Obama, Salman Khan, QE-3: Why we have to wait for 6 Nov

by Vivek Kaul  Sep 5, 2012 16:03 IST

#Barack Obama   #Ben Bernanke   #EasyMoney   #QE-3   #Salman Khan  

Richard Nixon, who was the President of the United States between January 1969 and August 1974, appointed Arthur C Burns as the Chairman of the Federal Reserve Bank of the United States (the American central bank) on 30 January 1970.

“I respect his (i.e. Burns) independence. However, I hope that independently he will conclude that my views are the ones that should be followed,” Nixon said on the occasion.

Burns did not disappoint Nixon and especially when it was election time in 1972.  From the start of 1972, Burns ran an easy money policy and pumped more money into the financial system by simply printing it. The American money supply went up by 10.6 percent in 1972.

The idea was that with increased money in the financial system, interest rates would be low, and this would encourage consumers and businesses to borrow more. Consumers and businesses borrowing and spending more would lead to the economy doing well. And this would ensure the re-election of Nixon who was seeking a second term in 1972. That was the idea. And it worked. Nixon won the second term with some help from Burns.

It's widely expected that Ben Bernanke would start another round of money printing, or QE-3, this year to help Obama’s re-election campaign.

As investment newsletter writer Gary Dorsch wrote in a column earlier this year, “Incumbent presidents are always hard to beat. The powers of the presidency go a long way….Nixon pressured Arthur Burns, then the Fed chairman, to expand the money supply with the aim of reducing unemployment, and boosting the economy in order to insure Nixon’s re-election…Nixon imposed wage and price controls to constrain inflation, and won the election in a landslide.” (you can read the complete column here)

History is expected to repeat itself  

Something similar has been expected from the current Federal Reserve Chairman Ben Bernanke. It has been widely expected that Bernanke will unleash the third round of money printing to revive the moribund American economy. Bernanke has already carried out two rounds of money printing before this to revive the American economy. This policy has been technically referred to as quantitative easing (QE), with the two earlier rounds of it being referred to as QE-1 and QE-2.

The original idea was that with more money in the economy, banks will lend, and consumers and businesses will borrow and this, in turn, would revive the economy. But the American consumer had already borrowed too much in the run-up to the financial crisis, which started in September 2008, when the investment bank Lehman Brothers went bust. The consumer credit outstanding peaked in 2008 and stood at $2.6 trillion. The American consumer had already borrowed too much to buy homes and a lot of other stuff, and he was in no mood to borrow more.

The wealth effect

The other thing that happened because of the easy money policy of the American government was that it allowed the big institutional investors to borrow at very low interest rates and invest that money in the stock market. This pushed stock prices up, leading to more investors coming into the market.

As Maggie Mahar puts it in Bull! : A History of the Boom, 1982-1999: What drove the Breakneck Market--and What Every Investor Needs to Know About Financial Cycles: “In the normal course of things, higher prices dampen desire. When lamb becomes too dear, consumers eat chicken; when the price of gasoline soars, people take fewer vacations. Conversely, lower prices usually whet our interest: colour TVs, VCRs, and cell phones became more popular as they became more affordable. But when a stock market soars, investors do not behave like consumers. They are consumed by stocks. Equities seem to appeal to the perversity of human desire. The more costly the prize, the greater the allure.”

As more money enters the stock market, stock prices go up. This leads to what economists call the “wealth effect”. Stock market investors feel richer because of stock prices going up. And because they feel richer they tend to spend some of their accumulated wealth on buying goods and services. As more money is spent, businesses do well and so in turn does the economy.

As Dorsch puts it, “Historical observation reveals that the direction of the stock market has a notable influence over consumer confidence and spending levels. In particular, the top-20 percent of wealthiest Americans account for 40 percent of the spending in the US economy, so the Fed hopes that by inflating the value of the stock market, wealthier Americans would decide to spend more. It’s the Fed’s version of “trickle down” economics, otherwise known as the “wealth effect.”

Why Bernanke won’t launch QE-3 soon

Given these reasons it was widely expected that Ben Bernanke would start another round of money printing, or QE-3, this year to help Obama’s re-election campaign. Bernanke has been resorting to what Dorsch calls “open mouth operations,” i.e. dropping hints that QE-3 is on its way. In August he had said that the Federal Reserve "will provide additional policy accommodation as needed to promote a stronger economic recovery." This was basically a complicated way of saying that if required the Federal Reserve wouldn’t back down from printing more money and pumping it into the economy.

But even though Bernanke has been hinting about QE-3 for a while, he hasn’t gone around doing anything concrete about it. The reason for this is the fact that Mitt Romney, the Republican candidate against President Barack Obama, has gone to town criticising the Fed’s past QE policies. He has also warned the Federal Reserve to stay neutral before the 6 November elections, says Dorsch. As Romney told Fox News on 23 August: “I don't think QE-2 was terribly effective. I think a QE-3 and other Fed stimulus is not going to help this economy…I think that is the wrong way to go. I think it also seeds the kind of potential for inflation down the road that would be harmful to the value of the dollar and harmful to the stability of our nation's needs.”

Even though Bernanke has been hinting about QE-3 for a while, he hasn’t gone around doing anything concrete about it because  Romney has gone to town criticising the Fed’s past QE policies. Reuters

Romney even indicated that he would prefer someone other than Bernanke as the Chairman of the Federal Reserve. “I would want to select someone new and someone who shared my economic views…I want someone to provide monetary stability that leads to a strong dollar and confidence that America is not going to go down the road that other nations have gone down, to their peril.” With more and more dollars being printed, the future of the dollar as an international currency is looking more and more bleak.

Romney’s running mate Paul Ryan also echoed his views when he said “Sound money… We want to pursue a sound-money strategy so that we can get back the King Dollar.”

Given this, it is highly unlikely that Ben Bernanke will unleash QE-3 before 6 November, the date of the Presidential elections. And whether he does it after that depends on who wins.

Of Obama and Salman Khan

As far as pollsters are concerned Obama seems to have the upper hand as of now. But, at the same time, the average American is not happy with the overall state of the American economy. “According to pollsters, two-thirds of Americans think the US economy is still stuck in the Great Recession, and is headed in the wrong direction. Only 31 percent say it is moving in the right direction — the lowest number since December 2011. The dire outlook is explained by a recent analysis by the US Census Bureau and Sentier Research LLC indicating that US-household incomes actually declined more in the three-year expansion that started in June 2009 than during the longest recession since the Great Depression,” writes Dorsch.

But despite this Americans don’t hold Obama responsible for the mess they are in. As Dorsch points out, “Although, Americans are increasingly pessimistic about the future, many voters don’t seem to be holding it against Democrat Obama. Instead, the embattled president is getting some slack because he inherited a very tough situation. In fact, Obama’s strongest base supporters are among also suffering the highest jobless rates and highest poverty rates in the country.”

Obama’s support is similar to the support film actor Salman Khan receives in India. As Manoj Desai, owner of G7 theatres in Mumbai, recently told The Indian Express: “Even when the fans are disappointed with his film, they never blame him. You will often hear them say, bhai se galat karwaya iss picture main. (They made Bhai do the wrong things in this movie)"

What’s in it for us?

Indian stock market investors should thus be hoping that Barack Obama wins the November elections. That is likely to lead to another round of quantitative easing. As had happened in previous cases a portion of the money will be borrowed by big Wall Street firms and make its way into stock markets round the world including India.

Vivek Kaul is a Mumbai-based writer and can be reached at vivek.kaul@gmail.com

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