Thoughts from the Frontline

What Would Yellen Do?

November 10, 2013

The US Senate Banking Committee will hold hearings on Thursday, November 14, on the nomination of Janet Yellen for Federal Reserve chair. There will be the usual softball questions, for example, "Do you think high unemployment is a problem in the United States and if so what do you intend to do about it?" (which allows a senator to express his concern over unemployment and for the nominee to agree that it's a problem). Or the always popular question, "What is the basis under which you would continue to hold interest rates at their current low level?" – as if she would answer anything other than, "Any future policy decision is of course data-dependent" or some variation on that response. Boring.

There have been a flurry of new research papers this week by Federal Reserve economists, IMF economists, and even Paul Krugman, all suggesting various policy responses going forward, but none suggesting a return to normal any time soon. I would be far more interested in getting a response from Yellen to some of that research, but even the questions raised in those papers don't get to the real heart of the matter. So today, let's pretend we are prepping our favorite Banking Committee senator (members here) for his or her few questions. What would you like to know? In this week's letter I offer a few questions of my own.

First a brief caveat. Each of the questions below deserves multiple pages of background. I get that. There is only so much I can write in one letter. Further, some of the questions are intended to provide an insight into Yellen’s thinking and what research she considers to be relevant. Those are more the "inquiring minds wants to know" type of question. And since Senator Rand Paul is not on the committee, I have omitted some of the questions he might ask. Not that they aren't interesting and shouldn't be asked, but there is only so much space.

What Questions Would You Ask Janet Yellen?

Secondly, I know for a fact that a few Senators on this committee and even more of their staff members read my letter from time to time. I would expect that to be the case this week. I also know that I have some of the smartest and most thoughtful readers of any writer I know. If you want to address a committee staffer about questions you think your senator should be asking Janet Yellen, the comments section at the end of this letter would be an appropriate place to do so. Your comments will get read. Be polite, offer links to supporting documents, and have fun. I'm sure I've missed several important questions, including ones you'll think I should have listed, so this is your opportunity to get them in front of the right people. Whether they will get asked is a different matter entirely, of course.

Finally, I am assuming that Yellen will be confirmed. While I would favor a Fed chair with a different economic philosophy, that is not going to happen. So rather than fantasizing about what is not going to happen, let's think about what we would like to actually learn.

What Would Yellen Do?

Now let's turn to our hypothetical hearing. (Insert a picture of your favorite senator here.) With the hope that we will get a glimpse of what a Janet Yellen chairmanship of the Fed will actually look like, let's think about what we would like to know from her.

Vice-Chairman Yellen, thank you for agreeing to attend this hearing. We have already interviewed you extensively for your present position, so I believe that most members of the committee and Senate already believe that you are qualified to be chairperson. Therefore I would like to use this opportunity to learn a little more about the thinking that goes on with regard to Federal Reserve monetary policy. In the spirit of the transparency that has been a hallmark of the Bernanke Federal Reserve, I would like you to shed a little light on the thinking and philosophy that will guide the Federal Reserve under the chairmanship of Janet Yellen. Here are a few questions that I believe we would all like answers to.

