John Mauldin: Thoughts From the Frontline
The Fed Adds a Third Mandate
The Fed has two mandates: keeping prices stable and creating an economic climate for low unemployment. I am sure I was not the only one to listen to Steve Liesman’s interview of Ben Bernanke this week and shake my head at the spin he was giving us. First, let’s set the stage.
In a paper with Alan Blinder early last decade, Bernanke made the case for the Fed to target a specific inflation number, and the number that came to be accepted as his target was 2%. In his famous helicopter speech in late 2002, he assured us that inflation could not happen “here,” even if the short-term rate was zero, because the Fed would move out the yield curve by buying large amounts of medium-term bonds. This would have the effect of lowering yields all along the upper edge of the curve. This became known as quantitative easing. In Jackson Hole last summer, he made very clear his intention to launch a second round of liquidity-injecting quantitative easing (QE2). In that speech, in later speeches in the fall, and in op-ed pieces he said that such a program would lower rates.
Then a funny thing happened on the way to QE2: long-term rates began to rise all over the developed world. As Yogi Berra noted, "In theory, there is no difference between theory and practice. In practice, there is." It’s got to be driving Fed types nuts to see the theory of QE, so lovingly advanced and believed in by so many economists, be relegated to the trash heap, along with so many other economic theories (like that of efficient markets). The market has a way of doing that.
So, Liesman asked Bernanke about one minute into the clip (link below) about the little snafu that, following QE2, both interest rates and commodity prices have risen. How can that be a success? Ben’s answer (paraphrased):
“We have seen the stock market go up and the small-cap stock indexes go up even more.”
Really? Is it the third mandate of the Fed now to foster a rising stock market? I wonder what the Fed’s target for the S&P is for the end of the year? That would be an interesting bit of information. Are we going to target other asset classes?
Understand, I am not against a rising stock market. But that is not the purview of the Fed. And certainly not a reason to add $600 billion to the balance sheet of the Fed when we clearly do not understand the consequences. If it looks like they’re making up the rules as they go along, it’s because they are.
A Rational Voice in Dallas
Richard Fisher is the president of the Federal Reserve branch in Dallas and a voting member this year of the FOMC committee. (Also a true gentleman, one of the nicest guys you could want to meet, and my neighbor, just a few blocks down the street.) But being a nice guy doesn’t keep him from espousing some strong and dissenting views about Fed policy. He recently gave a speech to the Manhattan Institute that should be required reading (link below) for all policy makers at all levels of government, and not just Fed types. As an anecdote to the Bernanke spin above, let me quote a few paragraphs:
“The new Congress and the new staff in the White House have their work cut out for them. You cannot overstate the gravity of their duty on the economic front. Over the years, their predecessors — Republicans and Democrats together — have dug a fiscal sinkhole so deep and so wide that, left unrepaired, it will swallow up the economic future of our children, our grandchildren and their children. They must now engineer a way out of that frightful predicament without thwarting the nascent economic recovery.
“I have been outspoken about the limits of monetary policy as a salve for the nation’s fiscal pathology. The Fed has done much, in my words, to provide the bridge financing until the new Congress gets to work restructuring the tax and regulatory incentives American businesses need to confidently expand their payrolls and capital expenditures here at home.
“The Federal Reserve has held rates to nil. We have expanded our balance sheet to unprecedented levels. After much debate — which included strong concern expressed by one member with a formal vote and others, like me, who did not have voting rights in 2010 — the FOMC collectively decided in November to temporarily undertake a program to purchase U.S. Treasuries that, when added to previous policy initiatives, roughly means we are purchasing the equivalent of all newly issued Treasury debt through June.
“By this action, we have run the risk of being viewed as an accomplice to Congress’ fiscal nonfeasance. To avoid that perception, we must vigilantly protect the integrity of our delicate franchise. There are limits to what we can do on the monetary front to provide the bridge financing to fiscal sanity. Last Friday, speaking in Germany, [European Central Bank President] Jean-Claude Trichet said it best: ‘Monetary policy responsibility cannot substitute for government irresponsibility.’
“The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we have reached our limit. I would be wary of further expanding our balance sheet. But here is the essential fact I want to emphasize today: The Fed could not monetize the debt if the debt were not being created by Congress in the first place.
“Those lawmakers who advocate ‘Ending the Fed’ might better turn their considerable talents toward ending the fiscal debacle that has for too long run amuck within their own house. The Fed does not create government debt; fiscal authorities do. Deficits and the unfunded liabilities of Medicare and Social Security are not created by the Federal Reserve; they are the legacy of those who control the purse strings — the Congress, working with the president. The Fed does not earmark taxpayer money for pet projects in local communities that taxpayers themselves would never countenance; only the Congress does that. The Congress and administration play the dominant role in creating the regulatory environment that incentivizes or discourages job creation.
“… A reader of Shakespeare will recall the dialogue between Glendower and Hotspur in Henry IV. Glendower claims, ‘I can call spirits from the vasty deep.’ And Hotspur replies, ‘Why, so can I, or so can any man; But will they come when you do call for them?’
“We shall see if the new Congress will prove worthy of the power the American people have ‘loaned’ them, and, together with the president, actually draw the spirits of fiscal reform and sanity from the ‘vasty deep’ to at long last implement meaningful fiscal and regulatory policy that incentivizes private-sector job creation here at home while arresting the hemorrhaging of our Treasury. If they do, then more Americans will find work and be better off, better paid, and freer to make their own decisions about the economy.
“If they don’t, then woe to our children, their children, and the American Dream.”
Let us hope President Fisher will find support within the FOMC. I commend his speech to you: http://www.dallasfed.org/news/speeches/fisher/2011/fs110112.cfm . And now on to Europe.