Despite the Federal Reserve exploding its balance sheet over the past six years from less than a trillion dollars to nearly four trillion, average GDP growth over the period remains only about 2%. The average pace of the current economic expansion is less than half the average of the last four recoveries and well under the 3% long-term growth rate of the U.S. economy.
We believe this is due in significant part to a lack of confidence by private-sector decision makers. This is evidenced by the fact that liquidity on corporate and individual balance sheets remains at record highs despite the enormous opportunity cost of such liquidity due to near zero interest rates.
Confidence remains low notwithstanding reasonably solid, albeit low, GDP growth; slowly declining unemployment; turnarounds in the automobile and real estate industries; and the fact that the U.S. is on the verge of becoming energy independent.
Certainly part of the problem is the dysfunction in Washington. Until the recent modest two-year budget accord, private enterprise decision makers witnessed complete disarray in Washington with the shutdown of the government and the inability to pass budgets or get spending under some semblance of control.
These fiscal policy problems are compounded by the monetary policies of the Federal Reserve. Only academic economists could possibly believe that a timid $10 billion reduction in the purchase of Treasury bonds by the Fed, while continuing to purchase $75 billion a month, would negatively impact the economy and increase unemployment.
The path to economic growth is not to be found in quantum economic theory. The poorly handled economic crisis of 2008-2009 resulted in a severe worldwide financial panic and shook public confidence to the core. The challenge is to restore confidence in the future and convince private sector decision makers that better times are ahead.
The Fed dominating the markets through massive, unprecedented quantitative easing and announcing the economy is in such dire straits that interest rates will remain near 0% for years to come rattles public confidence rather than restores it. Private decision makers fear a state-directed economy will result in misallocation of resources and create bubbles in various asset classes, which would inevitably have a bad ending. In these circumstances, many investors postpone major spending and investments until they become convinced that the markets will be allowed to operate freely without the heavy hand of government.
Business executives and economists can get reasonably comfortable assessing economic indicators and predicting the future. Predicting political trends and outcomes is hazardous at best.
Ironically, the Fed's current love affair with "transparency" is making matters worse, not better. Central banks throughout history have been careful not to signal future actions because they had the humility to understand their limits in predicting the future, and they feared causing distortions and unintended consequences in markets.
Markets work best when millions of independent decision makers try to predict the future and make their bets accordingly. Will rates go up or down and when and by how much? Should I sell or buy bonds or stocks? What will happen to the demand for autos or real estate? Should I expand my business by adding to my plant and hiring new workers?
The Fed declared it would purchase bonds and would keep interest rates at zero indefinitely. If instead it had purchased bonds and driven interest rates to near zero without announcing its future intentions, a lot of people might have viewed the very low interest rates as a once in a lifetime opportunity to borrow and expand their businesses. But there is no sense of urgency to borrow and invest when the Fed tells you that the future is so bleak it will keep interest rates near zero for years to come.
The recent budget deal gives hope that both political parties recognize it is in their best interests to work together in addressing their differences on fiscal policies. That helps build confidence.
The Fed should now do its part by withdrawing its promise to keep rates at or near zero until unemployment reaches some target level a target level that is not nearly as meaningful as the percentage of the population in the workforce. The Fed should taper quantitative easing without fanfare at whatever pace it believes appropriate period. It should allow market participants to make their own bets on what the Fed will do and when it will do it.
Our nation became great and powerful due to its democratic form of government accompanied by a free-market economy. Returning to our roots trusting our citizens to make the best decisions will do more to restore confidence than any other action government could take. We the people have prospered by having more faith in ourselves than in an overbearing and intrusive government.
Richard M. Kovacevich is the retired chairman and CEO of Wells Fargo. William M. Isaac, former chairman of the Federal Deposit Insurance Corp., is a senior managing director and global head of financial institutions at FTI Consulting, the chairman of Fifth Third Bancorp and author of Senseless Panic: How Washington Failed America. The views expressed are their own.