Boob jobs and the Federal Reserve aren't often mentioned in the same sentence.  The reason why should be clear.  One has nothing to do with the other. 

There is a metaphorical connection between the two, however, that is jumping out at us like a bad boob job, otherwise known in cosmetic surgery circles as an asymmetric outcome.

Asymmetry Defined

The word asymmetry is defined by Merriam-Webster as the lack or absence of symmetry, meaning there is a lack of proportion between the parts of a thing. 

All breast implant patients of course expect their surgical outcome to be symmetrical to the naked eye (no pun intended), notwithstanding the physiological fact that breasts are naturally asymmetric. 

Having seen more than a few episodes of E!'s Dr. 90210 back in the day, it was brought to my attention that expectations and reality don't always match up.  Asymmetrical outcomes, or bad boob jobs, happen.  When they do, psychological pain follows and corrective surgery is needed.

That brings us to the Federal Reserve, which has been operating on the economy with unconventional monetary policy since 2009.

Quantitative easing has been the Fed's main surgical instrument and it has been wielded in the fixed income market.  Specifically, the Fed's operating procedure has included buying more than $2 trillion worth of agency mortgage-backed securities and long-term Treasuries in a bid to hold down interest rates and to, ahem, enhance economic growth. 

Stock Market Has Double-D Confidence

It is the aim of Chief Surgeon Ben Bernanke to stitch things up with the wealth effect.  That is, it is his belief that higher asset prices, namely stock and house prices, will act as economic sutures that repair consumer confidence and increase end demand.

Well, the stock market is up nearly 130% from its March 2009 low and median existing home prices are up 17% from their January 2012 low.  That's the good news.

The bad news is that real GDP contracted 0.1% in the fourth quarter.  The CBO, meanwhile, estimates real GDP growth will be a meager 1.4% in 2013 if fiscal tightening occurs under current law.

The takeaway is that the stock market is strutting around with double-D confidence thanks to the Fed's surgical approach while the real economy is still stuck in a training bra due to high unemployment, debt deleveraging, and restrictive lending conditions.

The wealth effect sounds good and even looks good for some. 

The problem, though, is that the Fed's surgical approach is imbalanced to begin with, because it is irrelevant for many who don't own stocks and/or a house. 

A Theory That Sounds Good

The counterargument is that people who don't own stocks or a house will ultimately be pulled up by those who do as confidence in higher asset prices leads to more spending, more jobs, and higher incomes.  Subsequently, those people who don't own stocks and/or a house will become more confident themselves and start to spend more, thereby reinforcing a positive feedback loop.

Sounds good in theory, but as the 7.9% unemployment rate, zero growth in real hourly earnings over the last 12 months, and average real GDP growth of 1.5% over the last 16 quarters show, it remains largely a theoretical hope.

A number of explanations, such as worries about the eurozone and uncertainty about US fiscal policy, have been offered to explain the disconnect between the stock market and the real economy.  The charts below perhaps best explain why the Fed's focus on the wealth effect has failed to produce the economic enhancement for the real economy that was envisioned.

In brief, they show that:

• only 47% of all US households own stock (down from 49% in 2007) ⁽¹⁾
• only 31% of all US households that own stocks have stock holdings of $10,000 or more (down from 32% in 2007) ⁽¹⁾
• only 65% of occupied homes are owner occupied (versus 69% at the end of 2004).

What It All Means

The Fed's policy of targeting asset prices hasn't been off the mark altogether.  Stock prices have rallied sharply and house prices are starting to increase again from a very depressed base.

Still, the policy isn't hitting the mark of achieving escape velocity for the economy because it isn't enhancing household net worth in a balanced way.    

By targeting asset prices, the Fed is really only inflating one implant on the chest of the US economy. 

The other implant is out of proportion because the augmentation procedure isn't taking for a decent segment of the population that doesn't own stocks and/or a house.  Remember, too, the vast majority of households that do own stocks have less than $10,000 in stock holdings, which is barely enough to afford a boob job.

The Fed showed remarkable surgical skill  in the throes of the financial crisis, but it did so as an ER doctor whose chief goals are to assess, to diagnose, and to stabilize the patient.  

The Federal Reserve is proving less adept as a cosmetic surgeon working to enhance economic growth.  To be fair, that is due in part to a lot of boobs in Congress.

In any event, it is plain to see to the naked eye that proper proportionality is lacking in the Fed's policy approach.  Asset prices are inflating, but the real economy isn't.

To be succinct, expectations and reality are not matching up.

The more enhanced asset prices get without a concomitant pickup in the real economy, the greater the risk becomes that an asymmetric outcome will occur that inflicts psychological pain and forces the need for a surgical correction that even Dr. 90210 might not be able to fix.

--Patrick J. O'Hare, Briefing.com

Notes:

(1) The charts for stock holdings are based on an analysis of the 2010 Survey of Consumer Finances data by Edward Wolff for the Economic Policy Institute.