Wednesday, January 19, 2011
Kremlinology? Call It Fed-Res-ology: Reading the Tea Leaves of the Federal Reserve Board
Time was, no one gave a shit about the Federal Reserve’s board. Who the drones were? What they did? Who cared!
|No, not the Kremlin:
The Eccles Building.
What will happen not merely with monetary policy, but with the American economy itself.
The Federal Reserve controls the three tools of monetary policy—open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.
Clearly, the Board of Governors—because of their permanence—is where we should start our analysis. So let’s:
Ben Bernanke: Little needs be said about The Bernank—we know him all too well. Clearly in favor of Quantitative Easing in its various iterations. Here’s a video interview of him on 60 Minutes broadcast this past December—notice the trembling lips and trembling voice:
(Frankly, it was surprising that the bond and equity markets didn’t all crash to smithereens on the Monday following this interview.)
William C. Dudley: A former employee of Goldman Sach (1986–2007), where he held the post of Chief Economist for ten years, Dudley was hired by Timothy Geithner when he headed up the NY Fed; when Tinny Timmy went to Washington, Dudley assumed his old job. Close ties to Wall Street as well as hedge funds and private equity firms. He has supported The Bernank in all his foolish schemes—back in October 2010, he gave a speech where he said, “Viewed through the lens of the Federal Reserve’s dual mandate — the pursuit of the highest level of employment consistent with price stability — the current situation is wholly unsatisfactory.” This was the signal to Wall Street that QE-2 was a definite go. As the situation has not materially changed—unemployment steady at about 10%, “core inflation” at less than a percent—he will likely be at the vanguard for pressing for more QE, if QE-2 isn’t shown to be producing results when it expires in mid-year.
Elizabeth A. Duke: An up-from-behind-the-teller’s-window-by-her-bootstraps banker, Duke studied physics in college before switching to drama (I’m not kidding), graduating from Chapel Hill in ‘74. She worked as a teller, then rose rapidly through commercial banking, picking up an MBA at Old Dominion in ‘83 without interrupting her steady climb, with lots of positions in the local banking industry establishment. She’s a commercial banker—not an economist, not an investment banker: She’s a troops-on-the-ground community banker, housing being her thing; see this recent speech. She’s clearly in favor of keeping real-estate prices propped up in order to “stabilize” the economy—so she’s a hard-core supporter of QE insofar as it guarantees that real-estate prices will not “fall”. She recently declared that rising Treasury bond yields signalled, “If the market expects the economy to strengthen, investors ratchet back expectations for Fed purchases and reduce their bid for the assets, and rates rise.” Her blindspot is obvious: She doesn’t see the dangers of QE—so she will push for more of it, as it helps real-estate prices remain at their bubble level.
Sarah Bloom Raskin: A career government bureaucrat, Amherst College and Harvard Law, appointed by Barack Obama, her last post before taking a seat on the Board of Governors was as Maryland’s Commissioner of Financial Regulation. She assumed her post this past October, but considering her relative lack of experience, newness on the board, and the fact that she’s a career bureacrat, it is unsurprising that she voted in favor of QE-2. At this point, she seems to want to beef up the Fed’s regulatory responsibility over banks, if a recent speech is any indication. Then again, it could be an Obama Oration: Filled with promises that don’t mean squat. At this point, she’ll likely vote for an extension of QE-2 once it expires in June. (I’d like to write more about her, but she seems like the Democrats’ version of Katherine Harris—and just as boring: Another brunette suburban mom whom my mother would be friends with. BTW, Harris and Bloom shared an alma mater: Harvard.)
Daniel K. Tarullo: A law professor at Georgetown, his alma mater, but he’s been around: That think-tank-academia-advisory nether world of the Council on Foreign Relations, Princeton visiting professor, posts in the Clinton administration, “Deputy Assistant Advisor to the President”, up to and including Clinton’s envoy to the G-7/G-8. One listen to him, though, and you realize he is a complete fucking idiot—a windbag blowhard shit-for-brians stuffed shirt. See this video of a recent interview on CNBC. He seems to think spending is all that matters, that jobs creation will “catch up”, that there is no incipient inflation. He voted in favor of QE-2, though says he’d have a “high threshhold” about any extension. Yeah right: Blowhards always try pretending they’re tough, when they’re really just wimps
Kevin M. Warsh: The baby in the group (Stanford ‘92), he’s an attorney (Harvard Law ‘95) by training, appointed to fill a Fed Governor vacancy whose term expires in 2018—so he’ll be around for a while. He started his career with Morgan Stanley, eventually running their M&A department in less than seven years—impressive corporate climbing abilities. In 2002 he joined the Bush administration, becoming a Special Assistant to the President. Like a good Bush crony, he was rewarded with the Fed posting. The appointment was severely criticized, but Bush pushed it through, and Warsh charmed the other Fed governors, including Bernanke. What does that tell you? That he can suck the chrome off a trailer hitch—so therefore, he has no ideas or opinions of his own, following what’s popular among his peer group. A recent WSJ editorial he wrote was stunning in its blandness—all that clearly came through was his desire to see Federal government spending curtailed or cut. Strong ties to Wall Street, he’s also married to an Estee Lauder heiress—hence very wired to the NY money scene. Considered very savvy politically—obviously. And despite his mealy-mouthed editorial, he voted in favor of QE-2—and will likely vote for “extensions” of the policy.
