Can Janet Plan It? Speculation on a Yellen Fed
Today, the market is what the Fed says it is. Simple as that. Supply and demand, productivity, projected earnings… all have become mostly irrelevant, or at least vastly subservient to actions of the all-powerful Federal Reserve. When encouraging economic news is announced, markets sell off (this might mean tapering, after all). When terrible news is announced, markets rally (no tapering coming, and maybe a possible increase in QE). Good news is bad, bad news is good- because valuations and interest rates across the board are now based primarily on market interventions, QE, and control of interest rates. This is why, by the way, I named my blog ‘The world turned upside down’… traditionally positive things like delayed gratification and careful preservation of your capital are now bad, spending money you don’t have and taking on debt is good and indeed is encouraged. This is the world we live in.
One would be hard pressed to name one economic factor more important than the Fed right now, because in a very substantive way, the Fed IS the market. Therefore, understanding what a Janet Yellen-led Federal Reserve will look like might be the single most crucial factor in planning our investment strategies for the coming years.
What follows is entirely subjective, and is presented as my opinion only, based on a dash of game theory, my review of roughly three dozen published works by Yellen and a couple dozen more articles about her economic philosophy. I have tried to highlight aspects I believe are important to understanding how she may run the Fed and formulate policy, so this is not intended to be a balanced, general overview. A selected bibliography of Yellen’s publications, speeches, and articles about her is included at the end of this article for further research on your own.
The bottom line is that I think we have very good reason to be fearful of what is going to happen during a Yellen chairmanship. Since 1970 there have been just five Fed Chairmen, with an average tenure of about 9 years. If Janet Yellen follows suit, she will serve as the Chairman of the Federal Reserve until roughly 2023- do you think we might find ourselves in any important economic situations over that time? Yeah, thought so. How this chairman reacts to crisis, and the core underlying economic beliefs that will inform her actions, will go a very long way towards determining what daily life will look like for us, at some point in the not-too-distant future.
Yellen is the first purely academic Fed chair in history, having never held a paying job in the private sector
Much like our current President, Yellen’s entire adult life has been spent either in government or in the academy. She has never once had to actually turn a profit or make a payroll. Her understanding of how business works is therefore entirely theoretical, not based on any personal experience running a company or working in a corporation or financial institution. Put another way, the person entrusted with creating the business climate has never actually been in business. She has read about it, though. So she’s got that going for her.
Here is just one of the many reasons this worries me: In the aftermath of the 2008-2009 financial crisis, Yellen admitted that as San Francisco Fed chair, she had been completely unaware of the existential risks to the system the MBS, Credit Default swaps, etc. posed. Indeed, it appears she was largely ignorant of major portions of the financial industry’s business model or how these aspects functioned in actual practice. A New York Times report quoted by Zerohedge shows the degree to which Yellen was in the dark about how the financial system was actually being run:
“Ms. Yellen told the Financial Crisis Inquiry Commission in 2010 that she and other San Francisco Fed officials pressed Washington for new guidance, sharing the problems they were seeing. But Ms. Yellen did not raise those concerns publicly, and she said that she had not explored the San Francisco Fed’s ability to act unilaterally, taking the view that it had to do what Washington said.
“For my own part,” Ms. Yellen said, “I did not see and did not appreciate what the risks were with securitization, the credit ratings agencies, the shadow banking system, the S.I.V.’s — I didn’t see any of that coming until it happened.” Her startled interviewers noted that almost none of the officials who testified had offered a similar acknowledgment of an almost universal failure.”
Yellen is the most overtly political Fed Chair since Marriner Eccles.
Eccles was hand-picked to serve as FDR’s Fed chair during the New Deal, and deliberately crafted monetary policy as a direct aid to (big) governmental policy. Indeed, he was famously chastised during testimony before the House by Congresswoman Jessie Summers of Illinois on the role of the Fed in directly facilitating the increasingly statist policies of the Roosevelt administration. In response to an Eccles explanation of this support, Summers famously chastised "Oh, you just love socialism".
Yellen is clearly in this mold, and views monetary policy as an extension of the liberal project of “perfecting society” through large scale governmental action and intervention. A New York Times article on Yellen put it this way: “Her confirmation would reinforce the Fed’s evolution from an institution run by market-wise bureaucrats focused on controlling inflation to an institution run by academics committed to a broader mission” (link) That ‘broader mission’ is the liberal/progressive big government project, emphasized by the fact that that same NYT article glowingly described Yellen not as an economist but as a “Liberal theorist” in the headline. An interesting and probably accurate description.
Yellen is a Keynesian’s Keynesian- a fervent and devout believer in the faith.
