Janet Yellen Just Blinked
Jim Rickards' Real Time Commentary - September 21st, 2015
As we predicted in last week’s Real-Time Commentary, the Federal Reserve did not raise interest rates at the September 17 FOMC meeting. The reasons the Fed gave for no rate increase were also the ones we alerted readers about – slower global growth, especially in China, and no signs of inflation in the U.S. And, as expected, talk immediately turned to possible rate increases at one of the next two Fed meetings in October and December of this year. Don’t hold your breath waiting for them. At this point, the global slow-down is so pronounced that the Fed’s next move is more likely to be in the direction of ease rather than tightening.
The reason for the global slowdown is easy to discern. The Fed has been tightening monetary policy since May 2013. It’s true that the FOMC policy rate has been stuck at zero since 2008. Still, Ben Bernanke began the tightening process in May 2013 with his “taper talk” or threat to end asset purchases. This was followed by the actual taper in December 2014. Then Janet Yellen ended Fed forward guidance in March 2015, and threatened to raise rates throughout the year.
All of these moves affected market expectations and led to a strong dollar, imported deflation, and capital flight from emerging markets. The Fed got the impact of tightening without raising rates. But, it was a case of “be careful what you wish for.” The Fed pursued these policies based on flawed forecasts that the U.S. economy was strong enough to bear them. The U.S. economy was never that strong, and the Fed’s tough talk turned out to be an historic blunder. The Fed is now in damage control mode, looking for ways to ease.
In that sense, Janet Yellen just blinked. She’s finally ready to admit (almost) that the Fed’s tight monetary policy of the past two years has jeopardized global growth. Russia, Canada, and Brazil are already in recession. Japan and the U.S. are dangerously close to one. China is slowing perceptibly. The Fed needs to ease before global growth falls even further.
Many analysts assume that ease is impossible when interest rates are already at zero. Still, the Fed has at least five policy tools it can use to ease monetary conditions. Janet Yellen referred to several of these tools during her press conference following the FOMC decision. Those references were significant. She did not actually announce easing measures, but the fact that she referred to them shows she is leaning that way. Why discuss easing if your plan is to tighten? Ease is in the air. Here are what I call the Fed’s “five arrows” of monetary ease:
The Fed could start the easing path by reintroducing forward guidance. This is a process of assuring markets that the Fed will be “patient” about raising rates or saying that rates will not increase for an “extended period.” These tactics were used from 2010 to early 2015, and could be used again.
The next Fed easing technique is asset purchases, so-called quantitative easing or “QE.” The evidence on the effectiveness of earlier QE is weak, so this may be the least likely method, but it cannot be ruled out.
The third technique is negative interest rates. This has never been tried in the U.S. although it has been used in Switzerland and the Eurozone. It could be effective in encouraging banks to lend, and consumers to spend rather than watch deposits evaporate in front of their eyes.
However, there are technical problems with negative interest rates including the fact that it could destroy the money market industry. Money market funds need positive returns just to pay their overhead, and keep their doors open. The Fed will not move precipitously to negative rates despite Yellen’s passing mention on September 17. Still desperate times make for desperate measures, so like QE4, it cannot be ruled out.
Potentially the most powerful easing tool is helicopter money. The notion is that the Fed can always defeat deflation and increase nominal growth by printing money and throwing it out of helicopters for people to scoop up off the ground and spend. The idea is to disintermediate the banks and give printed money directly to the people.
In practice, the way this is done is through larger fiscal deficits. The Treasury issues bonds to cover the deficits, and the Fed prints money to buy the bonds. The difference between QE and helicopter money is that the money goes directly to beneficiaries of federal spending instead of to the banks. Of course, helicopter money requires the cooperation of the Congress and White House on fiscal policy. That seems like a long-shot given the polarized nature of politics today. Still, 2016 is an election year, and even Democrats and Republicans might like the idea of spending money for reelection, especially if the Fed has their backs. So, this option is a live one.
Finally the Fed could return to the currency wars, and try to engineer a cheap dollar. This was the policy used in 2010 and 2011 in the aftermath of the 2007-2009 recession and 2008 financial panic. This does nothing for global growth, but it could help U.S. growth in the short run. Since the U.S. is the world’s largest economy, stronger U.S. growth is certainly more desirable than a U.S. recession. A cheap dollar could also help emerging markets debtors with their dollar denominated debt burdens.
A cheaper dollar would have to be orchestrated with the cooperation of the Bank of Japan and the ECB (China is unlikely to join this round of cheapening the dollar because they badly need a cheap yuan.) A cheaper dollar would be done behind the scenes, and not announced publicly. Watch the USD/EUR cross rate for the tell.
In the short run, the Fed may continue to talk tough about rate increases this year. As a result, the bond rally has further to run. But beginning in 2016, the playbook may move to easing. That will be bullish for gold, oil, and other hard assets. How do I know? Because Janet Yellen just told us all on September 17.