  1. There were three papers delivered by highly regarded economists at Jackson Hole this summer that suggested that quantitative easing had no significant effect and that "forward guidance" was the actual effective policy. At about that time, economists from the regional reserve bank at which you were president (San Francisco) also published a paper suggesting the same thing. This past week major Federal Reserve staff economists, as well as other economists, reiterated this view and proposed a different set of policies. This growing discussion begs the following question: Do you agree with these papers and believe the quantitative easing has exceeded its usefulness, especially in its current rather massive form? If not, can you point us to research that supports your view, other than theoretical analysis?
  1. The Federal Reserve balance sheet is currently at $4 trillion. At the current pace it is expanding by roughly $1 trillion per year.
  1. Is there a theoretical limit in your mind as to the size to which the Fed's balance sheet should be allowed to grow? If so, what is that amount? Simply saying that this number would be dependent upon future economic data would imply that you have no true idea of the limit and are making up the rules as you go along. Perhaps we are indeed in unexplored territory for monetary policy and it is appropriate to adjust policies based upon unfolding economic events; but if that is the case, what are the guidelines you would use?
  2. Given the time lag required to realize the impact of monetary policy upon the economy, at what point and by what standard might you determine that the balance sheet of the Federal Reserve had reached its limit and that any further stimulus must be the responsibility of the Congress and the executive branch?
  3. Is there a discussion within the Federal Reserve that balance-sheet expansion has the potential to produce an asset bubble?
  1. There seems to be an emerging consensus that it would be inappropriate for the Federal Reserve to pursue quantitative easing indefinitely at the levels we see today. There must be an endpoint, but the question of course is, when? Last May, Chairman Bernanke suggested that the Fed might begin to taper in the coming months. Market reactions worldwide were decidedly negative, and many members of the FOMC and Board of Governors were at great pains in the following weeks to suggest that tapering would be either very gradual or postponed altogether. Even so, the markets seemed to assume that a small reduction in the amount of quantitative easing would be announced at the September FOMC meeting. There was quite a lot of surprise when there was no tapering at all. The decision not to taper brings up several questions:
  1. What data was the Federal Reserve looking at that caused it to back away from even a small reduction in the amount of quantitative easing?
  2. Given that the balance sheet of the Federal Reserve is $4 trillion, what was the thought behind not reducing the ongoing increase of the balance sheet by a mere $10 billion a month?
  3. All things considered, $10 billion would seem a rather negligible amount. Were you concerned that the economy might not be able to handle even such a small reduction in quantitative easing?
  1. Recent papers from Federal Reserve economists and others suggest that QE (i.e., the large-scale purchase of assets) is not as effective as forward guidance and that the FOMC should indicate that interest rates will be held at very accommodative levels as far out as 2017, in contrast to the current guidance that suggests rates will be allowed to rise gradually beginning in late 2014, or more likely in 2015.
  1. What do you think of this view?
  2. If you agree with this, are you concerned that such a policy shift might encourage a dollar "carry trade"? By that I mean that banks and other financial institutions might be encouraged to borrow in dollars to invest in all manners of financial engineering projects, especially overseas, given that the cost of borrowing would be so cheap. This is different from traditional banking in that it would not foster lending for productive domestic purposes such as the expansion of plants or the purchase of productivity-enhancing equipment.
  3. Given the problems we have seen with carry-trade currencies, especially the Japanese yen, how far out do you think forward guidance should go?
  4. Again, viewing the experience of Japan, carry-trade currencies seem to strengthen unduly, apart from natural trade and investment flows. Further, given the extraordinary developments in energy production in the United States and the reduction in the trade deficit, it is quite possible the dollar could strengthen rather dramatically on its own. Do you agree that positioning the dollar as a potential carry-trade currency would strengthen the dollar? Is that a good thing in your view?
  5. Given that the strength of the dollar is at least nominally (policy-wise) in the purview of the US Treasury Department, what kind of coordination with the Treasury do you think would be appropriate in extending forward guidance for a very-low-rate regime into 2017?
  1. Chairman Bernanke and others have clearly hoped there would be a wealth effect from current monetary policy. By wealth effect I mean that if asset prices rise, people are encouraged to spend money, and the positive effects trickle down to the lower echelons of the economy.
  1. There has been a significant amount of research which suggests that the wealth effect is no longer operative in the United States. Do you agree with this?
  2. If you do believe in the wealth effect, where is the research, beyond theoretical models, that supports your view?
  3. If you do not agree that current monetary policy is in effect a trickle-down monetary policy, then what do you believe is the transfer mechanism from quantitative easing to the general public?
  1. Chairman Ben Bernanke has explicitly taken credit for the rise in the stock market from his policies of quantitative easing. Do you think he's right? In pursuing QE, has the Federal Reserve taken upon itself an implicit third mandate, that is, to support the level of the stock market? Should that be the Fed's responsibility?
  1. When the Federal Reserve begins to taper, or even suggests it will begin to taper, it appears that the markets will react negatively; yet reactions from Federal Reserve Board of Governors members seem to suggest that the Fed is extraordinarily concerned about a negative market reaction and subsequent negative effects on the economy. UBS strategist Beat Siegenthaler wrote this last week:

The Fed seems to be facing two major risks: first, premature tapering disrupting markets and triggering global turmoil across asset classes, thereby threatening the fragile economy recovery; second, delayed tapering further fueling asset price bubbles, which could burst eventually and do major damage.

