Larry Summers and Keynesians love bubbles

large_8168642328The market is eagerly awaiting the last FOMC meeting of 2013. Will they taper or not taper? I highly doubt that Ben Bernanke will be the Grinch and choose to taper in his last Fed meeting. However even if he does, it is a few months overdue.

Larry Summers was President Obama's favorite to replace Fed Chairman Ben Bernanke. Even though Summers ended up bowing out, it is important to listen to his recent IMF Research Conference speech because his Keynesian view is very much in line with incoming Fed Chair Janet Yellen, ECB President Mario Draghi and Japan's Shinzo Abe. The simple conclusion is easy monetary policy, quantitative easing and zero interest rate policy will likely be with us for a very long time. Bubbles, crashes and more bubbles are going to be our future. This type of environment is going to be especially rough for traditional buy and hold investors.

Here are some key quotes from Summers:
“Even a great bubble wasn’t enough to produce any excess of aggregate demand…Even with artificial stimulus to demand, coming from all this financial imprudence, you wouldn’t see any excess.”
“The underlying problem may be there forever.”
"We may well need in the years ahead to think about how to manage an economy where the zero nominal interest rate is a chronic and systemic inhibitor of economic activity, holding our economies back below their potential.”

Our slower recovery from the Great Recession has scared the crap out of the central bankers. They worry about pulling back stimulus too fast and creating deflationary pressures. Instead we are likely to see super easy monetary policy for a very extended period.

With the bull market coming up on its 5 year anniversary and short rates stuck at zero, what will the Fed do if another recession hits us next year? Given their bloated balance sheet and ZIRP, they will have less power to combat the consequences. They seem to have two choices:

  1. The Fed could allow for greater inflation. This could incentivize people to spend sooner than later.
  2. The Fed cuts its current 0.25% rate on bank reserves held at the Fed. Executives at 2 of the 5 top US banks said that if this rate were cut, they would pass this cost to depositors. Yes you will be charged to keep your money at a bank! This would force people to move into riskier assets and/or spend the money.

Whatever the choice, the next downturn is going to be a vicious and nasty one.

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About the Author: Chris Wang

Chris Wang

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