Bloomberg Pleads With Trump: ‘Give Yellen Another Term’

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Via Bloomberg’s Editorial Board

President Donald Trump is weighing one of his most consequential appointments: Who should lead the Federal Reserve after current chair Janet Yellen’s term ends in February? The choice comes down to whether the president wants broad continuity in the way the Fed does its job — or a big change, and the accompanying uncertainty.

The U.S. economy has done well since the crash. The gradual recovery continues, the economy is back at full employment, and inflation is low. None of this could have been taken for granted in 2008, and the Fed deserves much of the credit. The case for continuity at the central bank is strong — and the best continuity candidate is Yellen. Trump should appoint her for another term.

To be sure, the Fed’s decisions haven’t been beyond question. There’s a debate to be had about the best path for short-term interest rates and the Fed’s protracted reliance on its unorthodox program of bond-buying, or quantitative easing. Even now, these issues are far from resolved. Nonetheless the central bank delivered strong economic stimulus when it was needed, and for much of the time had to shoulder that burden alone, because U.S. fiscal policy was poorly managed.

Yellen and her predecessor Ben Bernanke built broad consensus within the Fed in support of radical measures, and that consensus helped restore calm and confidence in financial markets and the wider economy. It would be rash to cast these gains aside.

Yellen isn’t the only candidate capable of providing continuity. Jerome Powell, a current Fed governor and former Treasury official, has been a close ally on monetary policy and would cause no anxiety on that account. (He’s tended to take a softer line on financial regulation.) But two other candidates reportedly in contention — John Taylor of Stanford University and Kevin Warsh, a former Fed governor and Morgan Stanley executive — are long-time critics of the Fed’s thinking on monetary policy.

Taylor advocates a more rule-based approach to setting interest rates. (Under the eponymous “Taylor rule,” the U.S. would have significantly higher interest rates right now.) Warsh rebukes the Fed for trying to do too much, arguing that it should stick to controlling inflation and leave other branches of government to do their part.

Both these arguments deserve a hearing when the Fed is judging policy. Monetary policy isn’t hard science, and in the end dissenters from the current approach might be proved right. But there’s a big risk in appointing a Fed chairman whose views are so far out of line with the prevailing consensus. Investors will ask how this disagreement will be resolved — and how abruptly, if at all, might policy change as a result.

At the moment, an abrupt change in policy isn’t called for. Faster progress on normalizing interest rates and reducing the Fed’s distended balance sheet would be good, but that is not to call for a fundamental rethink. An appointment raising the possibility of such a change would be a needless risk. The best and safest choice is Yellen.

risk involves the composition of the Federal Reserve Board of Governors. Janet Yellen’s term as chair of the Federal Reserve Board expires next February 3rd. In addition to the chair, there will be a number of opportunities for President Trump to appoint new Federal Reserve Board Governors relatively soon, including two current vacancies. One could envision a possible doomsday scenario for the financial markets and then likely the economy arising from very unfortunate choices by President Trump regarding appointments to the Federal Reserve Board. Logically, that should not happen. However, everything that has happened in the past year may not have followed logic.

Logically, a low interest rate policy would improve the already long odds against Trump’s budget assumptions of 3% real growth. Low interest rates would also help the trade deficit. However, President Trump may not be able to resist the temptation to reward some of his early supporters by appointing monetary “hawks” to the Federal Reserve Board who would raise interest rates precipitously. Since most mainstream Republican economists were originally in the “Never Trump” camp during the primaries, some monetary crackpots were able to have their populist views heard in the Trump campaign and administration.
The closing Trump advertisement in the election railed against a supposed cabal of international elite financial figures who were claimed to be causing America’s decline. It pictured financier George Soros, Federal Reserve Chair Janet Yellen, and Goldman Sachs (NYSE:GS) CEO Lloyd Blankfein as the prime villains. Trump’s inaugural address also reiterated the populist theme that the day of revenge against financial elites has arrived. Presumably, those in the Trump campaign who prepared the anti-Janet Yellen advertisements and more importantly, those at who the advertising was targeted and voted based on those advertisements, would be disappointed to see Federal Reserve Chair Janet Yellen reappointed by President Trump.

