Waiting for the Fed

The Lehmann Letter (SM)

Some folks are waiting for a pronouncement from Fed Chairman Ben Bernanke that will rescue the stock market: Something about expansionary monetary policy and low interest rates.

They shouldn’t set their hopes too high.

It’s true that low interest rates are good for the stock market, other things being equal. Interest-earning assets are an alternative to stocks. During the late 1970s, when inflation and interest rates were double-digit, investors abandoned stocks in favor of money-market funds. Today’s low interest rates promote stock-market investment. Low interest rates also promote borrowing and spending by households and businesses, stimulating economic activity and boosting profits. That’s why investors love low rates.

Trouble is: Rates are already low and monetary policy is expansionary. It’s true that lenders are leery of making the same errors that led to the 2008 debacle. Now borrowers must be credit-worthy, not risky. But there’s not much the Fed can do about that. After all, the Fed can’t appear to support the lax standards of 2003 – 2007.

In any event, neither high interest rates nor tightened loan standards are today’s principal impediment to robust borrowing and a booming economy. Household’s weakened balance sheet stands like a boulder in the road, preventing the rapid economic expansion required to restore full production, full employment, earnings growth and a rising stock market. Households have too few liquid assets, too much debt and too little net worth. That’s why they’re not borrowing and spending and businesses, in turn, aren’t investing in the plant and equipment required to make the goods that households are not buying. The Fed can’t fix that.

© 2011 Michael B. Lehman