A Schumpeterian "cold shower" market-cleansing could just be too risky...

Don't be fooled: The Fed's exit won't be easy

by John H. Makin

The celebration of the second quarter growth "rebound" to 4 percent will be short lived as Thursday's brisk stock market sell-off has already signaled. The headline number's strength exaggerates the growth pace. It would be dangerous if it speeds up Fed tightening as Philadelphia Fed President Charles Plosser appears to have suggested it should by dissenting from the July 30th FOMC statement's call for a continued "considerable period" of accommodation.

• Growth Remains Weak

How robust is US growth? First, its best to average two choppy quarters especially when the first quarter was said to have been depressed - now to a –2.1 percent pace - by special factors like weather. The average growth rate of the first half of 2014 was 0.95 percent, quite a lot weaker than the 3 percent pace expected early in the year by the Fed and most analysts and is actually pretty close to stall speed.

Inventory changes, changes in the stock of unsold goods, exaggerated the volatility of first half growth numbers, accounting for nearly half (1.7 percentage points) of the second quarter growth "rebound." Final sales, the best measure of demand growth, rose at a modest 2.3 percent pace after having fallen at a 1 percent pace during the first quarter. Those figures put the average pace of US demand growth during the first half of 2014 at 0.65 percent. We need four times that pace to sustain a recovery, especially when the Fed is tapering and talking about raising interest rates next year - as if to declare its confidence in the as yet nonexistent, sustainable recovery.

Despite the temporary distraction of misleading headline growth numbers, the biggest question facing investors, producers, and households in today's low volatility, yet largely trendless, global economy is this: Will we witness the bursting of the "mother-of-all-bubbles" that creates global economic chaos as the Bank for International Settlements (BIS) suggests in its June Annual Report? Or, alternatively, will the current Yellen Federal Reserve path of holding the federal funds rate at zero for a "considerable period" after the asset purchase program ends enable the Fed to successfully exit its extraordinarily easy money policy?

• Bubbles Are Dangerous ...
• No Easy Exit ...
• Humility and Caution ...

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