By: Ambrose Evans-Pritchard
October 9, 2013
We now know where we stand. Janet Yellen is to take over the US Federal Reserve, the world’s monetary hegemon, the master of all our lives.
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The Fed will be looser for longer. The FOMC will continue to print money until the US economy creates enough jobs to reignite wage pressures and inflation, regardless of asset bubbles, or collateral damage along the way.
No Fed chief in history has been better qualified. She is a glaring contrast to Alan Greenspan, a political speech writer for Richard Nixon, who never earned a real PhD (it was honorary) or penned an economic paper of depth.
She has pedigree. Her husband is Nobel laureate George Akerlof, the scourge of efficient markets theory. She co-authored “Market for Lemons”, the paper that won the prize.
Currently vice-chairman of the Fed, she was a junior governor from 1994 to 1997 under Greenspan, and then president of the San Francisco Fed from 2004 to 2010. She was head of Bill Clinton’s Council of Economic Advisers from 1997 to 1999, when she handled the Asian crisis. You could hardly find a safer pair of hands.
Note that she confronted Greenspan head-on in 1996, pushing for pre-emptive rate rises to choke inflation and wean the economy of cheap credit. She was entirely right to do so. That was the moment when the Fed began to make a series of fatal errors, becoming addicted to ever lower real interest rates. Nobody called her a dove then.
She was on the other side a decade later during those crucial months before the subprime housing crash, quick to sense the danger of a chain reaction through the shadow banking system. Ben Bernanke and the FOMC majority scoffed at worries that the subprime debacle was the tip of an iceberg.
“I feel the presence of a 600-pound gorilla in the room, and that is the housing sector. The risk for further significant deterioration, with house prices falling and mortgage delinquencies rising, causes me appreciable angst,” she told Fed colleagues in June 2007, a 15 months before the storm hit.
The transcripts show that she clashed with New York Fed chief William Dudley in December 2007 over the risks of subprime mortgage defaults, which is telling since Dudley (ex Goldman Sachs) was supposed to be the official with his finger on the market pulse. “The possibilities of a credit crunch developing and of the economy slipping into a recession seem all too real. At the time of our last meeting, I held out hope that the financial turmoil would gradually ebb and the economy might escape without serious damage. Subsequent developments have severely shaken that belief,” she said.
She was absolutely right again. We now know that the US economy was already in recession by then (though the Fed did not then have the data). We now know too from a devastating book by the Richmond Fed’s Robert Hetzel – “The Great Recession” – that the Fed itself was the chief cause of the disaster that unfolded in 2008. The FOMC was far too tight. It let the M2 money supply implode in early 2008. That is what led to the Lehman, AIG, Fannie/Freddie disasters. The rest is noise.
Janet Yellen was not to blame. She later backed QE to the hilt, fighting a chorus of amateur alarmists who claimed that inflation was poised to take off. She was again proved right. Core inflation in the US is currently hovering near a half century low. The greater danger is still deflation.
There is little doubt that the she is a dove in today’s circumstances. She tracks jobs. Her lodestar is the “non-accelerating inflation rate of unemployment” (NAIRU). When the rate is above NAIRU, she is a dove: when below, she is a hawk.
My guess is that we are still a very, very long way for NAIRU. Yes, the Fed is committed to tapering QE to zero once the jobless level reaches 7pc (and raise rates once it hits to 6.5pc), and yes, this could in theory happen much sooner than the think want since the headline rate has already plummeted to 7.3pc.
But this headline rate is wildly misleading because so many workers have given up searching for a job. They have fallen off the rolls. The labour participation rate has collapsed to a 35-year low of 63.2pc. It is blindingly obvious that the real rate of unemployment is much higher than it looks. Some of these people have been driven out of the work force for ever, left behind by new technologies, but surely not all.
Mrs Yellen tipped her hand in a speech to the labour unions in February, a text now being studied for clues.
Three million Americans have been looking for work for one year or more; that’s one-fourth of all unemployed workers, which is down from 2011’s peak but far larger than was seen before the Great Recession. These are not just statistics to me. We know that long-term unemployment is devastating to workers and their families. When you’re unemployed for six months or a year, it is hard to qualify for a lease, so even the option of relocating to find a job is often off the table. The toll is simply terrible on the mental and physical health of workers, on their marriages, and on their children.
And then the key line:
If the current, elevated rate of unemployment is largely cyclical, then the straightforward solution is to take action to raise aggregate demand. If unemployment is instead substantially structural, some worry that attempts to raise aggregate demand will have little effect on unemployment and serve only to stoke inflation.
I see the evidence as consistent with the view that the increase in unemployment since the onset of the Great Recession has been largely cyclical and not structural.
So there we have it. The next chairman of the Fed is going to track the labour participation rate. Money will stay loose. Markets have been spared again. The Brics can breathe easier.
This leaves me deeply uneasy. We are surely past the point where we can keep using QE to pump up asset prices. My view is that emergency stimulus should henceforth be deployed only to inject money directly into the veins of the economy as an adjunct to the US Treasury, by fiscal dominance, as deemed necessary.
That would take an intellectual revolution. Is Janet Yellen game for such incendiary ideas?
God Goliath is not your typical gold dealer.