Federal Reserve policy fuels wealth-led growth When Rwandan bonds are yielding below 8 per cent, Indonesian sovereign debt swings 150 basis points and the Indian rupee oscillates wildly in a matter of weeks, while every day the US equity market sets new highs, (despite lacklustre earnings growth which continues to be driven largely by cost-cutting), some people might conclude that markets are volatile and bubbly. Clearly, though, both the current Federal Reserve Chairman Ben Bernanke and Janet Yellen, nominated to take over as Fed chair, are not among the worriers. Ms Yellen's remarks, prepared for her confirmation hearings last week, contained no hint of tapering. That underscores the Fed's obsessive fear of the negative wealth effect of any slowdown in asset purchases and a move towards higher interest rates. Five years after the meltdown, it is clear the Fed's quantitative easing is not about a real economic recovery, it is only about generating the liquidity that gives rise to asset inflation and wealth-led growth. Or super wealthy people-led growth since wages and incomes for the rest of us are not rising at all. Despite the failure to restore growth all these years later, the Fed's response is to keep ramping up, reflecting an assumption that growth can return to its former speed of say 3 per cent a year. But many analysts believe potential growth is coming down. They say the assumption in the Fed chairman's office that the economy is performing below its trend, like some intractably ill-behaved child, looks increasingly doubtful. There are several reasons for this scepticism. For one thing, the labour participation rate is falling, making the target unemployment rate of 6.5 per cent ever more unrealistic. Until the 1980s, women were entering the labour force in increasing numbers, but now that trend is reversing. At the same time, many discouraged workers have dropped out. Moreover, productivity is falling. For example, JPMorgan economist Robert Mellman noted recently that the hope that manufacturing will be a catalyst for recovery in the US is probably unrealistic, despite the relatively low price of natural gas in the country and the use of labour saving technology. Indeed, despite low interest rates, real investment in structures for manufacturers shows that spending declined at a double-digit rate through the first half of the year. The correct interpretation of a slight rise in employment in that sector, Mr Mellman notes, is not that orders are on the rise but that growth in labour productivity is relatively weak. "Manufacturing output has lagged behind and is still about 5 per cent below its previous cyclical peak," he concludes. In addition, growth in the number of households has slowed, with long-term implications for the housing market. The Fed's policy means that companies have an incentive to engage in share buybacks and dividend issuance (preferably with borrowed money) rather than investing in their operations. Since the trough, such activity is up almost 200 per cent, according to data from Citigroup. All this means that the disconnect between financial asset prices (especially share prices) and the real economy remains as wide as ever. For a snapshot of what the world looks like today consider the better than expected earnings of AP Møller-Maersk, the shipping company, which is a proxy for world trade. Its operations today are all about taking out capacity, not placing orders to add capacity, its earnings a reflection of vigorous cost cutting rather than real growth. "We can't rely on GDP developments to help us, we need to do it ourselves," said Nils Andersen, Maersk's chief executive. Liquidity of course has its limits, and often liquidity-addicted markets demand ever more injections of liquidity to keep from falling back. In Japan, for example, the markets are already craving a new fix. That is despite the fact that the Bank of Japan has decided to double its purchases of Japanese government bonds. Nor is it clear how the BoJ goes about coming up with a new fix when it already buys so much. Still, however unproductive Fed policies are in the real world, it would be a mistake to think that this will all come to an end any time soon, at least in the US. Beyond the world of financial asset inflation, there is no sign of inflation anywhere else - least of all in wages - that could force the Fed to ease off its easy money policies. The investors making the most money today are those using leverage to magnify their returns. Many hedge fund managers have underperformed because they do not quite trust Fed policies - an irony given that they are viewed as the roll-the-dice players. They have gone from investing to short-term trading and holding high levels of cash. Meanwhile, it is the Fed that continues to roll the dice.