The September decision suggested a Fed more worried about the fragile recovery than about the potential for asset bubbles and other longer term problems associated with extended liquidity injections. Whereas it had originally assumed that a gradual tapering would result in a gradual market reaction, it now appears that the situation is much more binary. If so, the hurdles for tapering might be substantially higher than originally thought.

  1. Do you agree with that assessment, and if not, why?
  2. The Bank of England published the following chart in Q3 2011. It tells the story of their expectation that while QE was in operation there would be a massive rise in real asset prices, but that this would dissipate and unwind over time, starting at the point at which the asset purchases were complete. It also suggests that they felt it possible that real asset prices would fall after the withdrawal of quantitative easing. Did the Federal Reserve hold internal discussions (such as those evidently held at the Bank of England) regarding what would happen with the withdrawal of QE? Given the recent market response to the suggestion of tapering, was the possibility of a fall in asset prices accounted for in your decision to pursue quantitative easing?

  1. Has the Federal Reserve has, in reality, created a form of "monetary trap" for itself through its extensive use of quantitative easing? That is, do you see a way in which the Federal Reserve can exit QE without having a negative effect on the stock market, at least initially? And should the Federal Reserve care?
  1. The current philosophy of the Federal Reserve seems to be that monetary easing is stimulative of consumer spending and therefore of the economy in general. This improvement is apparently supposed to be transmitted through lower interest rates for housing and for leveraged borrowing that facilitates consumer spending (on autos and other durable goods) as well as lower interest rates for businesses, which hopefully encourage spending on plants and facilities to increase productivity and boost employment.

    However, lower interest rates also mean that investors and pensioners get less income, so they must reduce their spending. I assume it is not the policy or the suggestion of the Federal Reserve that retired individuals should increase the level of risk they take on in the deployment of their retirement savings; but if the Fed seeks to increase the assets of those who hold equity in the stock market, an unintended consequence may be to penalize savers at the very moment in their lives when they need higher interest rates to be able to maintain their lifestyles.
  1. Explain to us the economic rationale behind artificially lowering rates for an extended period of time, which penalizes savers at the expense of equity holders.
  2. Do you believe that consumer spending fostered by quantitative easing is greater than the consumer spending lost by decreased returns to savers and investors on their fixed-income investments? Is there any data that suggests this is turning out to be the case?
  3. If there is a greater good for the economy at large in pursuing massive QE, can you show us the research that proves it and explain why retirees should be content with your policies?
  4. Do you have suggestions for those who have saved all their lives and are now being forced to either reduce their standard of living or dip into their savings?
  1. If reserve injections by the Federal Reserve were evenly distributed throughout the economy, then the money multiplier would be higher and more stable. This has not happened, as evidenced by the graph below. Further, the availability of loans to middle-level banks and businesses does not seem to have risen. How has QE helped these banks and firms?

  1. The Federal Reserve has a dual mandate to achieve the stability of the purchasing value of money and to foster an environment that affords full employment. If the money multiplier is inordinately low and if it should begin to revert to what was its norm prior to the Great Recession, there would seem to be a serious potential for the return of higher-than-acceptable inflation.
  1. As chairperson of the Federal Reserve, which of the two mandates would you consider to be a higher priority in a time of rising inflation?
  2. Are you prepared, as Chairman Volcker was in the early '80s, to raise interest rates in order to protect the value of money, in spite of the harm it caused to employment? As a follow-on, I would also like to know what, if anything, you would have done differently from Chairman Volcker.
  1. Federal Reserve economic forecasts have proven notoriously inaccurate, historically speaking. Indeed, some have suggested that random models would have produced better results than those upon which the Fed relies.
  1. How can we trust your models and your policy projections when the Fed’s forecasts have been so wrong for so many years? Why does the Fed persist, to this day, in the use of models that have been so consistently bad at predicting the future?
  2. Will you be basing your monetary policy on projections generated by existing, clearly faulty models, or do you anticipate a change in the construction of your models?
  1. Finally, let us turn to the employment mandate.
  1. Can you explain to us precisely how monetary policy is supposed to work to improve employment? What is the transfer mechanism from quantitative easing to higher employment?
  2. If you were designing a central bank system from scratch, would you include an employment mandate? Where do you think the primary responsibility for establishing an environment for full employment should rest, with the federal government or the Federal Reserve?

