The difficult challenges facing Janet Yellen
Future actions of the Fed matter more than many people imagine
Janet Yellen had an atypical introduction as President Obama’s choice to replace Ben Bernanke as chair of the Federal Reserve. After Larry Summers exited the stage, Yellen was officially introduced during the self-inflicted congressional crisis and government shutdown – within days of a potential debt ceiling breach.
Though Yellen, who has served as Fed vice chair since 2010, will face some opposition, she will likely be confirmed by the Senate. I’ve been asked whether or not I think Yellen is a good choice to replace Bernanke.
Yellen, who has served since 2006, through one of the most turbulent times in American economic and political history, could be a transparent and competent choice with one caveat: How long will Yellen and the Fed continue the policy of the money printing stimulus that pumps up to $85 billion a month into the economy by buying mortgage and U.S. Treasury securities? This policy, now questioned by many economists, will not go on forever. Most importantly, how will the Fed introduce the “taper” and avoid the next “taper tantrum”?
Bernanke’s policies have been both controversial and understandable, given the Washingtonian gridlock that has stopped most other stimulus methods or even modest investments in infrastructure, education and technology. According to the Financial Times, our country’s public investment is now at the lowest level since post-World War II.
Some readers may be unaware that the Federal Reserve has a dual mandate: inflation and employment. Most people know the former but not the latter focus of the Fed.
In September, as if preparing for a shutdown, the Fed Open Market Committee said it would not adjust its purchasing program. In language often requiring a decipher, the FOMC said, “these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.”
In translation, it seems possible that the Fed does not trust the current political climate and that its policies may continue for a while longer. Currently, the Fed is not subject to political oversight. Inflation, other than in the health and food sectors, does remain historically low -- so much so that it’s easy to forget about it being a serious economic issue. Some members of the Fed appear very comfortable with higher inflation over time. The critical question on my mind is how long can the Fed prop up the markets by printing money?
It’s no coincidence that the Fed has stepped up its efforts as political gridlock has led to a consequence of low-job growth policies. Janet Yellen is a highly regarded economist and an expert on structural unemployment. But how long can she balance the need to deal with a systemically soft labor market while the Fed continues to pump new money into the system to grease the gears of the credit and liquidity markets? What might be the unintended consequences of such policies: asset bubbles, inflation or currency devaluation?
While Bernanke dealt with the Great Recession of 2008 and its aftermath, it’s quite possible that Yellen will face even greater challenges. Since 2009, Rob Arnott of Research Affiliates has warned about a possible “3D Hurricane” of deficits, demography and debt and suggests that the current levels of personal, and particularly governmental, debt obligations are unsustainable and unhealthy.
The 3D Hurricane may cause the Federal Reserve to rethink the path on which it is on. This may be why immigration reform has become a far more important priority than had been understood. Good reform could legitimize millions of workers who can contribute, improve our demographics, while helping to reduce our debt.
The future actions of the Fed matter more than many people imagine because the Fed is anything but a benign force in the marketplace. Very aggressive central bankers throughout the developed world can change traditional asset valuations and provide a crutch to the stock market. Has the Fed helped to create a Potemkin recovery?
Our website, thesedoricgroup.com, displays a remarkable chart of the correlation between Fed actions and the equity markets. For example, just before the crash of 2008, Federal Reserve assets were at .06 percent of nominal GDP. By the end of 2014, that number is estimated to rise to .21 percent of nominal GDP – a growth of almost 350 percent.
How long can it go on and how long do we trust that proverbial wizard behind the curtain? The real challenge for Yellen and the Fed will be to navigate their way out of the corner into which they have been painted.
Tom Sedoric, managing director-investments of the Sedoric Group of Wells Fargo Advisors in Portsmouth, can be reached at 603-430-8000 or www.thesedoricgroup.com.