Ruminations, October 13, 2013
Yellen and shoutin’ in the financial markets
Federal Reserve Chairman Ben Bernanke is picking a most opportune moment to retire. The Fed has accumulated a balance sheet of over $3.5 trillion, in large part due to quantitative easing (QE) – the Fed’s failed program to stimulate the economy by printing money. Now the trick is for the Fed to back out of QE without causing runaway inflation or a recession. Bernanke has always said that he had a plan to do so but never revealed exactly what the plan was but now he has: he’s going to turn over the problem to Janet Yellen.
Now Janet Yellen, vice chairman at the Fed and President Barack Obama’s pick to head the organization, is every bit as qualified as Ben Bernanke. But, does qualification have anything to do with implementing a sound program? For example, William McAdoo was Secretary of the Treasury from 1913 to 1918 and had few qualifications for the position – other than being President Woodrow Wilson’s son-in-law. But McAdoo organized the Federal Reserve and, through bold action (e.g., closing the New York Stock Exchange for 4 months) he was able to avert a financial panic, build a system to finance the allies during World War I and lay the groundwork for the American financial system.
Yellen and Bernanke are eminently more qualified for the job than was McAdoo. And maybe their qualifications are the problem. They are stuck in reliance on their computer models. Computer models are useful but they are not completely reliable – they don’t take into consideration the complex psychological actions of markets and individuals. Since the economic downturn in 2008, virtually everyone has become more risk averse and the models don’t allow for that.
And then there is the time element. If the Fed abandons QE, which they must at some point, Bernanke and his kindred spirit Yellin tell us that the U.S. may enter back into recession. What they ignore is the time element – we are borrowing money from future generations and that money will reduce future employment and economic growth. However, Bernanke and Yellen are hoping that their monetary policies will create current growth robust enough to offset future economic slowdown. In spite of the models, the current economic growth has not been forthcoming as the models had predicted.
Things are getting worse. Sales of euro-dominated bonds are increasing at the expense of dollar-denominated bonds – in spite of the hash the European Monetary Union has made of things. Sales of euro-denominated bonds are up 50 percent this year – and the year is not over. This means that the market for loans is losing confidence in the dollar – and 60 percent of that market consists of Americans. In part, this is blamed on the government shutdown and the battle over the reining in the borrowing cap on the debt. But this trend toward an increase in euro-dominated bonds has been going on all year. What it means is that, to re-attract bonds to the dollar, interest rates must rise and/or QE must ratchet down.
What a great time to retire. If Bernanke has no answers, then it is wise to turn the Federal Reserve System over to someone else. Maybe Yellen, being new to the job, may want to risk overturning Bernanke’s signature policies. Maybe. On the other hand, she has been a Bernanke supporter who has worked hand-in-glove with the Obama Administration. The chances are small that she will deviate from Bernanke’s policies.
But then too, who would have predicted McAdoo’s achievements?
Quote without comment
Economist and columnist Robert J. Samuelson, writing on political ideology in the Washington Post, October 7: “I’ve called this “the politics of self-esteem” — and it profoundly alters politics. For starters, it suggests that you don’t just disagree with your adversaries; you also look down on them as morally inferior. It’s harder to compromise when differences involve powerful moral convictions. Indeed, if politics’ subconscious payoff is higher self-esteem, it makes sense not to cooperate at all. Consorting with the devil will make you feel worse, not better. What’s more satisfying is to prove your superiority by depicting your opponents as dangerous, thoughtless and morally bankrupt.”