Sunday, July 27, 2014

Janet Yellen: The Manchurian Candidate?

  • Both the Right and Left see Yellen as a radical departure from her predecessors.
  • But she is just another Bernanke and she won’t upset the apple cart.
  • We can expect to see nothing radical coming out of the FOMC in the foreseeable future.
Janet Yellen has recently been getting a lot of attention in the media from both the Right and the Left.
On the Left, the New Yorker recently published a profile by Nicholas Lemann which painted Yellen and her economist husband in liberal if not leftist colors: “Yellen is notable not only for being the first female Fed chair but also for being the most liberal since Marriner Eccles.” Lemann reports that Yellen’s Nobel Prize winning husband, George Akerlof, called the Bush Administration “the worst government the U.S. has ever had in its more than 200 years of history”.
Lemann, who does not appear to be a close student of economics (“Economic management sounds technical, but it also has the quality of a powerful fable”), gets a bit confused when trying to make the case that there are “liberal” and “conservative” monetary policies. He tries to paint Milton Friedman as a conservative and Yellen as a liberal, when in fact they are both monetarists. Lemann is groping for the monetarist vs Austrian dichotomy, but he doesn’t have command of the scholastic nomenclature. In any case, he paints the Democrat Yellen as being to the left of the Republican Bernanke, and says that this has profound policy implications.
On the Right, Peter Schiff (a conservative hard-money pundit) recently published a column in which he takes the Lemann interview and runs with it. His column is a broad-ranging indictment of the new chairman as a dangerous liberal, leftist and inflationist: “She is very different from any of her predecessors in the job. Put simply, she is likely the most dovish and politically leftist Fed Chair in the Central Bank's history...She does not seem to see the Fed's mission as primarily to maintain the value of the dollar, promote stable financial markets, or to fight inflation. Rather she sees it as a tool to promote progressive social policy and to essentially pick up where formal Federal social programs leave off.”
Schiff deplores QE, saying that it “has prevented the government from having to raise taxes sharply or cut the programs she believes are so vital to economic health”, while “pushing up prices for basic necessities such as food, energy, and shelter”. He says that, as a liberal, Yellen focuses exclusively on employment: “Yellen clearly sees jobs as her top priority. Any hope that she will put these priorities aside and move forcefully to fight inflation when it officially flares up should be abandoned.” He expects her to pursue radically stimulative policies.
Obviously, a big part of the problem here is that not a lot of pundits understand monetarism (or Keynesianism). There is a strong desire to cast the FOMC as a battleground between the right and the left, much like the Supreme Court where there are “Democratic” and “Republican” justices. This analysis founders, of course on the fact that many “Republican” economists are monetarists, such as Friedman, Greenspan, Bernanke and many others, and that Republican presidents have nominated many monetarists to the Board of Governors.
The sad fact is that, despite the hopes of the Left and the fears of the Right, Yellen is another Bernanke, a radical monetarist who abandons all of his core beliefs the day he first sits down in the chairman’s seat. Lemann is wrong that Yellen will speed up growth, and Schiff is wrong that she will cause inflation. I hope that both of their predictions prove true, but I’ll bet two-to-one against it.
Bernanke had the best shot we will ever see of implementing radical reflationary policies, and he failed. He recanted almost everything he had preached as an academic about price-level targeting and the need to do whatever is necessary to oppose deflationary forces. If Bernanke couldn’t do it, in face of the Great Recession, there is no way that Yellen is going to do it.
That is because the #1 job of the Fed chair is not to grow the economy, but to maintain consensus in the committee and credibility on Capitol Hill. If Yellen were to form a growth caucus on the FOMC and ram through policies intended to get the economy moving again, the GOP would would pass legislation which would remove policy discretion and perhaps even the employment mandate. Such bills have already been introduced. This may happen even if Yellen stays on the reservation, but the probability would rise exponentially if she allowed inflation to hit 4%, which is now defined as hyperinflation.
Yellen and the monetarists know that, were they to incite such legislation, the future policy consequences could be dire. So they won’t. Instead we will see the end of QE, continued interest on excess reserves, and increasing pressure to “normalize" the Fed’s “bloated” balance sheet, despite the fact that money growth has been declining for the past two years, inflation has been below target and--most recently--both nominal and real growth have been negative.
Investment Conclusion
Because the Fed will not pursue reflationary policies, inflation, inflation expectations and bond yields will remain very low, while the wide equity premium will persist until stock prices go materially higher.

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