Gillian Tett has written an important article for the FT. She is amazed that financial market distortions did not figure in the discussion in Jackson Hole. She is right to raise the flag or raise an alarm. This is the comment I left on her column:
Well, finally, someone in FT is willing to say that the favourite emperors of the financial press know not and know not that they know not. What is funny (or tragic, depending on your point of view) is that several other journalists in FT are whistling through the dark, as though the policies that they are cheering and wanting more of, have nothing to do with the situation that has developed in the last few years.
It will be a big omission if I did not mention the blistering Op.-Ed. that Kevin Warsh, former member of the FOMC, wrote in the Wall Street Journal on August 24. That he served in the Federal Reserve for five years makes his critique all the more special and important.
The full piece must be read and re-read. But, I will just point out two sentences:
A numeric change in the inflation target isn’t real reform. It serves more as subterfuge to distract from monetary, regulatory and fiscal errors. A robust reform agenda requires more rigorous review of recent policy choices and significant changes in the Fed’s tools, strategies, communications and governance.
It expresses grave concern about income inequality while refusing to acknowledge that its policies unfairly increased asset inequality.
And it appears to make monetary policy with the purpose of managing financial asset prices, including bolstering the share prices of public companies.
I will also be remiss if I do not mention a more recent Edit by Wall Street Journal itself. Again, the full Edit is well worth a read. Some excerpts:
… the Fed now shows no signs that it wants to return to its narrower role, even eight years into an economic expansion. A Fed that wanted to reduce its political footprint would wind down its $4.5 trillion balance sheet as its bond holdings mature.
It will follow the European Central Bank in buying a board swath of corporate bonds. This will plunge the Fed even deeper into favoring some parts of the economy over others.
In a healthy democracy, nobody can accumulate power as the Fed has without more accountability. [Link]
As I was searching for the proper link for the Kevin Warsh article cited above, I ran into this piece co-authored by him with Stanley Druckenmiller:
The aggregate wealth of U.S. households, including stocks and real-estate holdings, just hit a new high of $81.8 trillion. That’s more than $26 trillion in wealth added since 2009. No wonder most on Wall Street applaud the Fed’s unrelenting balance-sheet recovery strategy. It’s great news for those households and businesses with large asset holdings, high risk tolerances and easy access to credit.
Yet it provides little solace for families and small businesses that must rely on their income statements to pay the bills. About half of American households do not own any stocks and more than one-third don’t own a residence…..
…. And the real difference is one between a balance-sheet recovery that helps the well-to-do and an income-statement recovery that advances the interests of all Americans.
Yes, the biggest crime of policymaking in the last thirty years or so is the deliberate distortion of wealth creation process as described below to one driven by consumption driven by borrowing driven by low interest rates and based on rising asset prices as collateral, engineered, in turn, by monetary policy induced liquidity:
Wealth creation comes from strong, sustainable growth that turns a proper mix of labor, capital and know-how into productivity, productivity into labor income, income into savings, savings into capital, capital into investment, and investment into asset appreciation. [Link]
Perhaps, it is appropriate to conclude this (already long) post with a reference to a recent piece by Nobel Laureate Michael Spence. He points out there are two forms of secular stagnation – one that is beyond policymakers’ control and he calls it SS1. It is caused by “growth-destroying headwinds that are impossible to counter in the near term without endangering future growth and stability.” – I have paraphrased him.
Then, there is SS2 – Secular Stagnation 2 – which is caused by adopting the wrong policy mix. He says the right policy mix would have measures that address income inequality – redistribution through taxation and social security measures, higher interest rates combined with capital controls and active fiscal policy, particularly in Europe.
I like his piece because he makes a beginning by acknowledging that growth cannot be engineered by monetary policy that is aimed at boosting asset prices through liquidity provision. Frankly, when I spell it out like this, it feels so dumb to me. Yet, the persistence of such wrong policies and the extraordinary amount of patronage and support they draw from the so-called intelligentsia is proof that only enduring reality is human irrationality.
I like his split of growth-impeding forces into SS1 and SS2. But, the SS2 solutions are somewhat underwhelming. My own view is that SS1 can be addressed and must be confronted by acknowledging that short-term growth and stability would take a hit and directing policy to ameliorating the ill-effects of short-term growth and stability pains particularly for those who cannot handle it themselves. The rest have to adjust, to downsize and if the resulting growth pattern for the world is slower for longer, then all the better. We have grown too fast for too long relying on too much debt. That needs to change and there is no change that does not involve pain.
Let us then get back to the growth model that is briefly recapitulated above by Warsh and Druckenmiller – growth through savings, investment, productivity and employment.
So, what shall we do with the Federal Reserve? Well, if it cannot wind down its balance sheet, it is time to wind down the Federal Reserve itself.