The Questions That Will Not Be Asked

The above questions will start the discussion, but I'm well aware that some of the questions I would really like to ask will have no chance to make it into the dialogue. These go to the very concept of a central bank. In my latest book, Code Red, I fully acknowledge the need for a central bank, but my view of its purpose is quite a bit more limited than is envisioned in the current manifestation. How can 12 men and women sit on a committee and think they can fine-tune the economy without creating imbalances and unintended consequences? Central banks should be for emergencies and for regulating banking institutions and making sure the playing field is level. They should not be responsible for the fate of the players on the field.

Current central bank policy has rewarded bankers and holders of assets. In an environment where everyone seems to be increasingly worried about the divide between the 1% and the 99%, our central bank has designed and implemented a policy that is explicitly rewarding the 1% to the detriment of savers and retirees. It is the rich who have assets and the poor who have liabilities. If you are looking for a reason why the spread between the rich and the poor is widening, one driver (and I admit there are others) is the central bank policies of the developed world.

Let me end by sharing the sentiments expressed by Ben Hunt this week after he had read the numerous academic papers that have recently been released. I totally share this sentiment, and he expresses it well:

I started writing this email as a detailed analysis of three monetary policy papers recently published by various Fed functionaries, papers that give a peek into how the Fed thinks about their role in the world and that have received some significant attention this week by our media arbiters of taste in articles such as "Fed Forward Guidance Proves Effective, NY Fed Research Says" and "Fed Study: Rate Peg Off Mark." Interpreting the meaning and impact of papers like this (and the media narrative around them) is a bread and butter topic for Epsilon Theory posts, as I feel a duty to read and report on these papers so you don't have to. It's not a pleasant duty.

Frankly, these papers frustrate me to tears, as they are written as post hoc "scientific" justifications of value-laden social assumptions and policy conclusions, not as an honest search for a truth that's larger than the local bureaucratic imperative. They're also … boring. As is the long analysis I wrote. So let's skip all that and go straight to the conclusion.

Spoiler Alert! The Fed believes that they are saving the world, and that any problems that persist in the world can be eliminated by doing more of what they've been doing and doing it for longer. I know this comes as a complete surprise to anyone who's been paying the least amount of attention over the past few years, but there you have it. That's what these papers say.

These papers say nothing that is terribly novel or interesting in terms of their content or intended purpose. The only interesting thing is how much media attention they are receiving and what that means. The triumphal procession of these papers is a reminder that the academic and bureaucratic capture of the Fed is complete, and that leads to what are (to me, anyway) much more interesting questions than the inside baseball topics of what these papers might imply for Yellen's policy preferences:

1) Has the academic and bureaucratic capture of US monetary policy been duplicated in other policy areas, such as national security and healthcare?

2) Is there a common academic and bureaucratic response across these policy areas to the economic and political duress of the past 10 years, such that emergency policy actions against immediate threats have been transformed into permanent insurance programs against future and potential threats?

3) Is this the common thread woven through the three most important and controversial policies of our day: QE, Obamacare, and NSA eavesdropping?

4) Are there useful lessons to be drawn from the last time we went through such a wholesale redefinition of the *meaning* of government policy, back in the 1930s?

5) What are the structural consequences for markets and investing that stem from this redefinition?

My answers: yes, yes, yes, yes, and I'm trying to figure it out.

New York, Ringing the NASDAQ Bell, and Home

I will be flying to New York next Tuesday to join in the closing-bell ceremony that afternoon at the NASDAQ. A firm that I have a small association with will be celebrating the creation of a new ETF with the symbol ROBO, which is an ETF comprising of robotic, 3D-printing, and automation stocks. I will be writing more about this in the future, as I'm quite excited about it, but ask your advisor before you make a decision.

I will be doing some media of course while I am in NYC, but I expect to be back in Dallas Thursday evening, where I will get to read about the Yellen confirmation hearings. I am NOT expecting fireworks.