Of course, not all monetary hawks are crackpots or populists. Since at least 2010 there have been many thoughtful and intelligent “adults” predicting and/or advocating for higher interest rates. Those adults calling for higher interest rates employed reasonable arguments based on sound economic theory. However, they were completely wrong, certainly with regard to their forecasts and arguably with regard to their policy proscriptions. There were also others calling for higher interest rates using arguments that displayed profound ignorance of facts and economics.

The more ignorant of the monetary populists and gold bugs claimed that the Federal Reserve was engineering an imminent collapse of the dollar and massive inflation. Some argued that higher interest rates would promote increased real investment, which is contrary to all macroeconomic principles. Some, idiotically claimed that the Federal Reserve was an enabler of the federal deficits, since absent the Federal Reserve’s low interest-rate policy the US would be forced to cut spending.

There has always been a populist anti-banker, anti-central banking factions in American history. President Andrew Jackson ran against and abolished the Second Bank of The United States. This caused the Panic of 1837 which was arguably worse than the depression of the 1930s. However, the panic of 1837 is much less remembered since in 1837 most American people lived on farms and ate the food they grew or the animals they hunted and sewed their own clothes. Thus, the financial collapse did not necessarily cause widespread deprivation as did the unemployment of the1930s. Also, in 1837 someone who lost everything could literally start walking west and start a new homestead on the frontier.

Some of those with modern a populist anti-banker, anti-central banking views filled some of the vacuum left in the Trump campaign by the absence of most mainstream Republican economists in the Trump camp. There is a much more respected school of thought which thinks that the Federal Reserve has too much power and/or operates with too much discretion. They favor a rules-based monetary policy. These may actually now be the most dangerous to fixed-income investors.

There is some overlap between those advocate that the Federal Reserve follow a rules-based policy and the “audit the Federal Reserve” camp. Trump might appoint to the Federal Reserve Board well respected individuals with very good academic credentials who would force the Federal Reserve Board into adopting a rules-based policy. This could be seen favorably by Trump’s populist base as reigning in the Federal Reserve and by some of Trump’s business supporters who have wanted higher interest rates for years.
Rules-based monetary policies are certainly not only the purview of cranks. Nobel Prize winner Milton Friedman and Anna Schwartz wrote: A Monetary History of the United States, 1867-1960, Which indicated that the money supply was the critical factor in determining economic activity and inflation. During the period of high inflation in the late 1070s and early 1980s Milton Friedman said that there should be a rule or a law that required the money supply grow at 3% per year. He even said the Federal Reserve could be replaced by a computer that insured that money supply grew at 3% per year. For the 1867-1960 period that Milton Friedman and Anna Schwartz examined the supply of money was probably a much more significant factor, as the United States was first on a specie money system, then on a fiat money system. Specie is gold and silver coins. Fiat money is paper currency and demand deposits.

However, very few would advocate a rule mandating a 3% money growth rate policy now. Essential to Milton Friedman’s argument was that the velocity of money, the ratio to the change in GDP to the change in the money supply was constant or at least stable. However, we are no longer on a fiat money system, but rather a credit money system and velocity is definitely neither constant or stable. As I said in Federal Reserve Actually Propping Up Interest Rates: What This Means For mREITs http://seekingalpha.com/article/1514632

.. Money is what can be used to buy things. Historically money has first been specie (gold and silver coins), then fiat money which is paper currency and checking accounts (M1) and more recently credit money. The credit money supply is what in aggregate can be bought on credit. Two hundred years ago your ability to take your friends out to dinner depended on whether or not you had enough coins (specie) in your pocket. One hundred years ago it depended on the quantity of currency in your pocket and possibly the balance in your checking account if the restaurant would take checks.

Today it is mostly your credit card that allows you to spend. We no longer have a fiat money system. Today we have a credit money system. Just because there is still some fiat money does not negate the fact that we are on a credit money system. When we were on a basically fiat money system there was still a small amount of specie in circulation. Even today a five cent piece contains about 5 cents worth of metal, but no one would claim we are still on a specie money system.