Near the end of the Reagan administration there was some soul searching on the part of Keynesian economists, and during this period they were challenged from both the right (a more “individual action/rationality” free-market oriented critique) and from the left (the Post-Keynesian critique) in ways that probably challenged the primacy of their orthodoxy more than at any time since Hayek’s writings in the 1940’s. It is therefore telling that during this period of soul-searching, Yellen and husband George Akerlof published a paper titled “Rational Models of Irrational Behavior” that was nothing short of a full-throated defense of Keynes General Theory against the rationalist barbarians at the gate. During this time of “a crisis in Keynesian economics” (as they described it in their introduction) the concluding paragraph is telling:
The bad press Keynesian theory has received from maximizing, super-rational theory is simply undeserved. The assumptions required to motivate Keynesian economics are quite consistent with the behavioral regularities documented by psychologists and sociologists. This motivation is in no way tortured out of complicated assumptions and models. It is highly natural. Keynesianism, both as theory and explanation of the facts, is alive and well on its fiftieth birthday. Happy Birthday, General Theory! (Akerlorf and Yellen, Rational Models of Irrational Behavior, American Economic Review Vol. 77 No. 2, 1987)
If/when we approach a time of economic crisis, it is my opinion that Janet Yellen is incapable of questioning the core foundational assumptions of her monetary faith- she is a true believer. If she encounters a situation where the Keynsian easy-money prescriptions are not only not working, but are actually making things worse in various areas, this is not a person who will suddenly discover the wonders of free markets and sound money. MOAR is the only direction this fervent acolyte is capable of going, and she will fight for the Keynesian approach to the bitter end.
The middle class, and savers, have virtually no place in Yellen’s worldview.
Based on her writings and the way she repeatedly characterizes sample problems in economics, it seems that Yellen’s worldview breaks people into three classes… they just aren’t the classes you might at first guess. To Janet Yellen, the world of economic actors consists of 1. labor, 2. the business owners who hire them, and 3. the technocrats (including politicians) who manage this system. The technocrats role is to manage the system to the benefit of labor in the form of “full employment” (seen as the ‘common good’, and the moral justification for technocrat administration), and to manipulate or at least work with the self-interest of those who hire labor.
I was particularly struck by the fact that in over two dozen scholarly articles I reviewed that were written or co-authored by this person, two terms were conspicuously absent: I never once read a single mention of savers (or the effect her favored monetary policy prescriptions has on them), and I never once read of her formulating an economic problem with regards to the middle class. In every sample problem or example she gave, Yellen always framed the issue using the leftist formulation of “labor (wage earners) and ownership (employers)”. Indeed, discussion of the creation of value and capital formation, or the conditions which bring these about, was startlingly absent.
She will be the first Fed chair (as far as I can find) to have been the keynote speaker at the national meeting of the AFL-CIO, showing how high the concerns of labor are to her (link). Her speech to this group made her priorities, and her policy path, crystal clear: the Fed under Janet Yellen will prioritize low unemployment over controlling inflation. She will do everything in her power to reduce joblessness by stimulating the economy, even at the expense of the other half of the “dual mandate”. Which brings us to…
Yellen has the highest tolerance for inflation of any Fed chair in history- she doesn’t fear the (pension and savings) reaper.
Yellen gave two speeches just last year emphasizing the benefits of keeping interest rates at 0% until 2015. The models she presented in these speeches showed inflation rising above the Fed’s previously stated “red line” inflation level of 2%, topping out in her estimates at 2.5% which she deemed acceptable because in these models she believed that unemployment would drop faster. This is interesting for several reasons. First, it shows that she actually believes it would be beneficial to rise above a level that the Fed previously agreed would signal tightening. Second, although CPI remains below 2% this is widely acknowledged to profoundly underrepresent the actual rate of inflation. One does not have to be a fan of John Williams at Shadowstats to realize that actual inflation, as experienced by ordinary consumers, is conservatively running somewhere between 5-7% at least, and that Yellen’s model could easily have actual inflation pushing double digits... and that is, IF they hit the target perfectly. Third, it must be remembered that these were public speeches designed for effect, and specifically crafted NOT to appear too extreme. They therefore likely represent the floor, not the ceiling, of a Yellen policy on inflation.
