Blog | Personal Finance

What’s all the Yellen About?

meet your own rich dad - start your quiz now

Janet Yellen, unlike her predecessors Alan Greenspan and Ben Bernanke, bears no responsibility for causing the global economic crisis. However, as the next chairperson of the Federal Reserve, she will still inherit the mess they made. Therefore, it is very important to understand how she plans to deal with it. There is no need to guess about her intentions. She has been clear about how she will proceed. It is only necessary to read her speeches over the last few years to understand her thinking. In this blog, I will write about Mrs. Yellen’s game plan for managing the economy, as well as what I believe will be the short-term and long-term consequences of her policies.

What matters most is her position on Quantitative Easing – because QE is now the most important driver of the global economy. At present, the Fed is creating $85 billion each month and using that money to buy bonds. That policy pushes up bond prices and drives down interest rates, thereby boosting property prices. It also causes more money to move into equities, which fuels the rally in the stock market. Rising asset prices enable Americans to spend more; and that spending causes the economy to grow.

So, how does Mrs. Yellen feel about QE? The answer is, she likes it. She believes QE is working and she thinks it should “continue until there is a substantial improvement in the outlook for the labor market in the context of price stability.”

A recurring theme throughout many of her speeches is her concern for the unemployed, as well as her belief that high unemployment risks doing lasting damage to the US economy. The unemployment rate in the United States is 7.2%. This is a very substantial improvement relative to the crisis peak level of 10% in 2009. However, it is still considerably above the 5.2% to 6.0% range that the Fed considers the longer-run normal rate of unemployment. Moreover, the underemployment rate, which incorporates those people working part-time because they can’t find full-time jobs, is 13.6%. And, further, wages and hours worked per week remain stagnant and the labor participation rate remains very low, which suggests people have become discouraged and stopped looking for work. Mrs. Yellen has stated that she believes all of these factors should be considered when judging the outlook for the labor market.

The press release at the end of the Fed’s FOMC meeting on October 30th reiterated Mrs. Yellen’s position:

“The Committee…. will continue its purchases of Treasure and agency mortgage-backed securities (i.e. QE)… until the outlook for the labor market has improved substantially in a context of price stability.”

The inflation rate is now 1.2% (as measured by the core Personal Consumption Expenditure price index). That is below the Fed’s preferred level of 2%. Therefore, unless there is a spike in inflation, we should expect QE to continue until there is a substantial improvement in “the outlook for the labor market.” Such an improvement appears unlikely in the near-term. Over the last three months, most labor market indicators have been weakening, rather than improving, as was the case earlier in the year.

Mrs. Yellen will replace Ben Bernanke in January. The debt ceiling will be hit again in February and may provoke another political crisis in Washington. Moreover, the outlook for the labor market is unlikely to improve substantially before the spring. For these reasons, the majority of financial analysts now believe that the Fed will not even begin to reduce the pace of QE until March.

If that view is correct, and I believe it probably is, then the near-term outlook for the stock market is very bullish. QE will continue to pump fresh money into the economy and that money will drive up asset prices, particularly the price of stocks.

The greatest near-term risk may be that the stock market moves up too far, too fast. That might force the Fed to take some step to rein it in to prevent a new bubble from inflating. So investors should enjoy the ride, but remember that too much of a good thing could prove to be dangerous.

As for the longer-term, Mrs. Yellen and her colleagues have stated repeatedly that the Fed is unlikely to begin increasing the Federal Funds Rate (which has been near 0% since 2008) until well after QE ends and most probably not until 2015. Such abnormally low interest rates are storing up serious problems for the future by encouraging investments to be undertaken now which will become unprofitable when interest rates return to more normal levels. If this kind of “malinvestment” continues, the size of the eventual losses are very likely to be such as to cause another very costly systemic banking crisis in the not too distant future.

I do not envy Janet Yellen. She is walking into what looks like an impossible job. If she stops QE and returns interest rates to a normal level any time soon, the stock market and the property market will crash and the economy will be threatened by a new depression; but, if she continues to create massive amounts of fiat money and to hold interest rates at 0%, then the US (and the global) economy will become so distorted by malinvestment that a new depression may become unavoidable in any case.

I do not envy her, but I respect her. Her concern for the unemployed is genuine; and her fears about the consequences of long-term unemployment are well founded. I wish her the very best of luck – and so should you. Our future depends on her success.

Original publish date: November 01, 2013

Recent Posts

The 3 Types of Education
Personal Finance

The 3 Types of Education

Most people think academic and professional education alone will make them rich. But here's what the wealthy teach their children to be financially free.

Read the full post
The Danger of College Education | Your wealth is equal to your level of knowledge
Personal Finance

The Myth of College for Success

Before taking on student loan debt, women must understand that success starts with financial (not higher) education.

Read the full post
Unlocking Wealth Secrets
Personal Finance

Unlocking Wealth Secrets: Strategies for Financial Mastery

"Actions speak louder than words." Discover why it's important to pay attention to what investors like Warren Buffett do, not what they say.

Read the full post