Fiat money is easy to measure; M1 was $1.376 trillion in 2007 and is above $3 trillion now. The effective money supply is the sum of fiat money and credit money. Credit money cannot be precisely measured. However, when the person in California whose occupation was strawberry picker and who had made $14,000 in his best year was able to get a mortgage of $740,000 with no money down and private equity could buy a company like Clear Channel in a $20 billion leveraged buyout, also with essentially no money down, the credit money supply was clearly much higher than today. A reasonable ballpark estimate of the credit money supply is that it was $70 trillion in 2007 compared to $50 trillion today.
The effective money supply is the sum of the traditional fiat money aggregates plus the credit money supply. Thus, despite the claims of many to the contrary, the effective or true money supply has fallen drastically over the last few years…. http://seekingalpha.com/article/1514632

Today the most well know rules-based monetary policy proposal is the Taylor rule. Many well respected economists advocate the Taylor rule or some similar rule that would instruct the Federal Reserve to set the target for short-term interest rates based on a formula. The Taylor rule sets the target Federal Funds rate based on a formula which uses: the neutral interest rate, the expected GDP growth rate, the long-term GDP growth rate, expected inflation rate; and the target inflation rate. The Taylor rule does not always result in a high Federal Funds rate. During the recession the Taylor rule would have required significantly negative interest rates. That and the fact that at any given time the can be wide disagreement as to the value of the Taylor rule inputs, is not the main cause for concern regarding possible adoption of rules-based monetary policy now.
The problem is that now the Taylor rule would suggest a target Federal Funds rate of between 2.7% and 4.0% depending on whose values of the inputs are used. Higher interest rates would seem contrary to most of President Trump’s objectives regarding economic growth and trade deficit reduction. However, that does not guarantee he would not act contrary to his longer run objectives. Many are bewildered by actions of Donald Trump that appear to be contrary to his objectives.

If President Trump had the objective of making the investigation of Russian interference in the election go away, or at least have the investigation become less thorough and intense, firing FBI director Comey, would seem a very short-sighted and counter-productive action. As we now know, firing Comey, and then saying on national television that his reason was the Russia investigation, led to the appointment of Special Counsel Mueller, which by all accounts will make the investigation more thorough and intense. Additionally, firing Comey led to possible charges of obstruction of justice. President Trump’s assertion that he will deny Comey’s account under oath may have temporarily boosted his standing with his base, but could lead to perjury charges. Now President Trump is in the position where he can avoid a perjury charge by claiming in a deposition that he does not remember what transpired after he cleared the room to talk to Comey. However, such an assertion would change the obstruction of justice issue from one person’s word against another, to one person who said under oath that he can’t recall what transpired, against the word of an FBI director he took extensive contemporaneous notes and informed others of the contents of those notes at the time.

Taking actions which may generate short-term gratification especially in terms of appearing to address a problem, but make the problem eventually much worse is behavior well known in various occupations. Professional bond traders and portfolio managers have various terms and analogies that refer to such situations. At times when a “problem bond” has been held too long in a portfolio, a trader or portfolio manager will execute trades that swap that bond for another “problem bond”. This gets the bond off the books, but may only delay the negative consequences or even make them worse. Bond professionals use the analogy of swapping “dead cows for dead horses”. Another analogy used when the trades actually make the problem eventually worse is that of being very cold under the covers and in bed and urgently have to go to the bathroom. Your problem is that if you get out of bed you will be even colder. Urinating in the bed will relieve your immediate problems, but make your situation worse. I cannot resist mentioning the possible relevance of that situation to President Trump’s behavior on more than one level.

Installing advocates of rules-based monetary policy as the chair and members of the Federal Reserve Board could generate short-term gratification as President Trump could be seen by some as fulfilling a promise to his base and early supporters. However, a policy that required much higher interest rates could possibly be disastrous, both for the mREITs and most likely the country.
https://seekingalpha.com/article/4082278

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One thought on “Bloomberg Pleads With Trump: ‘Give Yellen Another Term’”

Lance Brofman

October 22, 2017 at 1:02 pms Reply

risk involves the composition of the Federal Reserve Board of Governors. Janet Yellen’s term as chair of the Federal Reserve Board expires next February 3rd. In addition to the chair, there will be a number of opportunities for President Trump to appoint new Federal Reserve Board Governors relatively soon, including two current vacancies. One could envision a possible doomsday scenario for the financial markets and then likely the economy arising from very unfortunate choices by President Trump regarding appointments to the Federal Reserve Board. Logically, that should not happen. However, everything that has happened in the past year may not have followed logic.

