There is some disagreement over when the word “jawboning” first entered the English language. Some believe that its initial use characterized Herbert Hoover’s attempt to convince employers to maintain wage levels after the crash of 1929, while others believe it was first used during the Second World War, when officials at the U.S. Office of Price Administration and Civilian Supply attempted to restrain wartime profiteering. Politicians since at least the Johnson administration have engaged in the technique, and while its etymological origins may be in dispute, the term has since entered wide use, referring to a form of moral suasion, usually by government officials attempting to alter behavior or influence markets.
Typically, jawboning efforts have been undertaken by those seeking to lower or moderate price pressures, but Federal Reserve Chairman Ben Bernanke and his cohorts are putting a novel spin on the technique. By speaking regularly and aggressively about a second round of quantitative easing, they have been successfully jawboning inflationary expectations higher, as attested to by the recent dip of TIPS into negative yield territory for the first time. Whether such suasion is moral remains open to question, but it is clear that most market participants have bought into Big Ben’s rhetoric.
Trouble is, after weeks of furiously fanning the flames of those expectations, the Fed now appears to be qualifying their earlier pronouncements regarding the size and timing of QE2. The market reacted yesterday with a volatile session as traders adjusted to the reality that the central bank may not be injecting $2 trillion into treasuries all at once, a prospect which in retrospect may have merely reflected wishful thinking on the part of investors. Given the price action that accompanied the intimations that the Fed’s entrance into the market may proceed more gingerly than previously anticipated, traders should be operating under the assumption that the benefits of additional quantitative easing are already priced into the market. With so many buying into the inflationary scenario, Fed actions will carry more weight than its words as we move forward and that could pose a danger. If it turns out that the Fed has no intention of actually allowing inflation to reach the levels it has led others to expect, Chairman Ben will have slain more traders with his jawbone than Samson ever did Philistines.
Once raised, inflationary expectations tend to burn brightly and are famously difficult to extinguish, but the Fed appears to have decided that the risks of deflation and the overall sluggishness of the economy justify the gamble. For the last two years, we have all been listening as commentator after commentator has warned of an inflationary surge that has yet to arrive. According to those very same pundits, Bernanke and company are leading us down the path of runaway price increases and a devaluation of the dollar that will eventually lead us to the mother of all currency crises. While I am not willing to buy into that doomsday scenario just yet, there remains reason for concern. I suspect that we will be able to avoid the hyperinflation predicted by many of the most fervent Rick Santelli acolytes, but the easy money (some would say “free money”) that the Fed is pushing out the door could certainly lead to unanticipated asset bubbles. Because of that potential, I’m betting that QE2 turns out to be more talk than action, due to the inherent risk involved in its execution. After all, if those new bubbles were permitted to inflate to levels sufficient to once again threaten our financial system, Chairman Bernanke would someday be forced to look back on QE2 as the bonehead move of his once-illustrious career.
Bernie McSherry is senior vice president for strategic initiatives at Cuttone & Company.