Hoisington Investment Management’s Lacy Hunt, recently spoke with Mauldin Economics to discuss the effects of Federal Reserve Policy since the 2008 financial crisis. While Lacy Hunt holds that the Fed’s immediate response to the financial crisis was well executed, its policies since then have been highly destabilizing for the US economy.
The reason (for the financial crisis) is that they (the Fed) had not adequately regulated a massive buildup of debt, which was the root cause of the recession in 2008 and 2009. Then they instituted Quantitative Easing, which I think has only the most marginal of positive benefit, but it has also created a lot of negative. One of the most glaring is that this liquidity has fueled record leverage of the business balance sheet, and we are more leveraged in the business sector than we were in 2008 or 2009, or any other time in our history (Taps: as we discussed here), and I think that what the Federal Reserve did is they said to the world is ‘We are undertaking Quantitative Easing to boost the stock market… and the stock market will then produce the wealth effect and this will invigorate the economy.’ Well the wealth effect, which is a big item in the Federal Reserve’s econometric model, is in fact, not empirically observable (Taps: as we discussed here). This is the worst expansion in US economic history going back to 1790. By far the worst expansion since the end of WWII, and we have had a very strong stock market. There is not enough ownership, by enough people, for the stock market to benefit. However, when Bernanke, and later Ms. Yellen, said that their objective was to boost the stock market, it was a sign to the business executives to emphasize financial investments over real investments: ‘The fed’s backing your play and you can engage in financial engineering, buying back your shares, buying the shares of others, raising dividends, other financial transactions.’ The business managers think that they can reverse those, that the liquidity will be there. You install a set of new plants ans production lines and so forth, if the demand doesn’t materialize, you are stuck with it. You are not going to be able to liquidate it. And so, in essence, what the Federal Reserve mistakenly did is that they encouraged a shift from real investment into financial investment. Last year business debt increased by more than $700 billion and business debt to GDP set a new all time peak, but investment in plant, equipment, and inventories fell by over $20 billion, and it is the real investment that grows the economy, and so the Federal Reserve has in fact, by this unprecedented program, created very significant unintended consequences, which have undermined the US’s ability to grow, to have gains in productivity, and to lift the standard of living.”
We couldn’t agree more. The interview continues and covers much more so we encourage you to enjoy it below: