What a fascinating environment; each week bringing something extraordinary. Yet there is this dreadful feeling that things are advancing toward some type of cataclysm.
“U.S. President Donald Trump’s trade war with China keeps undermining the confidence of businesses and consumers, worsening the economic outlook. This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along? If the ultimate goal is a healthy economy, the Fed should seriously consider the latter approach… There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.” Bill Dudley, Bloomberg op-ed, August 27, 2019
The former president of the Federal Reserve Bank of New York’s piece galvanized an overwhelmingly negative response. Virtually everyone agrees it would be an outrage for the Fed to take such a plunge into the political maelstrom.
A Federal Reserve spokeswoman responded:
“The Federal Reserve's policy decisions are guided solely by its congressional mandate to maintain price stability and maximum employment. Political considerations play absolutely no role.”
Former Treasury official Larry Summers weighed in (from CNBC interview):
“The Fed’s job is to stay out of politics. The Fed’s job is to respond to the best assessment they can make of economic conditions and adjust the economy – interest rates - appropriately… But for a trusted former official of the Fed, whose thinking is inevitably going to be tied to the Fed, to recommend that they raise interest rates so as to subvert the economy and influence a presidential election is grossly irresponsible – is an abuse of the privilege of being a former Fed official… It is not the job of non-elected appointed officials to a technocratic role to decide how they’re going to act so as to constrain and influence the behavior the President of the United States – and the behavior of the remainder of the government of the United States. That is to misunderstand entirely the role of appointed officials in a democracy.”
Summers’ view is certainly well-founded, at least in theory. But it’s an especially complex world in which we live.
Is it the job of non-elected appointed officials to a technocratic role to decide the performance of securities markets, hence the distribution of wealth throughout society?
Asking for trouble...
Dudley’s bold op-ed requires context. It followed the previous Friday’s disturbing presidential tweets and the S&P500’s resulting 2.6% drop. “…Who is our bigger enemy, Jay Powell or Chairman Xi?” “Our great American companies are hereby ordered to immediately start looking for an alternative to China…” And contrary to Larry Summers’ comments, Bill Dudley made no suggestion to “raise interest rates so as subvert the economy.”
The critical issue is instead whether the Fed should respond with additional monetary stimulus to ill-advised tweets and policy dictum that risks deflating market confidence. This outrage at the thought of the Fed becoming “political” is illusory. The Fed began its insidious venture into the murky political realm under Greenspan’s reign in the nineties.
It has been long accepted that the Federal Reserve should refrain from policies that amount to Credit allocation. Picking winners and losers within the economy should be outside the Fed’s purview and risks political backlash and a loss of institutional credibility.
The notion that the Federal Reserve would not respond to declining stock prices – under any circumstance – has become heresy. There was no outrage when the Greenspan Fed manipulated the yield curve and adopted an asymmetrical policy approach to underpin the securities markets. Where was the outrage when Bill Dudley (while at Goldman Sachs) and others specifically called for the Fed to adopt policies to spur mortgage Credit expansion for the purpose of systemic reflation after the collapse of the “tech” Bubble? There was even minimal debate when the Bernanke Fed employed unprecedented post-mortgage finance Bubble Credit allocation and reflationary measures. And it was as if I was the only analyst that had an issue when Bernanke later stated the Fed would “push back” against a tightening of financial conditions, essentially signaling the Federal Reserve would not tolerate a market correction.
I am again reminded of the late Dr. Richebacher's important insight that asset inflation is the most dangerous type of inflation, certainly riskier than consumer price inflation. There is (was) general agreement that more than a modest increase in consumer prices is undesirable and would provoke tightening measures from responsible central bankers. But with rising asset prices almost universally viewed constructively (while confirming the soundness of policies), there is no constituency motivated to rise up and demand measures to contain inflating asset prices and Bubbles.
It is now a consensus view that the Federal Reserve (and global central bankers) should backstop financial markets to promote economic growth and wealth creation. The Fed, market participants and most pundits prefer to ignore that such a doctrine places the central bankers at the epicenter of Credit, resource and wealth allocation. Such a position ensures the Fed now wades chest deep in the political muck. It’s been a slippery slope I’ve been chronicling now for over 20 years.
The Fed’s market-centric and interventionist approach has essentially supported incumbent Presidents and Washington politicians. From this perspective, it is clearly “establishment” and susceptible to “deep state” innuendo. This regime is today challenged by President Trump, with his penchant for tariffs, confrontation, and scathing attacks on the Fed and its Chairman. The President is essentially blackmailing the Fed: Play ball or you’ll be blamed, ridiculed and targeted, with clear risk of losing your jobs along with the institution’s coveted independence.
What Dudley is really questioning is whether the Fed needs to make a departure from its regime in response to the market, economic, institutional and geopolitical risks posed by an unorthodox President increasingly considered unstable and pursuing a dangerously ill-advised policy course. Should the Fed continue to backstop the financial markets when the marketplace is responding rationally to increasingly high-risk financial, economic and geopolitical backdrops? With the administration clearly pursuing a risky strategy while placing a gun to Powell’s head, should the Federal Reserve continue to enable such a policy course when it is deemed to put so many things at great risk?