It is also revealing that on the rare occasions she has addressed rising commodities prices in the past, it is almost always in the context of “these are not the fault of the Fed”, repeatedly denying that easy money policies cause high commodities prices. A classic example of this was a speech in 2011, quoted below. Despite the most aggressive short-term expansion of the Fed’s balance sheet in history, despite a huge increase in the the money supply and literally trillions of dollars created out of thin air, Yellen strongly asserted that high commodities prices were not the result of Fed policy. Read for yourself:
Some observers have attributed the recent boom in commodity prices to the highly accommodative stance of U.S. monetary policy, including the marked expansion of the Federal Reserve's balance sheet and the maintenance of the target federal funds rate at exceptionally low level… I will make the case that recent developments in commodity prices can be explained largely by rising global demand and disruptions to global supply rather than by Federal Reserve policy. Moreover, empirical analysis suggests that these developments, at least thus far, are unlikely to have persistent effects on consumer inflation or to derail the recovery. Critically, so long as longer-run inflation expectations remain stable, the increases seen thus far in commodity prices and headline consumer inflation are not likely, in my view, to become embedded in the wage and price setting process and therefore are not likely to warrant any substantial shift in the stance of monetary policy. An accommodative monetary policy continues to be appropriate because unemployment remains elevated, and, even now, measures of underlying inflation are somewhat below the levels that FOMC participants judge to be consistent, over the longer run, with our statutory mandate to promote maximum employment and price stability.
Interestingly, she also gave a similar explanation back in 2005 regarding energy prices (link) .
Nothing I have read has ever indicated a “rethinking” of statements like this, or an examination of the true costs of inflation over the longer term. In fact, I honestly think she really doesn’t believes most of this “temporary forces, not Fed policy” stuff at all- it is just what she has to say publicly to manage perception. In truth, she is just fine with high and persistent inflation, and indeed is counting on it.
Under Yellen, market manipulation and interventions will not only continue, they will likely increase
Did you know that Operation Twist (intervening in the bond markets to reduce long-term interest rates) was invented by her mentor and dissertation advisor at Yale, James Tobin back in the 60’s? Did you know that her husband, Nobel Laureat George Ackerlof (described in one article as the mastermind behind her career), is a long-time advocate for MOPE- management of perception economics? In fact, Ackerlof recently published a book with Robert Shiller titled “Animal Spirits” in which he argued for the centrality of confidence, perception, and basically group psychology in stimulating the "animal spirits" required for people to be aggressive in spending money and taking out loans (which, apparently, is where they think productivity and creation of value comes from). http://www.bloomberg.com/news/2013-08-06/bernanke-seeking-animal-spirits-channels-yellen-spouse-akerlof.html
Yellen herself gives prominent play to sociological research and psychological factors in economics in her writings. The bottom line is that both she and the people whose ideas most influence her believe ardently that perception is critical to Fed policy and must be aggressively managed. She takes it as a given that it is right and proper for the Fed to intervene in markets and do whatever it can to encourage (some would say mislead) people into believing that market conditions are ripe for spending more and taking out more loans. I therefore expect increasing interventions in various markets, including precious metals, even greater than we have seen from Bernanke. Indeed, those whose opinion she most values consider this crucial.
. . .
So to summarize: 1. No private sector experience, 2. Favors policy that supports big government and big spending, 3. Deeply committed to Keynesian economics, 4. Unconcerned with effect of policy on savers, middle class, 5. High tolerance for inflation, “dual mandate” no longer equal, and 6. Very comfortable with aggressive intervention in markets, and “managing” expectations. Again, these are just my opinions based on reading her work, but I believe they are well-founded based on her own writings and statements.
Some questions remain:
- Does her lack of career ties to Wall Street mean that either 1. We see a reworking of the current “bank-centric” model of QE to a form of easing which channels money more directly to Main Street OR 2. She will be easily manipulated by an industry which she understands only in theory, and thus will continue the current policy path of using QE to prop-up TBTF banks? Perhaps both?
- How high (inflation-wise) is she really willing to go in pursuit of the white whale of full employment?
- How far will she be willing to go in support of MOPE?
- To what degree does she believe in free markets (voluntary exchange, free from coercion), if at all? In a time of crisis, could we see drastic measures such as de-facto price and wage controls or PM confiscation, supported and justified by the Federal Reserve?
I do not know the answers to these questions. What I do know is that, having reviewed all of this material, I have a deeply uneasy feeling about this person. I think her profoundly mechanical view of economics (turn a few knobs, tweak a few rates, and everything will be fine) will be overwhelmed at some point by a crisis situation in which her beloved equations no longer apply. I think when pressed, she will default to policies that make inflation/hyperinflation even more likely. I think deficits, and the Fed’s balance sheet, are going to explode during her reign. I think a middle class which has seen its net worth slashed by 1/3rd under Obama hasn’t seen anything yet.
And I think it is going to be crucial to protect yourself financially from what is to come.
