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Five Reasons the Fed Is Wrong About the Economy… Again

John-Rothans

Written by Philip Diehl

Jul 26, 2013

I'm still boggled by the Fed's June economic forecast, the one that led analysts to conclude the Fed would begin winding down QE3 this fall. Markets around the world, including the gold market, reacted so negatively to this news that Chairman Bernanke was forced to give reassurances that an end to QE3 was not imminent.

This is a very disquieting event.

First, it suggests that the Fed has underestimated how difficult it will be to continue QE3 long enough to ensure a sustained recovery but end it before igniting a spike in inflation. Monetary policy is a very blunt instrument and this transition will require the Fed to thread a needle.

QE3 is designed to keep long-term interest rates low. Last month, on the first hint that QE3 might be ending, long-term rates jumped. The economic recovery has rested on the housing sector and consumer spending. Low interest rates are boosting home sales and housing values, making homeowners feel wealthier and more willing to spend. New homebuyers are buying appliances and furnishings for their new homes. Take away low interest rates and the props under housing and consumer spending are gone.

Second, last month's events confirm that the Fed's economic forecasters continue to be out of touch with the real economy. I say “continue to be” because, since the financial meltdown of 2008, the Fed has repeatedly underestimated the depth of the recession and overestimated the strength of the recovery.

Here are five reasons the Fed has misread the state of the economy and why it will be forced to continue QE3:

The employment situation is not improving.

1. The Fed cited progress on the employment front in recent months. But if you take a step back you find that, over the past nine months, unemployment fell only 0.2 percent, from 7.8 percent to 7.6 percent. At this rate unemployment will hit the Fed's target for ending QE3 in 2017, and it would not begin ramping down QE3 until early 2016.

2. More telling is that the “real” unemployment rate, which includes the unemployed as well as part-time employees who want full-time work, worsened in June, rising from 13.8 percent to 14.3 percent.

3. Just before the 2008 crash, about 63 percent of Americans over 16 were employed. When the recession officially ended in 2009, 59.3 percent of Americans had jobs. Today, 58.6 percent of Americans are employed, and there's been no progress in 18 months.

But household wealth has risen, right?

4. Maybe the Fed based its optimism on a rise in household wealth. During the Great Recession, household wealth fell about 16 percent as home values and investment portfolios took a beating. Since 2008, household wealth has risen by about 24 percent, and now, on an inflation-adjusted basis, household wealth stands about where it was before the 2008 crash.

BUT, if you look below the top line numbers, this is what you find: the economic recovery has bypassed the vast majority of Americans. The average household wealth of 93 percent of Americans continued to fall — by 4 percent — in the first two years after the official end of the Great Recession. So, most Americans are in worse financial condition than they were when the recession ended. Over the same years, the top 7 percent of American households saw their wealth increase by 27 percent.

OK, but personal income is rising.

5. For most Americans, no. Maybe the Fed based its optimism on the modest rise in personal income since the Great Recession ended. But again, look below the surface and you find that the income of the vast majority of Americans is no higher than it was at the end of the recession. Total personal income in America has risen because the top 1 percent have enjoyed an increase of 11.2 percent.

Evidence that the economic recovery is reaching most Americans is very thin. There's been little improvement in employment, none in personal income, and household wealth has continued to decline since the recession allegedly ended.

Should the Fed decide to start unraveling QE3 too soon, many Americans could find their precarious financial situations unraveling right along with it.

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