Janet L. Yellen: A Brown A.B., Yale Ph.D. in economics, Yellen was the Fed President of the San Francisco Bank, and was only recently appointed to the Board of Governors—just this past October. But boy!, has she made an impact! She is The Bernank’s staunchest ally on QE-2. Starting her career in academia, in the economics department at UC Berkeley, she flitted through Democratic Party policy circles, landing jobs in the Clinton administration, including his Council of Economic Advisors, before landing in the San Francisco Fed. As an alternating regional member, she was part of the FOMC since 2009—and so was all gung-ho about QE, QE-lite, and the QE-2. (I can’t resist this: She’s married to George Akerlof, who shared the 2001 Nobel Prize in economics with Joseph Stiglitz, which makes me wonder: When they’re doing it, do either of them yell out, “Who’s your dirty little econometrician! Who’s your filthy little macroeconomist!”) Yellen is firmly in favor of QE-2, and has signalled she is thoroughly in favor of more QE, if necessary, viewing the likelihood of any inflationary ill effects as a phantom menace.
So much for the Board of Governors.
But Hoenig is now out (he will still attend the meetings, of course, and can voice his position—but he cannot vote). So let’s look at the new FOMC members who will be assuming their places at the year’s first meeting this January 25:
Charles L. Evans: A zero, but at least a well-intentioned zero. A B.A. from UVA 1980, Ph.D. in economics from Carnegie Mellon, he backed William Dudley’s October speech—in fact, he’s believed to want even more QE, in order to reduce unemployment. He’s the poster boy for the If-All-You-Have-Is-A-Hammer-Every-Problem-Looks-Like-A-Nail School of monetary policy—more Fed stimulus in order to boost employment. The 10% U-3 rate clearly makes him bug-eyed—but though his heart is in the right place (and in fact the only FOMC member who voices serious concern about the unemploye—which is an ominous omen unto itself), Evans is clearly willing to go far beyond QE-2, for the sake of the unemployed. He’ll not only vote with Bernanke—he’ll be egging on more and more QE as the unemployment remains high.
Richard W. Fisher: Fisher’s a more interesting guy, at least on paper: Born 1949, raised in Mexico, Naval Academy, Harvard B.A., a couple of years at Oxford studying Latin American politics (that must’ve hurt), then an MBA from Stanford, before starting at Brown Brothers Harriman. He joined the Carter administration’s Treasury department, then rotated back to BBH, before striking out on his own with Fisher Capital. He went back into government during the second Clinton administration and worked out trade negotiations, specifically NAFTA; the Oxford stuff finally paid off. Then onto academia, paving the way for a Fed slot with the Dallas branch. So someone who has a lot of experience to draw upon—especially as he was a player in the Carter years, during the Iran Oil Shock and the spiralling inflation, plus his Latin American history probably serves him well, as he understand how inflation can spiral quickly out of control. He was very wary of QE-2, and is now firmly opposed to any measure to expand or extent QE; it’s unclear whether he’d actually like to cut short QE-2, though that is simply not going to happen.
Narayana Kocherlakota: He’s a geek, graduating from Princeton at 19 and getting a Ph.D. in economics from the University of Chicago at age 24. A round of high-level academic posts followed, culminating in his being named Minnesota Fed Chairman in 2009, at age 46. What does this tell you? He’s a guy who goes with whomever he perceives as powerful—an establishment lackey. Any criticism coming from him sounds hard, until you unpack it: For instance, he says that the Fed’s “failure” during the 2008–09 crisis was that the Fed did not “clearly articulate” the case for bailing out the banks—in other words, fitting right in with the Obama administration’s mindset (the mindset of our sorry age, really), according to Kocherlakota, it was all a PR problem, not an actual problem. Just a couple of weeks ago, he claimed that the Federal Reserve did not cause the housing bubble; in the same speech, he said he is “an agnostic” as to the causes of the bubble—in other words, like a lot of superstar economists, he has no idea what caused the Global Financial Crisis, considering it a Who-coulda-known-it phenomena. He is predicting 1.5% to 2% inflation for 2011. Though he’s pretending to be semi-on-the-fence, he is definitely in favor of more Fed liquidity measures, probably including (though he has not said this—yet) an indefinite extention of QE-2.
(I respect him the least because he’s the smartest of the bunch, yet is clearly an establishment suck-up: So he’ll have the brainpower to recognize what’s right, but will not have the balls to vote for what’s right—only for what’s expedient.)
