The Federal Reserve has dominated the business news cycle in recent months as President Donald Trump engages in a battle over monetary policy with Jerome Powell, the man he nominated to helm the central bank. But as the president laments on Powell’s performance thus far, a former Fed head is providing her opinion on the economy – and it isn’t good.
Former Fed Chair Janet Yellen is sounding the alarm about a possible financial crisis on the horizon because of “gigantic holes in the system.” But she didn’t always believe that. So, let’s say that Yellen has a short memory when it comes to her prognostications about whether an economic collapse is nigh or not. [perfectpullquote align=”right” bordertop=”false” cite=”” link=”” color=”” class=”” size=”24″]…a trend that could send the economy spiraling out of control.[/perfectpullquote]
Yellen About the Economy
Yellen sat down for a discussion at a CUNY event, moderated by Keynesian darling Paul Krugman. She told the New York audience that she thinks another disaster could unfold, blaming the possible scenario on deregulation and banking regulators seeing their authority to address panics dissipate.
She cited leveraged loans as a trend that could send the economy spiraling out of control. This is a type of loan given to individuals or companies that already maintain vast sums of debt or have poor credit. Yellen echoed the sentiments of the current Fed leadership and other analysts, all of whom note that this is a $9 trillion debt bomb about to explode.
“I think things have improved, but then I think there are gigantic holes in the system. The tools that are available to deal with emerging problems are not great in the United States.
I’m not sure we’re working on those things in the way we should, and then there remain holes, and then there’s regulatory pushback. So I do worry that we could have another financial crisis.”
The Brookings Institution scholar pointed out that interest rates are low, and “they’re likely to remain lower than they’ve been in past decades.”
She added that the Eccles Building “probably could have done more” quantitative easing in the years following the recession, but the Fed refrained from doing so because of public pushback.
In the end, Yellen finds President Trump undermining institutions that have been integral to the U.S. and the rest of the globe “worrisome.” The president did not nominate Yellen to a second term because, according to several reports, he found her to be too short.
Dissection
So, there is a lot to unpack with her comments.
First, it’s interesting that she now thinks another calamity is imminent. Speaking at The British Academy President’s Lecture in London in June 2017, Yellen said she did not expect an economic catastrophe in “our lifetimes.”
“Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.”
Second, leveraged loans are a severe threat to the economy, especially with interest rates gradually inching higher. But how did these corporations become so indebted? It was the central bank slashing rates to historic lows, facilitating businesses taking on enormous sums of debt. Some of the biggest companies in the U.S. today, from General Electric to Uber to Netflix, are deep in the red because of their frightening borrowing habits.
It’s analogous to a fourth-grade classroom that is jumping around like a bunch of monkeys because they imbibed several bottles of Pepsi and ate boxes of chocolate bars. Who are you going to blame, the kids for acting like wild animals or the school that gave them junk food?
Third, quantitative easing – the creation of new money that is then pumped into the system – might have provided short-term stimulus, but there will be long-term ramifications. Remember, you can’t add trillions of dollars to the economy without some consequences. The primary outcome is inflation, which has been tame over the years, though we’re beginning to witness rising price inflation. Other effects are bubble formations, market manipulations, and overleveraged investors.
The Fed is unwinding the $4.5 trillion balance sheet, moderating money-supply growth, and pulling the trigger on rate hikes. As a result, the New York Stock Exchange is routinely posting triple-digit losses; the bull market of yesterday cannot be sustained by the efforts of today.
Former Dallas Fed President Richard Fisher had it right when he stated that “people are hooked on the heroin of quantitative easing.”
Lastly, Trump’s relationship with the Fed is complicated, but it’s only “worrisome” to statists because of how influential the institution is. Since its foundation more than a century ago, the central bank has just gotten more powerful. With this supremacy, the Fed creates the booms and the busts and leaves every trader hanging on each word.
Quit Yellen
When the real estate billionaire mogul was a candidate, Trump was the only person from either party to challenge the entity. His criticisms were justified, like when he said that it’s a political tool aimed at helping the White House or that artificially low rates hurt the average American. At times, he sounded like an Austrian theorist; today he channels the spirit of John Maynard Keynes.
Since working out of the Oval Office, his language has been a bit different, encouraging his man to suppress rates. Unlike his predecessors who were clandestine with the Fed, at least Trump is open and honest about what he wants it to do.
Maybe Trump pulling back the curtain is what’s troubling Yellen.
It was clear from the beginning that Trump’s nominee was the wrong person for the job. However, unless the individual is advocating for auditing, reforming, or abolishing the central bank, there isn’t anyone right for the position. Yellen or Powell, it doesn’t matter who heads the ship. The Eccles Building will still be the headquarters for handing out pixie sticks and lollipops to financial markets.
Fed critics say that it was established by bureaucrats and banking interests. But legendary economist Murray Rothbard added one more: academics hired to lend credence to their schemes.
