However, zero interest rates didn’t stimulate economic growth. Because the Fed couldn’t reduce rates below 0%, Ben Bernanke and his Fed friends had to find new ways to goose the economy.
That’s how we got programs like “Operation Twist” and “Quantitative Easing.” I know they’re hard to keep straight, so here is a quick rundown.
- Quantitative Easing #1: Between December 2008 and March 2010, the Fed spent $1.45 trillion buying toxic mortgage-backed securities from Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Banks. They also bought $300 billion of long-term Treasury securities.
- Quantitative Easing #2: From November 2010 through June 2011, the Fed spent a total of $600 billion to buy long-term Treasury bonds.
- Operation Twist: From September 2011 to December 2012, the Fed spent $667 billion to buy bonds with maturities of 6 to 30 years while selling bonds with maturities of less than 3 years. The goal was push long-term interest rates downward.
- Quantitative Easing #3 (aka, QE Infinity): In September 2012, the Fed began monthly purchases of $40 billion in agency mortgage-backed securities and $45 billion of longer-term Treasury securities.
All that twisting and easing pushed the Fed’s balance sheet assets up to almost $3.8 trillion as of Oct. 9. This already-staggering amount will keep growing by an additional $85 billion every month until the Fed starts “tapering.”
Janet Yellen: More of the Same!
With President Obama’s nomination of Janet Yellen as new Federal Reserve Board chair, the Wall Street crowd knows it can expect more loosey-goosey monetary policy.
Yellen, a Democrat, is another monetary “dove.” She has consistently supported all Bernanke’s asset purchase programs.
Yellen is a dyed-in-the-wool Keynesian. She earned her doctorate at Yale in 1971. She studied under Nobel laureate James Tobin, who advised presidents Kennedy and Johnson. Yellen embraced the Depression-era strategies of aggressive government action to reduce unemployment and spur economic growth.
Under Yellen, you can expect more debt … more money-printing … more government intervention … and more kicking the monetary can down the road.
As an investor, what does Yellen’s nomination mean to you? I expect four major effects:
- More Bubbles: Asset prices — including stocks and real estate — will keep rising. The old “Don’t fight the Fed” adage is still good advice. Stocks and other risk assets will be volatile but will also trend higher.
- More ZIRP: The Fed already promised to leave interest rates near zero until 2015. Yellen will probably push that out even longer. Income-oriented investors should get used to the “new normal” (pathetic) fixed-income returns.
- More Inflation: The Federal Reserve has a dual mandate to foster maximum employment and price stability. Yellen, like Bernanke, is as blind as Mr. Magoo about inflation threats.
- More Pain: Most dangerously, even super-dove Janet Yellen will have to take the Fed’s foot off the QE pedal eventually. The stock market’s negative reaction will be painful and last a very long time.
Enjoy the stock market ride while you can — but plan now how to deal with the next bear market. You have two options:
Option #1: Do nothing, get clobbered, and wait 2, 4, 6 or even more years to get your money back. Most people think they can ride out bear markets … but history shows they will panic and sell when the pain gets to be too much.
Option #2: Have some kind of defensive strategy — market timing, portfolio insurance and protective stops — to avoid the big downturns.
Enjoy the new Janet Yellen party … but watch out for the nasty hangover.
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