Charles I. Plosser: With a B.S. in engineering (Vanderbilt ‘70), MBA and Ph.D University of Chicago (1972 and ‘76), Plosser spent most of his professional life as an academic, serving as the Dean of the business school of the University of Rochester, with various pit-stops in the private sector, advising various name companies, but always staying in Rochester. He is quite open about his opinion that he was in favor of the original QE in 2008–‘09, when the shadow-banking sector collapsed and there was an urgent need for liquidity. But since then, he’s been very leery of Fed interference in the economy. In a recent speech, Plosser said, “To suggest that monetary policymakers must act simply because fiscal policymakers were unable or unwilling to act is not the proper way to conduct policy.” Right on, my brother. He’ll vehemently oppose any further QE, as well as any efforts—blatant or stealth—to monetize the fiscal debt.
So bottom line: Of the current members of the FOMC, all save Plosser and Fisher were in favor of Quantitative Easing 2. And moving forward, it is easy to see how Bernanke can have a sizeable majority for any extension ot QE-2 into the indefinite future.
Looking at just the Board of Governors, they all genuinely and honestly believe QE-2 is the right policy—and since they are the undisputed majority, under Bernanke’s leadership, they clearly have every intention of making it work, no matter what.
So the shift in the regional chairs—though it adds one more vote against QE-3 or QE-4—does not significantly change the current direction of the FOMC.
(As an aside: Apart from Fisher, I find the narrowness of the thinking of this group rather startling; even Plosser, I’m sorry to say. It’s not that they’re team players sticking to a public script—they really and genuinely do not have many differences in outlook, regardless of their personal backgrounds. They focus on the same thing—spending and consumption—and play down the same thing—unemployment (except in the aforementioned case of Charles Evans). They see growth in GDP as the be-all-end-all, yet aside from Plosser, none of them show much of a reaction to the shocking levels of fiscal debt that the United States Federal government has incurred. And aside from Plosser and Fisher, they all summarily dismiss any suggestion of inflation. The mention of the word hyperinflation is enough to get them all to coolly dismiss the interlocutor. This narrowness of vision—this homogeneity—leaves them huge blind spots that seem quite obvious to others. Yet they are completely unaware of them: It’s not that they know they have blind spots, or even that they argue with people claiming they have blind spots—they dismiss and reject anyone who even suggests that they might be running blind. And these people are running the U.S.’s monetary policy. Mm-hmm.)
Why This Is All So Terribly Wrong
A central bank cannot be playing Russian Roulette with monetary policy: Yet it is obvious to anyone with half a mind that the Fed is running scared, doing whatever is necessary to prop up the U.S. economy. The very existence of such an ad hoc, unsustainable policy as QE-2 proves that they are running scared—and running blind.
Clearly, the Federal Reserve does not believe in capitalism. If it did, it would allow companies to fail—indeed, it would allow the economy to fail, get back up, dust itself off, and rebuild itself. Creative destruction: The pain that is an inevitable part of capitalism is exactly what the Fed is hell-bent on avoiding.
This is a policy mentality that started with the previous Fed chariman, Alan Greenspan, and the famed “Greenspan Put”: Easy Al’s willingness—nay, eagerness—to flood the markets with liquidity, in order to avoid even the slightest downturn in the economy . . . which retrospectively we all now realize created bubble after bubble, which eventually popped when the real-estate bubble went bust, and the shadow-banking sector (which the Fed was supposed to supervise and keep from becoming systemically dangerous) blew up, and threatened to swallow up the entire world economy.
Greenspan clearly did not believe in capitalism’s creative destruction—he tried everything in his power to stop it during the 20 years of his tenure. And he created the mentality within the Fed that said creative destruction had to be stopped.
Hence The Bernank. Hence the iterations of QE. Hence the Final Bubble—Treasury bonds: When that bubble pops, it will be all over for the dollar.
Hence, at this point in time, what the Federal Reserve and the FOMC have to do is increase interest rates, tighten money, and let the creative destruction of capitalism take place: Let those weak companies and zombie banks be wiped out, and start over.
This of course will never ever happen. And since it is clear from this brief survey that Ben Bernanke has the votes to continue adding more and more easing to his latest version of QE, there is very little that can be done: Once QE-2 is complete in June, it is likely that Bernanke will press for an extension of the policy (as his original statement regarding QE-2 outlined that he might), and continue in $75 billion monthly increments. This policy will inevitably end in tears: The Treasury bond bubble will burst, and inflation will gallop to unprecendented heights as there is a run on the dollar—a direct result of the QE policy.
Therefore, the next thing to be wondering about, regarding the Board of Governors, is whether they will raise rates aggressively against inflation, so as to halt inflation firmly and shore up the dollar; or whether they will raise rates as the Fed did pre-Volcker: Piecemeal, little by little, reacting to inflation rather than getting out ahead of it. (For a brief overview of the ‘79 crisis, and the Fed’s reaction to rising inflation during Volcker’s tenure and just before it, see my post Was Stagflation in ‘79 Really Hyperinflation?)
Considering the current composition of the Board of Governors, it will do whatever it can to avoid the short term pain. Therefore, interest rates will not rise, when inflation starts up for real. Therefore, when the Treasury bond bubble pops and the dollar begins collapsing, the Fed will not provide effective leadership in saving the American currency.