I do hope to return to more progress on my new apartment construction. I have committed to move out of my current leased place before Thanksgiving, and I fully intend to have the family and friends over for Thanksgiving; but if you were to drop by the place this weekend, you would walk away thinking I am irrationally optimistic to believe it can be finished in time. Major components are still being shipped, not even in the queue to be installed yet. A finely choreographed finale is taking shape, with workers coming and going in droves. I am excited that we are getting closer to the finish line.

I am somewhat amazed at the level of technology that has been designed into the place. Every light, media player, sound system, (powered!) curtain, security system, door lock, and fan switch can be controlled from an iPad mini. The kids are already anticipating the movie and sports watching. And there is full agreement that we will be doing more cooking and less restaurant visiting in the future. I have been kind of hoping that the new place will be a family magnet, and it may indeed turn out that the reality will be more time with the kids and grandkids. That was part of the design, so to speak.

The letter is running later than usual, so I will end here and hit the send button. Have a great week. It is Melissa's birthday this weekend, so Sunday brunch is at a new Italian place launched by chefs from Naples. I see pizza in my future.

Your wondering how the Fed gets changed analyst,

John Mauldin


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Ronald Nimmo

Nov. 18, 2013, 6:19 p.m.

Response to Carl Linden:

The point is that the academics aren’t really doing any “scientific” thinking or displaying any great intellectual prowess but are simply rubber-stamping economic policies that are the product of misguided ideological convictions. It is a form of both a kind of political correctness and an invocation of the leftist populist wisdom that “easy money” is what working-class and middle-class Americans need. However, it is not producing good results for the majority of the populace. Really, social science (includes economists) academics are to a large extent not original or independent thinkers but employees who produce “research” that is paid for by particular interests and funding sources.

Nov. 15, 2013, 12:23 p.m.


My question is this:

After every recession in US history a recovery has naturally occurred.  This is the economic cycle.  The Fed’s argument for QE is that the economy would have been worse without it, but we can’t measure it.  By many, though not all, measures this is one of the worst economic recoveries in American history. 

If we are already at the lower end of economic recovery given the time passed, why was this recession going to be so much worse than ever before without the Fed’s actions?  With extensive historical evidence on recoveries, what analysis can you bring to argue the recovery would have been far worse than one of the worst recoveries on record?

How much worse would things need to be to justify printing several trillion?  How do you quantify the value creation vs. the costs of printing money?

Do you have any historical evidence or analysis to show the long-term economic gains from printing money?  Based on that, can we empirically back into what the recovery would have been without quantitative easing? 

What analysis has been done on major economic powers which attempted to print money but failed.  Japan, Rome, Germany, etc…  Why is the US different?

Finally, my personal cynical question:
If you’re saving the world, who the hell are you saving it from?

Thank you

Stanley Haye

Nov. 13, 2013, 4:45 p.m.

Common wisdom, supported be considerable evidence, is that increasing interest rates or reducing QE would reduce the value of stocks but have little effect, positive or negative,on the economy. Therefore, Ms Yellen, if in fact the Fed increased interest rates and reduced QE and the stock market went down, would the Fed hang tough or chicken out and decrease interest rates and Increase QE, or leave it up to Congress and the Executive to do their job and take care of the situation?

Nov. 13, 2013, 1:59 a.m.

A pair of simple questions for Ms Yellen:
Have you read Adam Fergusson’s “When Money Dies”?
Have you read Reinhart & Rogoff’s “This Time Is Different”?

I’ll leave it for the questioner to devise the follow-on questions.

David Kondner

Nov. 12, 2013, 5:14 p.m.

“Central Bankers” are “central planners”.  It’s in their blood.  Any solution they come up with will screw-up the system and take us further and further away from Adam Smith’s “invisible hand”.  As they screw-up the system with bigger and bigger solutions, they will create bigger and bigger problems requiring even bigger solutions.  Eventually, someone will need to dismantle the entire solution-set to get things back to where we need to be.
A good question for Yellen should be, “Do you believe in free markets?  If so, how can you defend all the massive intervention taking place?”

singyee chung

Nov. 12, 2013, 6 a.m.