Logically, a low interest rate policy would improve the already long odds against Trump’s budget assumptions of 3% real growth. Low interest rates would also help the trade deficit. However, President Trump may not be able to resist the temptation to reward some of his early supporters by appointing monetary “hawks” to the Federal Reserve Board who would raise interest rates precipitously. Since most mainstream Republican economists were originally in the “Never Trump” camp during the primaries, some monetary crackpots were able to have their populist views heard in the Trump campaign and administration.
The closing Trump advertisement in the election railed against a supposed cabal of international elite financial figures who were claimed to be causing America’s decline. It pictured financier George Soros, Federal Reserve Chair Janet Yellen, and Goldman Sachs (NYSE:GS) CEO Lloyd Blankfein as the prime villains. Trump’s inaugural address also reiterated the populist theme that the day of revenge against financial elites has arrived. Presumably, those in the Trump campaign who prepared the anti-Janet Yellen advertisements and more importantly, those at who the advertising was targeted and voted based on those advertisements, would be disappointed to see Federal Reserve Chair Janet Yellen reappointed by President Trump.

Of course, not all monetary hawks are crackpots or populists. Since at least 2010 there have been many thoughtful and intelligent “adults” predicting and/or advocating for higher interest rates. Those adults calling for higher interest rates employed reasonable arguments based on sound economic theory. However, they were completely wrong, certainly with regard to their forecasts and arguably with regard to their policy proscriptions. There were also others calling for higher interest rates using arguments that displayed profound ignorance of facts and economics.

The more ignorant of the monetary populists and gold bugs claimed that the Federal Reserve was engineering an imminent collapse of the dollar and massive inflation. Some argued that higher interest rates would promote increased real investment, which is contrary to all macroeconomic principles. Some, idiotically claimed that the Federal Reserve was an enabler of the federal deficits, since absent the Federal Reserve’s low interest-rate policy the US would be forced to cut spending.

There has always been a populist anti-banker, anti-central banking factions in American history. President Andrew Jackson ran against and abolished the Second Bank of The United States. This caused the Panic of 1837 which was arguably worse than the depression of the 1930s. However, the panic of 1837 is much less remembered since in 1837 most American people lived on farms and ate the food they grew or the animals they hunted and sewed their own clothes. Thus, the financial collapse did not necessarily cause widespread deprivation as did the unemployment of the1930s. Also, in 1837 someone who lost everything could literally start walking west and start a new homestead on the frontier.

Some of those with modern a populist anti-banker, anti-central banking views filled some of the vacuum left in the Trump campaign by the absence of most mainstream Republican economists in the Trump camp. There is a much more respected school of thought which thinks that the Federal Reserve has too much power and/or operates with too much discretion. They favor a rules-based monetary policy. These may actually now be the most dangerous to fixed-income investors.

There is some overlap between those advocate that the Federal Reserve follow a rules-based policy and the “audit the Federal Reserve” camp. Trump might appoint to the Federal Reserve Board well respected individuals with very good academic credentials who would force the Federal Reserve Board into adopting a rules-based policy. This could be seen favorably by Trump’s populist base as reigning in the Federal Reserve and by some of Trump’s business supporters who have wanted higher interest rates for years.
Rules-based monetary policies are certainly not only the purview of cranks. Nobel Prize winner Milton Friedman and Anna Schwartz wrote: A Monetary History of the United States, 1867-1960, Which indicated that the money supply was the critical factor in determining economic activity and inflation. During the period of high inflation in the late 1070s and early 1980s Milton Friedman said that there should be a rule or a law that required the money supply grow at 3% per year. He even said the Federal Reserve could be replaced by a computer that insured that money supply grew at 3% per year. For the 1867-1960 period that Milton Friedman and Anna Schwartz examined the supply of money was probably a much more significant factor, as the United States was first on a specie money system, then on a fiat money system. Specie is gold and silver coins. Fiat money is paper currency and demand deposits.

However, very few would advocate a rule mandating a 3% money growth rate policy now. Essential to Milton Friedman’s argument was that the velocity of money, the ratio to the change in GDP to the change in the money supply was constant or at least stable. However, we are no longer on a fiat money system, but rather a credit money system and velocity is definitely neither constant or stable. As I said in Federal Reserve Actually Propping Up Interest Rates: What This Means For mREITs http://seekingalpha.com/article/1514632

.. Money is what can be used to buy things. Historically money has first been specie (gold and silver coins), then fiat money which is paper currency and checking accounts (M1) and more recently credit money. The credit money supply is what in aggregate can be bought on credit. Two hundred years ago your ability to take your friends out to dinner depended on whether or not you had enough coins (specie) in your pocket. One hundred years ago it depended on the quantity of currency in your pocket and possibly the balance in your checking account if the restaurant would take checks.

