Janet Yellen, unlike her predecessors Alan Greenspan and Ben Bernanke,
bears no responsibility for causing the global economic crisis. However,
as the next chairperson of the Federal Reserve, she will still inherit
the mess they made. Therefore, it is very important to understand how
she plans to deal with it. There is no need to guess about her
intentions. She has been clear about how she will proceed. It is only
necessary to read her speeches over the last few years to understand her
thinking. In this blog, I will write about Mrs. Yellen’s game plan for
managing the economy, as well as what I believe will be the short-term
and long-term consequences of her policies.
What matters most is her position on Quantitative Easing – because QE
is now the most important driver of the global economy. At present, the
Fed is creating $85 billion each month and using that money to buy
bonds. That policy pushes up bond prices and drives down interest rates,
thereby boosting property prices. It also causes more money to move
into equities, which fuels the rally in the stock market. Rising asset
prices enable Americans to spend more; and that spending causes the
economy to grow.
So, how does Mrs. Yellen feel about QE? The answer is, she likes it.
She believes QE is working and she thinks it should “continue until
there is a substantial improvement in the outlook for the labor market
in the context of price stability.”
A recurring theme throughout many of her speeches is her concern for
the unemployed, as well as her belief that high unemployment risks doing
lasting damage to the US economy. The unemployment rate in the United
States is 7.2%. This is a very substantial improvement relative to the
crisis peak level of 10% in 2009. However, it is still considerably
above the 5.2% to 6.0% range that the Fed considers the longer-run
normal rate of unemployment. Moreover, the underemployment rate, which
incorporates those people working part-time because they can’t find
full-time jobs, is 13.6%. And, further, wages and hours worked per week
remain stagnant and the labor participation rate remains very low, which
suggests people have become discouraged and stopped looking for work.
Mrs. Yellen has stated that she believes all of these factors should be
considered when judging the outlook for the labor market.
The press release at the end of the Fed’s FOMC meeting on October 30th reiterated Mrs. Yellen’s position:
“The Committee…. will continue its purchases of Treasure and agency
mortgage-backed securities (i.e. QE)… until the outlook for the labor
market has improved substantially in a context of price stability.”
The inflation rate is now 1.2% (as measured by the core Personal
Consumption Expenditure price index). That is below the Fed’s preferred
level of 2%. Therefore, unless there is a spike in inflation, we should
expect QE to continue until there is a substantial improvement in “the
outlook for the labor market.” Such an improvement appears unlikely in
the near-term. Over the last three months, most labor market indicators
have been weakening, rather than improving, as was the case earlier in
the year.
Mrs. Yellen will replace Ben Bernanke in January. The debt ceiling will
be hit again in February and may provoke another political crisis in
Washington. Moreover, the outlook for the labor market is unlikely to
improve substantially before the spring. For these reasons, the majority
of financial analysts now believe that the Fed will not even begin to
reduce the pace of QE until March.
If that view is correct, and I believe it probably is, then the
near-term outlook for the stock market is very bullish. QE will continue
to pump fresh money into the economy and that money will drive up asset
prices, particularly the price of stocks.
The greatest near-term risk may be that the stock market moves up too
far, too fast. That might force the Fed to take some step to rein it in
to prevent a new bubble from inflating. So investors should enjoy the
ride, but remember that too much of a good thing could prove to be
dangerous.
As for the longer-term, Mrs. Yellen and her colleagues have stated
repeatedly that the Fed is unlikely to begin increasing the Federal
Funds Rate (which has been near 0% since 2008) until well after QE ends
and most probably not until 2015. Such abnormally low interest rates are
storing up serious problems for the future by encouraging investments
to be undertaken now which will become unprofitable when interest rates
return to more normal levels. If this kind of “malinvestment” continues,
the size of the eventual losses are very likely to be such as to cause
another very costly systemic banking crisis in the not too distant
future.
I do not envy Janet Yellen. She is walking into what looks like an
impossible job. If she stops QE and returns interest rates to a normal
level any time soon, the stock market and the property market will crash
and the economy will be threatened by a new depression; but, if she
continues to create massive amounts of fiat money and to hold interest
rates at 0%, then the US (and the global) economy will become so
distorted by malinvestment that a new depression may become unavoidable
in any case.
I do not envy her, but I respect her. Her concern for the unemployed is
genuine; and her fears about the consequences of long-term unemployment
are well founded. I wish her the very best of luck – and so should you.
Our future depends on her success.
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