This week, Federal Reserve Chairwoman Yellen gave her bi-annual testimony to Congress. Many have begun to think that this was the Chairwoman’s swan song, as her term is up in early 2018. Naturally, talk has picked up around who the next Chairperson will be if it is not Ms. Yellen. Whether or not you have agreed with her Fed’s performance over the last three years, you have to admit that she has handled one of the most powerful positions in the world with class and dignity. Over the last 38 years, we have had only four Federal Reserve Chairpersons: Paul Volcker, Alan Greenspan, Ben Bernanke, and Janet Yellen. The power of the Federal Reserve and its leader has always been great. Yet, as strong as Mr. Volcker and Mr. Greenspan were, the institution they headed from 1979 to 2006 has grown immensely. I think a parallel would be comparing the office of President of the United States before nuclear weapons and after.
Between the monetary policy response to the financial crisis of 2007–2009 and the portion of power over the economy that the Legislative and Executive branches ceded to the Fed (both wittingly and unwittingly), the Fed and its policy tools have become paramount. The world now looks to the Chairperson of the Federal Reserve as they would look to the President of the United States for direction. I believe that this came to pass when the Fed discovered that they could intervene in the financial markets with an unlimited and unregulated use of their balance sheet through the program of Quantitative Easing (QE) in 2008.
The impact of QE, in my mind, has become a policy that has reached far beyond its purpose as a tool to make borrowing rates for consumers lower and spur economic growth. It has picked societal winners and losers whether the Fed recognizes it or not. There have been many winners, and the policy has been responsible for keeping moderate but steady economic growth in the USA, and to some extent the world, since we are the world’s largest economy. Additionally, QE has fueled a boom in innovation in vital sectors of the economy, like energy, by steering large amounts of money toward investment-grade and high-yield corporate bonds.
However, for savers, life insurers, and pension funds, there have been many losers. The segment of our population that used to be able to retire and put their savings into a federally insured bank account or credit union share certificate and, combined with their social security check, actually live off the interest generated by their savings has been negatively impacted significantly. Many have moved their investments into riskier assets to make up for the lack of relatively risk-free income. When we scratch our heads sometimes and wonder why the stock market just keeps going up, this flow of funds is a big reason. In the end, and there is always “the end,” people are going to lose money that they can’t afford to lose.
If I stay with a President of the United States nuclear weapons analogy, we can call Ben Bernanke “Harry Truman,” the Chairman who dropped the bomb (QE), and Janet Yellen “Dwight Eisenhower,” the first Chairperson to deal full time in a QE world. Ms. Yellen has been working to de-escalate QE. In her testimony this week, Ms. Yellen stated that she didn’t see QE as a normal tool of monetary policy. However, there have been a few in the Fed who have expressed the opposite view. It seems a lot like the kind of nuclear weapons debate that would have taken place in the 1950s. After all, many powerful generals and even President Eisenhower (in private) thought seriously of using nuclear weapons to end the Korean War. Luckily, after the war ended without the use of these weapons, President Eisenhower worked to establish some framework to de-escalate the potential of a nuclear exchange.
If Chairwoman Yellen is not reappointed, staying with the analogy, who will be the John Kennedy equivalent at the Fed? There were two John Kennedys. The first was the cold warrior who sparked a nuclear arms race with the Soviet Union and tried to invade Cuba. Then, after the Cuban Missile Crisis, there was a new John Kennedy, sobered from the experience, who worked to significantly reduce the risk of nuclear war. Who will be the “Kennedy” at the Fed? Will it be someone who realizes that QE is extraordinary monetary policy, only to be used if the entire economy is melting down or one who thinks QE is just another tool in the Federal Reserve's kit, available for use in a broad variety of situations? I hope it is the former but I fear it will be the latter.
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