Negative Interest Rates
“Accommodative policy is appropriate, in my view, because the economy is operating well below its potential and inflation is undesirably low. If it were positive to take interest rates into negative territory I would be voting for that*” – San Francisco Federal Reserve Bank President Janet Louise Yellen – February 2010
Janet Yellen, Vice Chair of the Board of Governors of the Federal Reserve System has been nominated by President Obama to become the Chair of the Federal Reserve, replacing outgoing Chairman Ben Bernanke.
If her nomination is approved, what type of Fed Chair will she be?
Upon receiving word that Ms. Yellen would be the nominee we wrote: “…we will have gone from the low interest rate policies of Alan Greenspan, to the no interest rate policies of Ben Bernanke to the negative interest rates of Janet Yellen.”
Ms. Yellen will most likely follow the policies of her immediate predecessor and as her quote above indicates, may be more willing to extend quantitative easing (QE) than to “taper” it.
Here is a quick review of Ms. Yellen’s two predecessors:
Benjamin Shalom Bernanke (2006-present)
Mr. Bernanke became Chairman of the Federal Reserve when all seemed well with the economy. The housing market was still strong, although weakening, and the sub prime crisis was a couple of years in the future.
Mr. Bernanke’s tenure as Fed Chairman will be remembered for the actions he took after the financial crisis of 2008.
Starting in 2009 and continuing through the present, Mr. Bernanke instituted a “highly accomodative” monetary policy that involved bringing interest rates down to near zero and embarking on a series of QE programs whereby the Fed bought trillions of dollars of U.S. Treasuries and Mortgage Backed Securities with money printed out of thin air in order to lower interest rates to stimulate the economy. The results have been at best mixed with the labor market and growth remaining stagnant. QE has managed to help reflate the housing and stock markets as prices in those two markets have neared or reached their pre-2008 financial crisis levels.
A student of the great depression, Mr. Bernanke saw the biggest threat to the U.S. economy as deflation. In a 2002 speech Mr. Bernanke said “Sustained deflation can be highly destructive to a modern economy and should be strongly resisted.” In the same speech Bernanke made reference to dropping money from helicopters to combat deflation, earning him the nickname “Helicopter Ben”. The QE programs were initiated in 2009 to combat deflation that would have sunk in as the economy would have gone through a deleveraging process to cleanse itself of the excesses of the housing bubble than had burst a year earlier.
While Mr. Bernanke has started speaking about tapering the latest round of QE and eventually ending it, to date no steps have been taken, in part because Mr. Bernanke admitted that rising interest rates (caused by threatening to taper the program) would harm the still fragile and weak economy. Mr. Bernanke has created a circumstance for his successor that will make it difficult to taper QE (or even talk about it) or close the program with out a sharp rise in interest rates and an adverse shock to the economy. The further down the QE road Mr. Bernanke took us, the further down the road Ms.Yellen must go.
Alan Greenspan (1987-2006)
From Gold Bug to “The Maestro”
Alan Greenspan was appointed Federal Reserve Chairman in 1987 by President Reagan to replace outgoing Chairman Paul Volker. Mr. Volker’s chairmanship was characterized by the willingness to raise interest rates into mid double digits to break the inflation that had been plaguing the country since the early 1970’s. Volker’s move caused a steep recession. When it was over, however, inflation had been vanquished and the economy recovered, resulting in President Reagan’s landslide reelection in 1984 on the back of his “Morning in America” campaign.
Alan Greenspan was a former banker and Ayn Rand acolyte gold bug before becoming Chairman of the Federal Reserve. “Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process.” Greenspan wrote in “Gold and Economic Freedom” and published in Ayn Rand’s “Objectivist” newsletter in 1966.
During Greenspan’s tenure as Fed Chair he confounded us with an inimitable and often indecipherable verbal style. From softening the effects of the 1987 stock market crash (the Fed “stands ready to serve as a source of liquidity to support the economic and financial system”), to his attempt to jaw bone some of the “irrational exuberance” out of the nascent Nasdaq .com bubble in late 1996, to the arrangement of a bailout of Long Term Capital Management in 1998, to the pouring of liquidity into the market and lowering of interest rates in 2001 post 9/11, Greenspan’s Fed tenure had a decidedly interventionist streak that was antithetical to his pro free market/anti statist views of two decades earlier. Indeed, Mr. Greenspan’s Fed used an interventionist monetary policy so often to prop up the markets that such actions were called the “Greenspan put”.
Bob Woodward in his book, rather paen to Mr. Greenspan, referred to him as the Maestro for his seemingly masterful orchestration of the economy during his tenure. Shortly after Mr. Greenspan abdicated the Fed Chair in 2006 the economy imploded. Some Fed observers attributed the collapse to the low interest rate policies that Greenspan enacted following 9/11 that led to excesses in the housing market and subsequent bubble that burst in 2008.
Janet Yellen follows in a line of interventionist Fed Chairs. Ms. Yellen believes that central planning and Fed monetary policy can make positive contributions to the economy. To date, Ms. Yellen has been a proponent of the QE programs and indeed seems to be less interested in “tapering” QE than her fellow Fed Board members.
Given that the Fed appears to have no intention of tapering or shutting down the QE program, we expect Ms. Yellen to trot out the same excuses for continuing QE (economic projections coming in below the Fed’s expectations, the government shut down caused economic harm, unemployment is too high, inflation too low) or even adding to its size. Her desire for negative interest rates evidenced by the comment at the top of this post is an indication that she believes in highly accomodative monetary policy. We believe this means QE will continue unabated into 2014, or perhaps be increased if the economy deteriorates.
As we have noted on this blog, QE is inflationary and discriminates against savers, has created asset bubbles in the real estate and stock markets but has not had a positive impact on the labor market or meaningfully increased the GDP.
The labor participation rate is at a 35 year low and wages are lower today than when the QE programs began.
The Fed’s Dual Mandate Includes Maximum Employment
In 1977, Congress amended The Federal Reserve Act to include the goals of maximum employment, stable prices and moderate long-term interest rates.”
Ms. Yellen wishes to use monetary policy to improve the labor market. In a speech earlier this year, Ms. Yellen remarked: “With employment so far from its maximum level and with inflation running below the Committee’s 2 percent objective, I believe it’s appropriate for progress in the labor market to take center stage in the conduct of monetary policy.”
After five years of QE, we question the efficacy of an accomodative monetary policy’s ability to achieve employment goals. QE may aid in making debt financed spending easier, but spending itself doesn’t lead to production that leads to jobs. Savings and investment are required for production and QE discourages savings and often encourages a mis allocation of investment.
Yellen: Playing With Fire?
Because we expect Ms. Yellen will continue and expand QE, her policies will have an increased inflationary effect that will begin to result in higher consumer prices during her term.
The Wall Street Journal cites Ms. Yellen’s “record of concern about excessive inflation” as a positive attribute. This is a foolish statement. Her concern about inflation has not prevented her from advocating inflationary money printing schemes like QE. Extolling Ms. Yellen’s “concern about excessive inflation” is like praising a kid playing with matches in the woods as someone who is concerned about raging forest fires.
We expect Ms.Yellen’s nomination to receive Congressional approval. We also expect Senator Rand Paul to continue the tradition of his father Congressman Ron Paul, in asking the hard questions of Fed Presidents as to whether their policies are doing more harm than good.
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