The US economic recovery seems to have slowed. Although the percentage of people out of work fell from 9.1% last August to 8.2% in April, it rose again in May. Growth forecasts are being revised down rapidly. Consumer confidence is at its lowest in the last six months. There is a growing consensus that ‘something must be done’ – and the fact that it’s an election year just adds to the sense of urgency.
While the FT has recently argued that, “the US can and should, therefore, choose a more expansive fiscal policy”, we wouldn’t hold our breath. The Republicans are opposed to any major new government spending plans, and have the power to block them if necessary. Even if they agreed with a big spending boost, they wouldn’t hand Obama a major propaganda victory before November.
So while some tax cuts may be extended, and some minor spending on roads and bridges approved, fiscal policy will not be the major driver of growth.
This only leaves monetary policy to pick up the slack. The website nowandfutures.com reckons that growth of the US M3 money supply has dropped from 6.4% at the start of this year, to 2.9% in late May (there is no official measure).
This makes the next Federal Reserve meeting, later this week, very important. No Fed meeting is a foregone conclusion, but analysts are particularly uncertain of which way the Fed will go this time. Capital Economics believes there won’t be any more quantitative easing, whereas Goldman Sachs – often seen to have the ear of the Fed – reckons there’s an 80% chance.
Who’s right? And what should you do about it?
Falling oil prices will make it easier to justify more QE
The biggest argument against QE is that it leads to higher inflation. In March James Bullard, a senior Fed official, said that the “ultra-easy” monetary policy was risking a worldwide surge in prices. He even refused to rule out the possibility of interest rate rises next year.
Others have warned of stagflation: a toxic combination of soaring prices and low growth. Given that the Fed adopted an informal inflation target of 2% in January, Fed chief Ben Bernanke is clearly keen to give the impression that the Fed at least cares about inflation.
However, the recent collapse in the crude oil price may help Bernanke out. WTI prices (the best approximation for the US oil market) were as high as $105 per barrel at the start of last month, but they have now fallen to under $85 a barrel.
My colleague John Stepek thinks that crude oil price, and that they could fall even further. This would help to lower inflation in the short run, and would increase the scope for further QE. Of course, further QE would likely help to buoy up oil prices, but that’s something Bernanke can worry about later.
What about the political backdrop?
Politics will also play a key part in getting the Fed to begin QE3. Like most central banks, the Fed is ostensibly independent from the central government. However – also in common with most central banks – its power to influence the economy means it has also drawn a lot more attention in the past four years.
Bernanke was easily re-appointed by the Senate as Fed chairman two years ago. However, he received the largest number of opposing votes in history – nearly double the previous record.
And Mitt Romney, the Republican presidential candidate, has been unafraid to talk about monetary policy. QE2 “did not bring jobs back to this country or encourage small businesses to open their doors”, he recently argued. In a debate last September he went even further, stating that he’d be looking “for someone new” as Fed chair if elected.
Of course, all of this may be election rhetoric. Romney’s comments are mild compared with those of Rick Perry, one of the unsuccessful primary candidates, who said that QE was “treason”.
However, Reuters’ Mark Felsenthal thinks that if the Republicans win, Bernanke is likely to be replaced when his term expires at the start of 2014. Professor Martin Feldstein of Harvard and John Taylor of Stanford University, both critics of QE, are two possible candidates.
Bernanke’s best chance of keeping his job therefore lies in an Obama victory. And the best way to make this happen would be another round of QE, delivering a short uplift to the economy in time to make Obama look good.
Rail traffic is warning of a US slowdown
But Bernanke may not have to worry about politics. The economy may well look shabby enough to justify QE3. One of the most reliable leading indicators in the US is pointing down.
I’m talking about rail data. Before finished goods hit the stores, or warehouses, they have to travel from the factory. Much of this transport is done by train. Rail freight data therefore tells us a lot about what firms expect to happen – it gives us an idea of how much they’re ordering.
And it doesn’t look good. The data suggests that the US economy is heading for a slowdown. Logistics Weekly reports that according to the Association of American Railroads, the total number of carloads shipped in the week ending 2 June was down by 3.1% compared with the same time last year.
How do you defend against yet more QE?
And all of this is without taking into account the pandemonium in the eurozone. So, it seems there’s a good chance of more QE appearing in the next few months. This will give it enough time to boost the economy, while being far enough from the election to avoid accusations of being partisan.
Regardless of what you think of the efficacy of QE, printing more money certainly drives up the price of assets. Indeed, Fed chief Bernanke has indicated that this is one of his goals with QE.
This suggests two options. The first option is to buy US shares. The most popular ETF is the Standard & Poor’s 500 Index Depository Receipts (AMEX: SPY). However, given that US markets are currently quite expensive compared to history (if you look at the cyclically adjusted p/e ratio at least), then we’d prefer the second option – to buy gold. We take a look at gold and some promising gold miners in the next issue of MoneyWeek, out on Friday (if you’re not already a subscriber, you can subscribe to MoneyWeek magazine).