Jackson “Black” Hole?
A friend, mindful of my interest in both the arcana and folklore of the bond world, recently presented me with a gift only a monetarist could love: a March 1982 copy of Time magazine with then-Federal Reserve Chairman Paul Volcker on the cover. It was headlined “Interest Rate Anguish” in reference to Volcker’s tight-money attempt to stamp out inflation in the middle of a recession. The lead story cast the chairman as “the scapegoat for all the economy’s ills,” and implied that new President Ronald Reagan might dump Volcker, appointed by his predecessor Jimmy Carter, when the chairman’s term expired.
Volcker prevailed. Inflation was subdued, making the world safe for the Reagan revolution and years of uninterrupted growth. (And lest we forget, record deficits to go with it.)
The Time cover photo is as illustrative as the story – not only because “Interest Rate” should have been hyphenated as it modifies a noun, but also as a measure of how the Fed chairman’s authority has diminished since Volcker’s reign. He appears to be testifying before Congress, a nebula of cigar smoke swirling about his ample brow and his eyes fixed witheringly on his inquisitors – a portrait of insouciance from a central banker confident not only in his policy goal but also in the tools at his command to achieve it.
Sadly, our own generation of central bankers are lacking in both.
Compare, for example, the respect heaped upon Volcker to the general estimation of his current successor. (To be fair Volcker, at 6-feet, 7 inches and 240 pounds in his prime, would have commanded respect in a bikers’ bar. I have met him at several business events and his grasp of monetary and microeconomic matters is as daunting as his stature.) Last week, addressing the Fed’s annual gathering at Jackson Hole, Janet Yellen once again tried to split the difference between credit hawks and doves and predictably impressed neither camp. This has become a hallmark of her administration and it has fueled a crisis of credibility that would have been unheard of in Volcker’s day. Prior to the gathering at Jackson Hole nearly two-thirds of those polled in a CNBC survey expressed frustration not only with Yellen but the Fed’s very capacity to set interest rates. If that sounds dire, the reality could be worse.
For some time now we at Anfield have been calling for a gradual increase in interest rates to preempt a triad of asset bubbles – U.S. stocks and real estate, in addition to emerging markets – from triggering another meltdown. (Indeed, we first sounded the alarm in October 2014.) In China the reckoning has already struck; it’s “A” share indices have lost some 40 percent of their value over the last six months and there is no sign of recovery. Having wasted most of the year in fruitless deliberation and distracted it seems by the political calendar, the Fed finds itself in the shadow of a financial economy so large and opaque that its raison d’être – manipulating the price of money – is in play.
Consider for example the rise, both qualitatively and quantitatively, of the London interbank offered rate and its primary role in the “stealth” tightening of credit rates worldwide. For the last twelve months Libor rates have climbed to their highest levels since 2009 as growing numbers of companies opt to raise capital via longer-dated bonds pegged to Libor instead of more commercial loans. At the same time fixed-income investors are scarfing up Libor-referenced debt in search of respectable yield.
Incredibly, the proliferation of Libor-linked assets and the subsequent credit-rate creep – first felt in the commercial and industrial sector and now squeezing consumers – has barely registered among Fed mandarins, to say nothing of Ms. Yellen. As Bloomberg News beseeched last week, “Regardless of the cause or permanence of the [Libor] rate increase, broader effects can already be seen throughout markets, and the Federal Reserve should take greater notice.”
The Fed is not the only central bank flirting with redundancy. Earlier this year the Bank of England embarked on a quantitative easing program to counter the likely effects of Brexit. It was a good idea in theory: by purchasing bonds worth billions of pounds the BoE would bid up bond prices, flatten yields and encourage banks to write cheap loans for industrialists and consumers in the real economy. Not only that, it would nudge investors to invest in riskier assets and ventures, freeing up additional capital to fuel the economy.
The operation was frustrated, however, by the unwillingness among pension funds to sell their bonds despite the BoE’s highly competitive bids. No longer under the sway of central banks, such funds are now a formidable market force in themselves. The irrelevancy of central banks was foreshadowed by former BoE governor, Mervyn King in his recent book, The End of Alchemy. In it King disparages how regulators “have thrown everything at their economies, and yet the results have been disappointing … neither strong, nor sustainable, nor balanced.”
Lurking in the news reports and commentary from Jackson Hole were hints that Ms. Yellen and her colleagues sense that their tools, if not their regulatory writ, may be obsolete. The Wall Street Journal reported that the Fed is owning up to a policy failure that would leave it “with less ammunition to counteract economic shocks going forward.” The story concluded that the three options facing the Fed – accept the secular trend of weaker growth and lower rates; concede much of their authority to the fiscal policy realm; or raise the inflation target – were all “unsettling.” Reuters, meanwhile, reported that Fed policymakers may ditch their reliance on inflation as an interest-rate trigger in a low-growth world and instead assume a new role as “guardians of long-term growth prospects,” a brief so elastic as to mean nothing and everything.
When bureaucracies start mulling new roles for themselves it’s usually because they have either failed to prosecute their existing ones effectively or succeeded so well they are no longer needed. I may concede that even a giant like Volcker may be obsolete in a world where social media has consigned even congressional hearings to history’s dumpster. I also believe, however, in the need for a vigorous, public regulator to protect investors from the animal spirits of fear and greed. In the end, Volcker succeeded because he identified a policy objective and ruthlessly defended it regardless of the political consequences. His predecessor has yet to display such resolve, with potentially grievous harm to the institution she serves.