On Wednesday the Federal Reserve announced it will buy back about $105 billion in Treasury bonds next month as part of a second round of quantitative easing, or QE2 for short. The announcement came a week after the Fed’s Federal Open Market Committee (FOMC) voted to purchase a total of $600 billion of longer-term Treasuries by the end of the second quarter of 2011.
But the monetary stimulus won’t solve the economy’s problems, contends Richard Fisher, president and CEO of the Federal Reserve Bank of Dallas and a nonvoting member of the FOMC. Indeed, QE2 could increase financial speculation and ultimately produce “superordinary” inflation, said Fisher in his speech at the Association for Financial Professionals conference in San Antonio earlier this week.
QE2 is intended to increase the supply of money and lower interest rates further in a bid to spur spending and make credit more available. In Fisher’s words, its goal is to “[challenge] the propensity for economic actors to hoard rather than invest.” But he said his recent conversations with Texas-area businesspeople in manufacturing, railroads, shipping, and retail suggested that business activity is picking up, and that lack of credit is not the problem.
“Several of my CEO and CFO interlocutors report that in the past few weeks the biggest banks have approached them ‘literally begging to lend us 10-year money at less than 3%,’” said Fisher. He cited the Dallas Fed’s Texas Manufacturing Outlook Survey in October, in which only 18% of 240 companies reported having “substantial” or “extreme” difficulty getting financing.
Despite rock-bottom interest rates, “businesses lack confidence that they will earn a superior ROI by investing so as to expand their domestic workforce, in comparison to what they might earn from alternative investments abroad, or by buying in their stock or cleaning up their balance sheets,” said Fisher. “Consumers aren’t borrowing either, because they’re worried that future income streams [won't] be sufficient to cover their payment obligations.”
Meanwhile, depressed consumer consumption and rising prices for commodities such as corn, cotton, pulp, and metals are beginning to put pressure on profit margins, said Fisher. He cited the example of one company whose 450 Chinese suppliers are upping their bids for next autumn’s supply contracts by 30%, because of higher commodity prices and efforts by the Chinese government to get manufacturers of low-tech products to increase wages. CEOs whom Fisher has talked to don’t “have the pricing wherewithal to pass on cost increases of more than 2% in light of the weakness of consumption,” he said.
Absent pricing power and given “anemic demand,” businesses are investing to finance productivity enhancement to protect their margins, Fisher said, not in large-scale capital expenditures that increase employment. Even a boom in merger and acquisition activity by financial sponsors, which would be aided by greater economic liquidity, wouldn’t change this dynamic, he said. “Buyout people do not typically acquire companies with a plan to expand the workforce, but instead with an eye to tighten operations, drive productivity, rejigger balance sheets, and provide an attractive payback.”
The real beneficiaries of QE2 will be financial market speculators, said Fisher, who are already stepping up activity in stocks, bonds, and commodities. He pointed to a climb in investors’ margin-account debit balances, which as a percentage of the market capitalization of S&P 500 companies now exceed the precrash levels of 1987 and 2001.
Fisher said that while he respects the FOMC’s will, he thinks the Fed has “taken a leap of faith” that Congress and the President will carve “a sensible budgetary and regulatory path that incentivizes businesses to put to work the money the Fed is printing.” Said Fisher: “If the Congress and the [President] fail to deliver, I believe the FOMC will have to consider changing course.”