Ben "Burn-anke" is throwing an economic Hail Mary in the Federal Reserve's next implementation of quantitative easing. At this point, on the topic of tools that cause consumers to start spending more, all the Fed has left is the "wealth effect. " In several speeches, Ben has pointed out that businesses need to feel confident that increasing demand will be sustained, at which point they would start expanding their operations.
While the wealth effect does exist generally, I do not believe it will work at this juncture, meaning QE3 and any subsequent QEs would simply be inflation-inducing wastes of time. The problem is simple: Increased wealth does not put more money in people's pockets. Burn-anke argues that if your house value is up, you will feel confident and spend more. Well, if your take-home pay is $2,000 a week, and your house goes up 20%, guess what? Your take-home pay is still $2,000 a week. Where is the additional cash you can spend at the mall this weekend?
Until 2008, the trick was that consumers would borrow more and spend the proceeds. Be it via credit-card debt or mortgage-equity withdrawals, the wealth effect could work in a clumsy -- and dangerous -- way. Of course, the problem with the old system was that you still needed to pay back your debts, and incomes did not increase sufficiently to allow for debt retirement. In a post-2008 world, consumers know better. Your house can do whatever Zillow tells you it is doing, but people are not going to borrow simply to spend, especially with stagnant incomes.
The stock-market wealth effect can be more real, since you can liquidate some of your holdings for spending. The open question here is whether unencumbered stock ownership is wide spread enough to matter. People have more exposure to stocks than they realize -- in their pension funds, for instance -- but much stock is held in 401(k)s and IRAs, and therefore is not accessible. I think any wealth effect from a rising market is limited to the high end of the market.
So, ultimately, Burn-anke is really spinning his wheels trying to create stronger demand. The only real way will be through higher wages, and I do not yet sense that businesses are willing to bid up wages in order to secure talent. Meanwhile, all of this new money needs to go somewhere. I am not sure when and to what magnitude. But unless the laws of economics are repealed, more money without more output will eventually lead to inflation. I am protecting my portfolio with more gold, via the SPDR Gold Trust (GLD), and with dividend-paying stocks in industries with demonstrated pricing power, such as tobaccos.