When the Fed (and other central banks) returns to keeping its own counsel, we’ll move towards a better reality
US Fed Governor Janet Yellen’s act at the last Federal Open Market Committee (FOMC) meeting on September 17—coincidentally, the day that Ganpati arrived—was almost perfect.
It left markets completely confused about whether the Fed was really concerned about global (and, by reflection, US) growth, as a result of which markets tanked; or whether it merely believed it needed to wait a little longer to end monetary accommodation, as a result of which markets recovered the next day. Uncertainty appears to have increased.
I say “perfect” because, contrary to practice and belief over the past 20 years or so, it is not the Fed’s job to tell people what they are thinking. Transparency is, in principle, a good thing, but not in situations where it ends up underwriting risk, the cost of which is ultimately paid by taxpayers. Remember the Greenspan put (and the Bernanke put, the full impact of which is still playing out).
I say “almost” because I believe the Fed should have raised rates, not to quell uncertainty but because near-zero rates encourage building up of ever more debt, which puts continuing downward pressure on growth. Again, super low interest rates distort the already heavily skewed income distribution, as already noted by Governor Yellen, which leads to lower demand, which, again, leads to lower growth. There is little doubt that the extremely slow recovery from the financial crisis of 2008 is largely the result of the huge amount of debt that was infused into the system through multiple rounds of quantitative easing.
Whether these “side effects” are worth the “cure” remains to be seen—markets certainly appear unconvinced.
But, returning to my oft-articulated point, central banks, rather than pandering to the financial markets with faux transparency, should actually be strong and silent, like God: You know he (or she or it) is there—if you are a believer—but you only see him (her/it) in an emergency, not every two months plus multiple speeches and interviews and certainly not as the largest player in the market.
That’s what central banking used to be as recently as the 1980s. Before this, nobody even knew the name of the Fed Chairman. This changed when Paul Volcker cranked up interest rates to nearly 18% to break the back of inflation. He was loudly vilified by many at the time—in fact, he became the first Fed Chairman with a loud media presence—but his effort was eminently successful. Inflation in the US, which ran at double digits for three years from 1979, has averaged 2.8% in the 30-plus years since then.
There are many market players who, unsurprisingly, believe Volcker is past his prime—markets are different, the world is different, they say. True, but certain fundamentals—gravity, for instance, or the certainty that if you continue to pile up debt and remain oblivious to risk, you will meet a difficult end—have not and will not change.
I believe Mr Volcker is a voice worth listening to. In a recent (June 2015) interview, he spoke about how the financial sector had “become too big for its britches” and was the prime force in pushing inequality higher and destroying the American dream. Sure enough, financial firms’ profits (in the US) as a percentage of GDP, which had held broadly steady around 1.5%, started climbing in the mid-1980s, peaking at nearly 3.5% before the bubble burst in 2008.
Additionally, financial assets in the US form fully 65% of total assets, far higher than any other country in the world (except, oddly enough, South Africa) and financial markets dominate 24-hour news broadcasts, turning otherwise sober economists (and Fed Chairmen) into rock stars.
Fortunately, Ant Janet (as I like to call Governor Yellen) appears to be made of a different cloth than her immediate predecessors—more like Mr Volcker and our own Dr Reddy. She isn’t really looking to be the Lady Gaga of the finance world and doesn’t need to expose her views with any greater degree of clarity than she has been doing. She needs to report to Congress, of course, but not yield to the bleating demands from the market, which will surely get louder, particularly if she really does this part of her job right.
When the Fed (and other central banks) returns to keeping its own counsel, we will move towards a better reality. There will be a period of heightened uncertainty at first—and this may last a while since it will be difficult for markets to get accustomed to the new “don’t ask don’t tell” Fed—but, in time, markets will return to a saner disposition. Risk will again start getting more correctly valued, the financialisation of the global economy will reverse, capital allocation will improve, and real growth will finally re-emerge.
The author is CEO, Mecklai Financial