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Is Janet Yellen really a closet hawk?

My longstanding correspondent Ken Fisher, the West Coast money manager, has a typically contrarian take on how the new head of the Federal Reserve, Janet Yellen, should be regarded by the markets. In a column for the Financial Times, he says that, although an adherent of Ben Bernanke’s approach to monetary policy, she is in reality more of “a closet” hawk than a dove. This is essentially because while she supports QE, in practice that kind of monetary stimulus only forces down long term interest rates, inhibiting rather than encouraging banks from lending. She is also in favour of requiring banks to shore up their capital bases, which also inevitably tightens the flow of credit to the real economy and leads to slower than expected economic growth.

It is only since the Bank of England stopped its QE programme, Ken notes approvingly,and the new Governor Mark Carney has loosened the balance sheet restritions on banks, that economic growth in the UK has started to revive.

If Ms Yellen were a dove, she would follow Mr Carney: drop QE and give banks more leeway. The ivory tower intellectuals who love her pedigree do not understand this. They live in theory fairyland, not the real world. In theory, QE works – so they cannot explain the reality of slow growth. If they spent time in your world, they would know! They would know good business sense incentivises good balance sheet management and that onerous capital requirements are not necessary. They would know banks lend more if they can profit more. They would know small rate rises do not keep business owners from borrowing.

And he adds:

Academic purity does not spur growth. Theory is not reality. Cloistered academics like Ms Yellen do not fathom how businesses grow because they do not understand the real world. Does that mean she will keep up Mr Bernanke’s bad policies? Again, you cannot know this yet. Maybe she will get amnesia like every other Fed head and do things differently than pundits expect. Pray it is so! Either way, considering stocks have overcome years of bad Fed policy, they can keep rising even if Ms Yellen remains a hawk.

This kind of argument is certainly open to challenge, but the thrust of it is music to the ears of those of us who have grave doubts about the wisdom of extending QE from what was a (justifiable) emergency response to the global financial crisis into something approaching a permanent policy regime, despite the clear warnings of the risks that such an undisciplined and experimental policy carries with it, and the lack of evidence that it has been at all effective in stimulating growth (prompting some to recall Einstein’s definition of insanity: “doing the same thing over and over again and expecting different results”).

My personal hope remains that once we get to the New Year, we will in due course see a resumption of “taper talk” from the Fed. That may well send bond yields rising again, but it is absurd to think that bond yields of 3.5% or less will kill any recovery in its tracks. It is the availability, as much as the price, of credit that is slowing down the recovery, and we are unlikely to see businesses investing again until (a) they can see a decent prospect of earning a return on their capital and (b) it is in banks’ interest to start lending to them again. Neither is likely as long as an artificial QE-inspired regime persists – much as the equity markets, in their normal myopic way, may love it pro tem. I wish I were more confident however that Ms Yellen will in practice turn out to be a hawk in drag, as Ken seems to be suggesting.

Written by Jonathan Davis

November 4, 2013 at 4:11 PM