Todd Bliman
Monetary Policy

An Open Letter to Janet Yellen

By, 10/11/2013
Ratings664.022727

Dear Ms. Yellen:

Congratulations on your nomination to lead the Fed! It’s my sincere hope you find the nomination process less excruciating than some other political appointees have in recent years (though I wouldn’t recommend betting on that). From what I can tell, your credentials seem totally in line with your predecessors, if not more robust. Superior educational credentials? Check. Fed board experience? Check. Well-regarded in the Economics community? Double check—one for you, one for your Nobel-laureate husband. It’s clear you’re very advanced in terms of economic thinking, but I’d like to call your attention to some basics your predecessor seemingly overlooked. Basics like prices’ signals in a capitalist economy—and what they might mean for growth and, hence, stocks.

You see, the Bernanke Fed’s policies boosted the output of complex acronyms to never-before-seen heights, but the same cannot be said of those policies’ impact on the economy. After all, the Bernanke Fed brought QE, the PPIP, TALF, TAF, TLSF, CCAR and DFA stress tests, CPFF, AMLF—deep breath—MMIFF, ZIRP and just recently FRFARRP. Most of these are implemented through the FRBNY (that’s the New York Fed’s moniker). Of course, you know all that—you were there! You probably also know loan and money supply growth (M2 growth) have been tepid at best. Puzzling! But the issue is all this complexity, this alphabet soup of monetary strategery, overlooks the fact interest rates are the price of money and if the price is too low, suppliers won’t bring it to market.

Consider the US’s shale oil boom for an example. Wouldn’t have happened without oil prices high enough to justify investing in wells. Over the last decade or so, prices have increased—which fundamentally changes the economics of more difficult oil drilling. Fact: Overall, it costs more to drill in deepwater or frack shale than to drill a very shallow well in Texas. Oil prices must be higher to justify the investment. The market cooperated, and the result is a massive surge in domestic oil production that, by some accounts, puts the US first in global energy production. In places like North Dakota—arguably the nexus of this shale boom—unemployment has run sub-4% for years. Nonfarm payroll employment since the recession has increased by 22%. The investment in infrastructure—both direct and indirect—is huge. But it never would’ve happened if oil prices were persistently low. High oil prices created jobs because the hiring firms aren’t charities. Profitable businesses tend to hire, not unprofitable ones.

Which brings me to quantitative easing. Interest rates are merely the price of money. What your predecessor overlooked in his zeal to keep that price low and stimulate borrowers is those borrowers have to get the money from somewhere. Look to oil: If you want to boost supply of something, increase profitability. But with each successive round of QE long-term bond buying, the price of long-term money fell. That’s key for banks who typically borrow short-term money and lend it long! Lower profits mean reduced supply. Ms. Yellen, this is why I believe loan growth in this expansion is the slowest of the last five—despite the fact lending is building off of an ultra-depressed 2009 base. Ending QE makes the price of long-term lending rise some—attractive to banks, who likely boost the supply of loans accordingly. Growth likely accelerates as a result—later spurring employment. The notion QE is a growth and job booster misses all this, instead relying on the bizarre notion the great and powerful Fed chair has his (or her!) hand on the national economic levers, pulling hard on the HIRE MORE and GROW FASTER levers from behind a curtain. But pull back the curtain and you find only a fallible human—and the levers just blow smoke.

QE is a humbug. But here’s the good news! You don’t need fancy, magical solutions. The problem you’re tasked with solving is basic and mechanical. The Fed is struggling with poor policy prescriptions tied to an inaccurate diagnosis of US economic issues, and this has weighed on economic growth. My suggestion: Do what coaches of struggling sports teams do—simplify. Go back to basics. Econ 101 might not win you a shiny new prize, but it’s likely to accelerate lending and growth.

So good luck to you, Ms. Yellen, as the nomination process continues and remember, lex parsimoniae! (In case Latin isn’t on your curriculum vitae, that’s Occam’s razor: Simpler is, often, better.)

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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