Today it is mostly your credit card that allows you to spend. We no longer have a fiat money system. Today we have a credit money system. Just because there is still some fiat money does not negate the fact that we are on a credit money system. When we were on a basically fiat money system there was still a small amount of specie in circulation. Even today a five cent piece contains about 5 cents worth of metal, but no one would claim we are still on a specie money system.

Fiat money is easy to measure; M1 was $1.376 trillion in 2007 and is above $3 trillion now. The effective money supply is the sum of fiat money and credit money. Credit money cannot be precisely measured. However, when the person in California whose occupation was strawberry picker and who had made $14,000 in his best year was able to get a mortgage of $740,000 with no money down and private equity could buy a company like Clear Channel in a $20 billion leveraged buyout, also with essentially no money down, the credit money supply was clearly much higher than today. A reasonable ballpark estimate of the credit money supply is that it was $70 trillion in 2007 compared to $50 trillion today.
The effective money supply is the sum of the traditional fiat money aggregates plus the credit money supply. Thus, despite the claims of many to the contrary, the effective or true money supply has fallen drastically over the last few years…. http://seekingalpha.com/article/1514632

Today the most well know rules-based monetary policy proposal is the Taylor rule. Many well respected economists advocate the Taylor rule or some similar rule that would instruct the Federal Reserve to set the target for short-term interest rates based on a formula. The Taylor rule sets the target Federal Funds rate based on a formula which uses: the neutral interest rate, the expected GDP growth rate, the long-term GDP growth rate, expected inflation rate; and the target inflation rate. The Taylor rule does not always result in a high Federal Funds rate. During the recession the Taylor rule would have required significantly negative interest rates. That and the fact that at any given time the can be wide disagreement as to the value of the Taylor rule inputs, is not the main cause for concern regarding possible adoption of rules-based monetary policy now.
The problem is that now the Taylor rule would suggest a target Federal Funds rate of between 2.7% and 4.0% depending on whose values of the inputs are used. Higher interest rates would seem contrary to most of President Trump’s objectives regarding economic growth and trade deficit reduction. However, that does not guarantee he would not act contrary to his longer run objectives. Many are bewildered by actions of Donald Trump that appear to be contrary to his objectives.

If President Trump had the objective of making the investigation of Russian interference in the election go away, or at least have the investigation become less thorough and intense, firing FBI director Comey, would seem a very short-sighted and counter-productive action. As we now know, firing Comey, and then saying on national television that his reason was the Russia investigation, led to the appointment of Special Counsel Mueller, which by all accounts will make the investigation more thorough and intense. Additionally, firing Comey led to possible charges of obstruction of justice. President Trump’s assertion that he will deny Comey’s account under oath may have temporarily boosted his standing with his base, but could lead to perjury charges. Now President Trump is in the position where he can avoid a perjury charge by claiming in a deposition that he does not remember what transpired after he cleared the room to talk to Comey. However, such an assertion would change the obstruction of justice issue from one person’s word against another, to one person who said under oath that he can’t recall what transpired, against the word of an FBI director he took extensive contemporaneous notes and informed others of the contents of those notes at the time.

Taking actions which may generate short-term gratification especially in terms of appearing to address a problem, but make the problem eventually much worse is behavior well known in various occupations. Professional bond traders and portfolio managers have various terms and analogies that refer to such situations. At times when a “problem bond” has been held too long in a portfolio, a trader or portfolio manager will execute trades that swap that bond for another “problem bond”. This gets the bond off the books, but may only delay the negative consequences or even make them worse. Bond professionals use the analogy of swapping “dead cows for dead horses”. Another analogy used when the trades actually make the problem eventually worse is that of being very cold under the covers and in bed and urgently have to go to the bathroom. Your problem is that if you get out of bed you will be even colder. Urinating in the bed will relieve your immediate problems, but make your situation worse. I cannot resist mentioning the possible relevance of that situation to President Trump’s behavior on more than one level.

Installing advocates of rules-based monetary policy as the chair and members of the Federal Reserve Board could generate short-term gratification as President Trump could be seen by some as fulfilling a promise to his base and early supporters. However, a policy that required much higher interest rates could possibly be disastrous, both for the mREITs and most likely the country.
https://seekingalpha.com/article/4082278