Crazy like a fox. A clear flaw in the Fed’s interventionist regime is now being exploited, while Dudley’s “outrageous” op-ed is only making public what must be an area of intense discussion within the Marriner S. Eccles Federal Reserve Board Building.
Politico (Victoria Guida):
“Peter Conti-Brown, a professor at the University of Pennsylvania's Wharton School who specializes in Fed history, noted that Fed watchers have long debated whether the central bank should be used as an insurance policy against bad economic policy decisions. But ‘in today’s climate, an op-ed from the former vice chairman of the [Federal Open Market Committee] arguing that the Fed should be transparently reactive to Donald Trump is a little bit dangerous,’ he said. ‘Where Dudley completely jumps the shark is by saying we should have a republic with central bankers who pick winners and losers… ‘If Powell follows Dudley’s advice … then we’ll mark that as the end of independent central banking,’ he said.”
A central bank beholden to securities market Bubbles has already forsaken independence. After accommodating the mortgage finance Bubble with years of loose monetary policy, the Fed has been completely hamstrung for the past decade. Our central bank waited too long to commence the process of normalizing policy. In the end, it was unwilling to impose any semblance of a tightening of financial conditions, despite securities markets signaling dangerous monetary excess. Still, the Fed is now condemned for excessive tightening that has put U.S. markets and economic prospects at risk. This is the narrative the President is using as he fashions a scapegoat while aiming to hammer the Fed into submission.
And from Slate (Jordan Weissmann):
“It is hard to overstate what a tremendously dangerous concept this is. Dudley is not talking about a conflict between two equal branches of government. If the economy crashes and Democrats don’t want to pass a stimulus because it might help Trump, that would be crappy and inhumane, but it’d also fundamentally be politics. Voters could decide who to hold accountable. Here, Dudley is effectively talking about an economic coup staged by a group of unelected technocrats. He doesn’t seem to be worried about the implications of this idea, because he feels the president has already politicized the central bank… The best way for the Fed to show it is not a political institution is to not act like a political institution, and intervene to help the economy when circumstances obviously dictate it.”
The problem: circumstances don’t obviously dictate that the Fed should be intervening. The unemployment rate is 3.7%, near a 50-year low. Stock prices are within 3% of all-time highs, while all varieties of bonds are priced at unprecedented lofty levels. And after declining to near zero in March, the Atlanta Fed’s GDPNow Forecast has current growth maintaining a reasonable late-cycle 2% pace.
August 28 – Bloomberg (Rich Miller and Christopher Condon): “A Republican member of the Senate Banking Committee called for the panel to hold a hearing on what he termed the danger that the Federal Reserve will meddle in the 2020 presidential election, a day after a former top central bank official suggested that the Fed resist interest-rate cuts that would aid Donald Trump. Senator Thom Tillis… said… he was ‘very disappointed’ that… Bill Dudley appeared to be ‘lobbying the Fed to use its authority as a political weapon against President Trump,’… ‘The president is standing up for America against China after 30 years of our country and our workers being ripped off and there is now an effort to get the Fed to try to sabotage the president’s efforts,’ Tillis said.”
The Fed’s political problem will not end with Donald Trump or Chinese trade negotiations. Going forward, our central bank will be under unrelenting pressure to support the markets and boost the economy - and will be a target for the party on the losing side of election outcomes.
As the Fed policy regime evolved, it failed to articulate a sound framework for explaining the factors driving monetary policy decisions. A view took hold that there is little risk of aggressive stimulus so long as consumer price inflation stays within its 2% target. As things turn increasingly dicey, the Fed will struggle to push back against calls for aggressive rate cuts and the restart of QE. For years now, loose monetary policy has accommodated egregious financial excess, including fiscal deficits approaching 5% of GDP during peacetime economic expansion. Deficits don’t matter; speculative excess and asset Bubbles don’t matter.
I expect Trump's attacks are the first salvo in what will be only more intense political pressure directed at the Fed to employ aggressive stimulus measures.
August 30 – Wall Street Journal (David Harrison and Maureen Linke): “The decadelong economic expansion has showered the U.S. with staggering new wealth driven by a booming stock market and rising house prices. But that windfall has passed by many Americans. The bottom half of all U.S. households, as measured by wealth, have only recently regained the wealth lost in the 2007-2009 recession and still have 32% less wealth, adjusted for inflation, than in 2003… The top 1% of households have more than twice as much as they did in 2003. This points to a potentially worrisome side of the expansion, now the longest on record. If another recession comes, it could be devastating for people who have only just recovered from the last one.”
The rise of populism is in its initial stage. The situation turns much more serious when the current Bubble deflates. There are major costs associated with the Fed’s loss of independence – independence from politics as well as from market pressure. For now, however, markets are trading on the prospect of aggressive global monetary stimulus (rate cuts and QE).