The Federal Reserve has bent over backwards in order to meet its twin mandate of low inflation and maximum employment. Since the mortgage meltdown of 2008, the Fed has expanded its balance sheet to a staggering $2.92 trillion dollars. By purchasing U.S. Treasuries and mortgage securities, the Fed has driven interest rates to historic lows. Nonetheless housing remains in a quagmire, with over 25% of all existing home owners underwater, and home prices are still not expected to bottom till sometime this year (calling housing market bottoms has been fraught with error, and with a huge shadow inventory of unsold homes, could continue their downtrend into 2013). Meanwhile, while unemployment has been coming down, it remains high at 8.5%.
Question 1. Has the Fed achieved maximum employment?
Answer. No. Unemployment at 8.5% and a still falling housing market does not equate with meeting the Fed’s first mandate.
According to the Bureau of Labor Statistics, inflation as measured by the consumer price index increased 3.4% over the last 12 months.
Question 2. Is inflation low?
Answer. No. It is arguable that inflation is not exactly low at 3.4%, but not exactly high either.
While the Fed has yet to achieve its twin mandate, what it has clearly achieved is staggering profits from its enormous balance sheet. While the average hedge fund lost 10% in 2011, and stock investors pulled money out of stock funds virtually every week in 2011 for a sum total of $148 billion for all of 2011, the Fed managed to book $79.3 billion in profit. Not bad for a bunch of public servants. These funds will be handed over to the U.S. Treasury to cover the near $1 trillion deficit in 2011. A drop in the bucket to be sure, but for the many investors in the U.S., both retail and institutional, it must no doubt seem unfair that the Fed can make turning a profit in the market look so easy.
It must be nice when your funding cost is 0%, and your buying ability is unlimited. The Fed’s jaw-dropping activities should remind all investors that we hardly operate in a free-market economy, but a centrally-planned market where a small group of unelected central bankers can make the capital markets a farce.