According to Einstein, time is affected by gravity. Clocks far from strong gravitational fields run more quickly; those close by run more slowly. We can only assume, then, that Janet Yellen has the density of a neutron star. Under her leadership of the US Federal Reserve, time seems to have stopped.
It is now seven years since the Fed pegged short-term interest rates at 0%. That was in response to the credit crunch that engulfed the world after the fall of Lehman Brothers. A lot can happen in seven years. The typical newborn, by age seven, can talk fluently, has well-developed physical coordination, and can read and write. Evidence of progress at the Fed has been somewhat more limited.
Unlike many central banks, the Fed is empowered to pursue two specific mandates: stable prices, and maximum employment. The data on jobs look clear enough: the US unemployment
rate stands at just 5.1%, half its level during the height of the financial crisis.
(Just ignore the fact that those out of work – politely called “discouraged” – tend to fall out of the statistics after a while.) But the progress on prices – or lack of it – is even more startling.
Despite quadrupling its balance sheet to $4.5trn (which means the Fed is sitting on $4.5trn worth of bonds), signs of “proper” inflation – in the prices of goods and services, say – are almost invisible. Given that the experiment of quantitative easing (QE) was always predicated on triggering inflation, the near-total lack of inflation so far might be seen as something of a failure.
The neo-Keynesians will no doubt argue that QE has worked, and that Yellen and our own Bank of England boss, Mark Carney, simply haven’t done enough yet. I have a subtler fear: what if expectations of our central bankers are simply too high?
The food you eat and the clothes you wear and the house you live in and the petrol you put in your car all have a price. The price of each of those goods was set in a marketplace consisting of buyers and sellers, providers and consumers. You may not like a given price, but you are then free to shop elsewhere and buy other items instead.
But the most important single price in the entire modern economy – the price of money itself – is not set in a market, but by people like Yellen. Whatever you may think of her intellectual credentials, she does not have godlike powers of omniscience over the workings of the economy. No central banker does. But we allow them to dictate monetary policy as if they do.
Note also that nowhere in the Fed’s constitution is there provision for China’s economic problems, or its stockmarket, or the appreciation of the US dollar. But they were all cited, directly or indirectly, by the Yellen Fed last week as reasons for delaying a rate hike. Another contributory factor was doubtless the chorus of naysayers from Wall Street, urging Janet to hold the line (and keep the party going). City folk like to maintain the myth that central banks are independent of the brokerage community, but the reality is somewhat different.
Most Fed meetings don’t matter, but this one did. As the McKinsey consultancy noted earlier this year, after a financial crisis triggered by the bursting of a vast debt bubble, there is now more debt than ever before: $57trn more, raising global debt-to-GDP ratios by some 17%. If a problem is caused by an oversupply of something, what good can come of expanding that supply by way of remedy?
The Austrian-school economist Ludwig von Mises expressed it more darkly: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
Nudging rates higher by a quarter percentage point would not have caused an extinction-level event. It would certainly have made life more interesting for bond traders, most of whom have never seen a bear market in their careers. But it would have sent a powerful signal from the Fed: we are ahead of events. But Yellen blinked – which makes any future Fed tightening that much more problematic. It also reinforces the suspicion that our central bankers don’t know what they are doing, but have entirely capitulated to the financial system they are supposed to control.
Category: Market updates