In the latest Hosington quarterly review, Lacy Hunt asserts that the low interest regime created by the Fed through Q.E. actually reduces rather than promote economic growth. This because banks find it difficult to make money from normal commercial lending because of the ultra low interest rate environment. They therefore prefer to use scarce capital for proprietary trading in pursuit of profits thus reducing capital available for commercial entities. As evidence, Hunt points to the fact that money multiplier has fallen to 100 years low.
Does Yellen agree with this?

jack goldman

Nov. 11, 2013, 2:37 p.m.

Since 1984, Greenspan, Bernanke, have created $15 Trillion in debt, payable by US Taxpayers and their children and unborn children. I call this selling children into debt slavery, condemned by America when done in other nations, but not here.

1776 - 1986, $2 Trillion US debt at $10 Billion a year over 210 years. 1986 - 2013, $15 Trillion MORE US public debt created at $600 Billion a year, a 60 fold increase in peace time, in only 27 years. Greenspan and Bernanke are funding globalism, the electronic banking take over of the world by computer, internet, and smart phone. Will it work? No one knows. It’s an electronic war. All who resist are labeled terrorists. The debt traditionally is defaulted on and will end in a crash of defaulted debt and a massive wealth transfer. The 2008 drop was a movie trailer for what will happen next time but much deeper. I have to protect myself.

jack goldman

Nov. 11, 2013, 2:32 p.m.

The issues are simple. Silver is real money, bank debt notes are counterfeit currency. In 2013, real silver dollar sells for $20 US Federal Reserve Bank debt notes. To find the real price divide by 20 to compare our progress since 1964 when silver money was taken off the market. Dow $15,000 is really Dow $750, same at it was in 1964. No progress measured in real US Treasury silver coins available today. That $200,000 house is really $10,000 in real silver money from 1964, same at it was in 1964, no real progress in real money. When the debt crash comes the real money is waiting. Prices could easily fall 90%, same as 1929-32. Imagine a Dow $1500 or so after all the internet stocks and fake pump and dumps drop to zero.

The US Treasury and private secret foreign owned US central bank made a deal with the devil. Using debt notes as money has ALWAYS ended badly, ended in tears, as the counterfeiting of currency ALWAYS drives up prices, creates more debt, and ends in default. Nobody cares. I got mine. The Fed is counterfeiting money to continue the failed policies of a women and minorities, subsidized, quota economy of entertainment and information traffickers started in 1971 and continues today.

Where to hide? Land? Silver? Paid for real estate? No one knows. Maybe stocks will inflate. No one knows. It’s a game and it’s uncharted territory with the computers, smart phones, and internet. Good luck to us all. Traditionally this counterfeiting ends in social collapse, war, and loss of freedoms. I have to protect myself.

Nov. 11, 2013, 1:16 p.m.

All current assumptions about life in general and especially in this economic discussion rest on the mistaken belief that the past economic growth can be made to continue by the wise applications of some sort of human actions. You can call them skill, luck, voodoo, magic fairy dust, stupidity, arrogance, all the way to gross negligence and incompetence.

All around the world there is another list of things, probably longer than the above list, which can muck whatever “good” intentions you may decide to use to steer the course.

In the Fed and Senate world, such things as debt limits, devaluations, terrorism, conventional and thermonuclear war, unintended consequences, normalcy of deviance events, totally unforeseen happenings, or even simple entropy of existing processes cannot and will not be discussed for fear airing such truths will in some way affect all of your (and our) future security.

Perhaps there is only one true solution that will never be discussed until one or a number above stupendous events forever change the future. What ever happened to the primitive, view first proposed by Adam Smith, the Invisible Hand does a better job and providing jobs and growing wealth than the fondest dreams of technocrats and politicians.

Nov. 11, 2013, 12:13 p.m.

I actually think these questions should and must be asked. If the responses are boilerplate or incomprehensible, so be it. But it is incredible that no one has ever, to my knowledge, publicly asked Yellen to explain her continuing support for QE given that it has at least some risk/cost and her own SF Fed staff found virtually no economic benefit.

John, I’d love to see you send these questions to the offices of the members of the Senate Banking Committee. I think some of the Members would be very receptive. Don’t just talk the talk - make something happen!

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