Ruminations February 2, 2014
2014 and the Fed: The year of economic recovery?
On the bright side, we have a new Federal Reserve Chairman – Janet Yellin. Although it is said that her monetary philosophy is fully in sync with outgoing chairman Ben Bernanke’s, that remains to be seen. Certainly, if Yellin wants to make her mark, she will have to create her own policies and it is hard to see how much worse than Bernanke’s they could be.
Fighting deflation. According to the Wall Street Journal, Bernanke’s “record before the  crisis was a clear failure.” His record after the crisis isn’t much better. While Federal Governor, the Journal tells us, “he gave a famous speech [in 2002] warning about deflation that didn't exist.” Subsequent to the crisis of 2007, he has also warned of deflation that didn’t exist. When Bernanke’s Fed initiated its quantitative easing program in 2010, which is still functioning, he said “the goal was to avoid deflation.” (We should note that Bernanke is a great student of the Great Depression and how the Fed’s tight money program contributed to deflation. It almost seems that since he has studied deflation so intensely, he sees it under every bedstead.)
Economic bubbles. When the dot-com bubble burst in 2000, Bernanke with then-Fed Chairman Alan Greenspan decided to offset that bubble with a new one – the housing bubble. In concert with low-interest rates (negative real interest rates) and the Community Reinvestment Act, the housing market took off only to crash in 2007 – something one would expect a financial expert to foresee. And in the aftermath of the bubble collapse, Bernanke has continued his program of low-interest and the Fed’s purchase of mortgages in order to re-inflate the housing bubble. (In the past 12 months, real estate prices in the United States have gone up more than they have since 2006 – it makes you stop and think.)
Quantitative easing. In order to keep interest rates low and increase the available liquidity, Bernanke’s Fed embarked on a program of quantitative easing (QE) which critics labeled “printing money.” Effectively, the Fed has been (until recently) printing $85 billion dollars a month and has accumulated a balance sheet of $4 trillion in debt. The effect of QE has been to prop up the housing, commodities and stock markets, without stimulating the economy. One wonders why it took over $4 trillion and five years to figure out the ineffectiveness of this program. Furthermore, since we can’t stay in this mode forever, we need to figure a way to ease back from QE without damaging the economy. (The Bank of Japan had tried QE earlier and declared it ineffective in 2001 but who needs to listen to them.)
The impact of QE will only become apparent to Americans when interest rates begin to rise on the $4 trillion of Fed holdings.
Cut off of QE. The Fed has recently begun to reduce the amount of QE from $85 billion per month to $65 billion with promises to continue its reduction. While this is still increasing the Fed’s balance sheet, it caused a sell-off in markets. Well, this was a market largely created by the Fed; it makes sense that it will turn down as a result of the Fed’s actions.
Unemployment. Bernanke said that the Fed would continue with QE until the unemployment rate fell to 6.5 percent while keeping the inflation rate close to the Fed’s target of 2 percent. So, evidently, Bernanke believes that his policies can dictate the unemployment rate – in spite of five years of failure. How much can the Fed policy influence unemployment?
It was in 1937, with Great Britain’s unemployment rate around 10 percent when economist John Maynard Keynes said "… I believe that we are approaching, or have reached, the point where there is not much advantage in applying a further general stimulus at the centre." That’s at 10 percent.
Or course, the Fed has tried before to target inflation and unemployment in the 1970s. They failed then, too. The targets were unemployment of 4 percent and inflation of 3 to 4 percent. What we got was unemployment of 7 percent and inflation of 13 percent. Have we learned anything?
Monetizing the debt. When the Fed prints money and then uses that money to buy treasury bonds from banks, the money supply goes up and, since the Fed hold the Treasury bonds, it has financed the debt by printing money – which can be highly inflationary. Richard Fisk, President of the Federal Reserve of Dallas warned in 2010 that QE is monetizing the debt. "The math of this new exercise is readily transparent: The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation's central bank will be monetizing the federal debt.”
Well, that can’t be good.
Lost independence. The Federal Reserve is supposed to be independent of the executive branch (although the chief is nominated by the president). But the link between the administration and the Fed has always been tenuous. William Miller, chairman of the Fed under President Jimmie Carter admitted to carrying out Carter’s policies. Arthur Burns was suspected by some of doing the same for Nixon.
Bernanke, while not taking direct orders from the White House, has worked closely with Treasury on taxes and spending, which made his independence somewhat suspect. During the 2012 presidential campaign, Republican presidential candidate Mitt Romney had promised, upon election, to fire Bernanke.
What to expect from Janet Yellin. By all accounts, Yellin is a well-qualified and thoughtful person with the type of leadership qualities that are necessary in her new position as Fed chief. She is also said to be a kindred spirit of Bernanke.
One hopes that she has learned from Bernanke’s missteps and has the independence to chart a new course for the Fed.
Quote without comment
Der Spiegel editorial, December 3, 2013: “Central banks around the world are pumping trillions into the economy. The goal is to stimulate growth, but their actions are also driving up prices in the real estate and equities markets. The question is no longer whether there will be a crash, but when.”