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 altogether.
It is now seven years since the Fed pegged short term interest rates at zero percent. That was in response to the credit crunch that engulfed the world after the collapse of Lehman Brothers. A lot can happen in seven years. The typical newborn, by the age of seven, can talk fluently, has well-developed physical coordination, and can read and write. Evidence of intellectual or kinetic progress at the Fed has been somewhat more limited.
Unlike many central banks, the Federal Reserve is empowered to pursue two specific mandates: stable prices, and maximum employment. The data on jobs looks clear enough: the US unemployment rate stands at just 5.1 percent, or half its level during the height of the financial crisis. (Just ignore the fact that those out of work who are politely called ‘discouraged’ tend to fall out of the statistics after a while, so the true count is some way off.) But the progress on prices – or rather, the lack of it – is even more startling. Despite quadrupling the size of its balance sheet to $4.5 trillion (which incidentally means the Fed is sitting on $4.5 trillion worth of existing bonds), signs of ‘proper’ inflation – in the prices of goods and services, say – are almost invisible.
Given that the experimental policy of Quantitative Easing was always predicated on triggering inflation, the almost complete lack of inflation so far might be regarded as something of a failure.
The neo-Keynesians will no doubt argue that QE has worked, and that Janet and our own Mark Carney simply haven’t done enough of it yet. I have a subtler fear: what if expectations of our central bank policymakers 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 purchase 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 Janet 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 constitution of the Fed is there provision for China’s economic problems, or its stock market, or the appreciation of the US dollar, but they were all cited, directly or indirectly, by the Yellen Fed 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 Federal Reserve meetings don’t matter, but this one did. As McKinsey pointed out earlier this year, after a financial crisis triggered by the bursting of a colossal bubble in debt, there is now more debt than ever before: $57 trillion more, raising global debt-to-GDP ratios by some 17 percent. If a problem is caused by an oversupply of something, what possible good can come of expanding that supply by way of remedy ?
The great Austrian economist Ludwig von Mises expressed it somewhat 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 interest rates higher by the order of a quarter percentage point would not have triggered 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 entire careers. But it would have sent a powerful signal from the Fed: we are ahead of events.
But Janet 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.