Federal Reserve

The poisoned chalice

 This is a guest post from money and metals commentator, James Hickling, on what new Fed chief, Janet Yellen can expect to face. Read on for a pithy, questioning reminder of whether central bankers provide us with any value at all…


“For my own part I did not see and did not appreciate what the risks were with securitisation, the credit ratings agencies, the shadow banking system, the S.I.V.’s — I didn’t see any of that coming until it happened.”
– Janet Yellen, 2010.

So said the next Federal Reserve chairman. As others have commented: with someone like this in charge, what could possibly go wrong?

Not that Lawrence Summers – the other big name mentioned earlier this year in connection with the top job at the Fed – would have been any better. In his position as Deputy Treasury Secretary and later as Treasury Secretary in the Clinton administration, Summers was a leading advocate of a light (or no) touch approach to derivative regulation, commenting in Congress that “the parties to these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies.” During the financial crisis, Harvard University’s endowment fund lost nearly $1 billion thanks to some of the interest rate swaps that Summers implemented during his tenure as Harvard President from 2001-2006.

As the Bloomberg author linked to above notes, Summers “seems to have trouble with interest rates”. But to be fair everyone has problems with interest rates, which is why no one person or institution should be charged with setting them for an entire economy. Everyone sensible recognises the futility of price controls when it comes to food, clothing, petrol, prescription drugs and any number of other consumer goods – yet it remains accepted practice that arguably the most important economic good of all, money, should have its price (interest rate) controlled by a central committee of bureaucrats. This despite the fact that the greatest period of industrial expansion in America got underway during the late 19th and early 20th century, when there was no central bank, and when the nation remained on an informal and later formalised gold standard.

“Aha”, say the advocates of monetary price controls. “But the volatile boom bust cycles experienced in the pre-Fed America wrought havoc with businesses’ ability to plan for the future, and resulted in much economic misery for the masses. A wise central bank would have smoothed out this rough-and-tumble business cycle, to the benefit of everyone.”

Perhaps. Though since the Fed’s formation 100 years ago there have been some 18 recessions, including the Great Depression and the more recent “Great Recession”. 100 divided by 18 gives me 5.55, which doesn’t seem a tremendous improvement on what went before. And as for its secondary goal of “maintaining price stability”, the record is stark: as of April last year US consumer prices were up 2,241% since 1913 – another way of saying that the Fed has overseen a tremendous collapse in the value of the dollar. Contrast this with the long-term stability seen in prices from the founding of the Republic until the founding of the Fed, and I defy anyone to argue that central planning has been good for price  stability. Unless of course you define “price stability” as a steady decrease in the dollar’s value, punctured by occasional serious bouts of inflation (the 1970s and early 80s).

Maybe Summers is starting to see the light. Though little commented on in the media at the time, his decision not to seek the Fed chairman job at the comparatively young age of 58 is perhaps an indicator that he recognises the monetary disaster that is brewing. The even-younger former Obama Treasury secretary Timothy Geithner is another one who made it very clear that he did not want the job, despite the prestige that it would carry. Both men must know that another recession is a certainty within the next 2-3 years, and that they will then be forced to resort to even more drastic easing measures.

With interest rates already at record lows and the Fed’s balance sheet (now at over $3.5 trillion) ballooning as a result of the QE policies implemented since 2008, what would they do when faced with another downturn, or a black swan a la LTCM? Increase the balance sheet to $7 trillion? $10 trillion? What effect would this have on the dollar, and people’s perception of the Fed as a credible institution? There is no precedent for this in US history – nor in world history for similar policies being pursued simultaneously by all of the world’s major central banks.

Good luck Janet. You’re going to need it.


About the author: Since graduating from the University of Nottingham in 2008, James Hickling has worked at and written articles for The Daily Telegraph and Standpoint magazine. He is a winner of the annual TE Utley Memorial Award, a writing competition that honours the memory of the late British journalist Peter Utley. James is a keen observer of financial markets.