Note: I first published this Opinion Piece on November 2, 2016. A version of this was adapted for MarketWatch (link provided below). The charts were updated on September 1, 2017. -- Minyoung Sohn, Founder of Blue Room
When Alan Greenspan, the former Chairman of the Federal Reserve, states fear that the Economy is at risk of sliding into Stagflation, Americans should take notice. Stagflation is a rare and nasty form of Economic Recession where the Economy is stagnant or stuck in slow growth, while at the same time inflation forces higher interest rates.
The Maestro Chairman Greenspan says "There is only so much that monetary policy can do"
Quantitative Easing is no longer working
QE has proven unable to deliver Economic Growth above 2%
The Fed recently suggested that buying stocks could help the Economy. This is bad thinking!!!
Let's Change Strategy of QE and Focus on Fixing Student Debt
The Federal Reserve has focused QE on the Asset Side of the Consumer Balance Sheet
QE (formally known as Quantitative Easing) is a Monetary Program where our central bank, the Federal Reserve (also known as The Fed) drives up bond prices in an attempt to increase the Money Supply.
This is a form of Expansionary Monetary Policy. Higher bond prices result in lower interest rates, and lower interest rates are generally viewed to be positive for the the Economy.
QE focuses on the Asset side of the Consumer Balance Sheet. The theory is that asset price inflation creates a wealth effect which inspires Americans to increase spending, which the drives economic growth (consumption is two-thirds of the U.S. Economy).
Since 2008, the Fed has been steadfast in its use of QE. Interest rates in the US have been pushed down near 0%* and record low rates have successfully propped up the stock market. The Dow Jones Industrial Average is 33% above its last peak in 2007.
The stock market is at all-time highs
But there is a growing uneasiness that the S&P 500 could falter. Meanwhile, Fed policies have been unable to sustain any Economic Growth above 2%.
This begs the question: Is this the best that QE can do for the Economy?
In addition to the stock market, other investment classes, such as Income Property are also valued at record levels. However, this asset price inflation comes with offsetting "bad inflation" - monthly rent increases have been accelerating. Rapidly rising rental expense puts a real squeeze on disposable income for lower income Americans as well as Millennials.
Furthermore, the Fed had destroyed the earning power of Savings through a one-two punch of its Zero-Interest Rate Policy as well as Quantitative Easing
ZIRP has zapped the benefits of savings
Before the Financial Crisis, a retired American would earn $5,000 per year in safe, interest income for every $100,000 in savings. Under the Fed's Zero-Interest Rate Policy, now if you have $100,000 in savings in the bank, the earning power of this same nest egg was slashed by over 90%.
Quantitative Easing is the second hit of the one-two punch against Retired Americans. ZIRP destroyed bank certificates of deposit as a viable savings vehicle. The Fed's massive bond-buying program under QE then proceeded to push down interest rates across all fixed income instruments.
Now, the Fed should shift QE to Focus on the Debt Side of the Consumer Balance Sheeet
The primary strategy of Quantitative Easing is to increase asset prices and create a wealth effect to stimulate consumption and drive economic growth.
Yet, in 2016, U.S. Economic Growth has lagged most economic forecasts. In my opinion, the problem is a bifurcated Economy. On the one hand, the 1% is as wealthy as ever as the Financial Markets are at all-time highs. On the other hand, we still have 43 million Americans who depend on Food Stamps.
The Marginal Propensity to Save
Before the Financial Crisis in 2009, roughly half of Americans preferred saving money to spending money. Since the Financial Crisis, the ratio has significantly. Now, more Americans prefer to save money than spent it by a 2 to 1 margin.
#HelicopterHope
Optimism Is Inflationary. An Unconventional Play for Unconventional Times
Focus More on the Debt side of the Consumer Balance Sheet
If Debt is the Problem, Fix the Debt
Step 1. Refinance All Outstanding Student Debt at the U.S. Government Borrowing Rate, which is currently less than 2% for 10-year bonds. The Fed has Engineered record low interest rates.
The American people own over $1 trillion of student loans through the Federal Student Loan Program. We should tell Congress to pass through the benefits of Quantitative Easing to our student borrowers.
Enter Fiscal Policy
Implement Loan Forgiveness and other Negative Amortization mechanisms to reduce Student Loan Debt
Many Americans no longer trust the stock market and it is unlikely they will rush out to spend windfall investment returns. However, helping American reduce debt will is unambiguously positive and more likely to be viewed a permanent improvement in well-being. This is far more likely to create optimism and encourage some spending.
Homeownership has strong emotional connection to the American Dream
Homeownership Rate Has Fallen Fast. Unintended Consequence of QE, or Something Else?
You could call this next chart Wall Street's collective outlook on growth, specifically 5 years out
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In conclusion, there are two clear deflationary forces in the Economy today
Young Americans: They have too much (expensive) student debt and not enough income. Until they are rightside up, they will continue to restrain their economic participation.
Retirees: Imagine working your entire life to build a nest egg, only to have the Fed eliminate your ability to earn risk-free income on your Savings.
Interest income on savings
(In this environment, we value the certainty of income so high . . . think about the perceived loss of wealth when Retirees can no longer save at a reasonable interest rate)