Selected Yellen Publications and Speeches
Fair Wage Effort Hypothesis and Unemployment, 2013: http://www.washingtonpost.com/blogs/wonkblog/files/2013/10/fair_wage_effort_hypothesis.pdf
AFL-CIO speech, 2013: http://www.federalreserve.gov/newsevents/speech/yellen20130211a.htm
Commodity prices, the economic outlook, and monetary policy, 2011: http://www.federalreserve.gov/newsevents/speech/yellen20110411a.htm
Stabilization Policy: A Reconsideration, 2011: http://www4.fe.uc.pt/jasa/m_i_2010_2011/stabilizationpolicyreconsideration.pdf
The Outlook for the Economy and Inflation, and the Case for Federal Reserve Independence: Los Angeles, CA, 2010
The Outlook for the Economy and Monetary Policy: San Diego, CA, 2010
Speech, National Interagency Community Reinvestment Conference, 2008: http://www.frbsf.org/our-district/press/presidents-speeches/yellen-speeches/2008/march/yellen-opening-remarks-national-interagency-community-reinvestment-conference-2008/
Speech, Center for the Study of Democracy, 2006: http://www.frbsf.org/our-district/press/presidents-speeches/yellen-speeches/2006/november/economic-inequality-in-the-united-states/
Stabilization Policy: A Reconsideration (2006)
Prospects for the US Economy(2005): http://www.frbsf.org/news/speeches/2005/050302.pdf
Why has the natural rate of unemployment increased through time (1991): http://www.jstor.org/discover/10.2307/2534590?uid=3739864&uid=2&uid=4&uid=3739256&sid=21102948943621
Speech, 2005 in Review and Future Prospects: http://www.frbsf.org/our-district/press/presidents-speeches/yellen-speeches/2005/december/the-u-s-economy-2005-in-review-and-prospects-for-2006/
NBER paper: Waiting for Work: http://www.nber.org/papers/w3385.pdf
Fairness and Unemployment (1988): http://www.jstor.org/discover/10.2307/1818095?uid=3739864&uid=2&uid=4&uid=3739256&sid=21102948943621
The New Keynesian Economics and the Output/Inflation Tradeoff, 1988 : http://www.jstor.org/discover/10.2307/2534424?uid=3739864&uid=2&uid=4&uid=3739256&sid=21102948943621
Job Switching and Job Satisfaction in the US Labor Market, 1988: http://www.jstor.org/discover/10.2307/2534536?uid=3739864&uid=2&uid=4&uid=3739256&sid=21102948943621
Rational Models of Irrational Behavior (Akerlof/Yellen)
1987 - Annual Mtg. of American Economic Association :
A Near-Rational Model of the Business Cycle, with Wage and Price Inertia, 1985
CNN article, Yellen says "There's more of the same on the horizon of good times. There's no obvious reason for the good times to end." as she resigns Clinton econ adviser post in June 1999: http://money.cnn.com/1999/06/08/economy/yellen/
Economists View article (noting how she missed the housing bubble): http://economistsview.typepad.com/economistsview/2005/09/yellen_there_is.html
Rose-colored lenses of hindsight -- The Story of a Bubble (2004 book review on a Yellen book from 2001): http://www.nybooks.com/articles/archives/2004/jan/15/the-story-of-a-bubble/
Yellen’s poor forecasting track record: http://www.economicpolicyjournal.com/2013/09/the-truth-about-janet-yellens-forecast.html
NYT: Yellen’s Path From Liberal Theorist to Fed Voice for Jobs: http://www.nytimes.com/2013/10/10/business/economy/for-yellen-a-focus-on-reducing-unemployment.html?_r=1&
Business Insider, Who Is Janet Yellen: http://www.businessinsider.com/who-is-janet-yellen-2013-6
Bloomberg, Seeking Animal Spirits Bernanke channels Yellen Spouse: http://www.bloomberg.com/news/2013-08-06/bernanke-seeking-animal-spirits-channels-yellen-spouse-akerlof.html
NYT, For Yellen a focus on reducing unemployment: http://www.nytimes.com/2013/10/10/business/economy/for-yellen-a-focus-on-reducing-unemployment.html
Seventeen Yellen papers and summaries useful for understanding her philosophy http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/09/seventeen-academic-papers-of-janet-yellens-that-you-need-to-read/
NYT, Fed Nominee Gives Views on Rates (1994):
Silver Bear Cafe on Yellen, 2010: http://www.silverbearcafe.com/private/03.10/scam.html
Yale article, 2000: http://www.yale.edu/opa/arc-ybc/v28.n34/story1.html
Timeline of Yellen’s career: http://blogs.wsj.com/economics/2013/10/08/janet-yellen-timeline-of-her-career/
Ten Fast Facts About Janet Yellen (Wealthmanagement.com): http://wealthmanagement.com/people/gallery-ten-fast-facts-about-janet-yellen