claimed housing prices had stabilized while they lost another ten percent.

    It’s like the author noted, there are no other buyers. So the only thing they accomplished was to delay the collapse by another couple of years and increase the cost and hardship to get through it.

    • Carl Nemo  March 1, 2011 at 1:51 pm

      For the un to ill informed this is valid news, for us at CHB, it’s just more propagandist bullsh*t…! / : |

      Carl Nemo **==

  4. griff  March 1, 2011 at 2:09 pm

    Ha.

    Hahahahahahaha.

    Hahahahahahahahahahahahahaa.

    Ha.

    Goebbels had nothing on the American propaganda machine.

  5. Hal (GT)  March 1, 2011 at 4:12 pm

    How exactly did it work? I thought that if we didn’t do what Ben wanted we were going to have massive job loss? Oh wait we did do what he wanted and what he warned still came to pass.

    I think what has happened here is that another bubble has been created. Now, what do you suppose will be the needle prick?

    Hmm.. Maybe those higher rates you note.

  6. senegoid  March 2, 2011 at 7:07 am

    That was rubbish. Gold and silver at all time highs, the more QE the higher they go.

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