Those of us who follow economic news as well as politics were treated to a view of two sides of this country. Turn on a news channel and there is Donald Trump, burly, blonde, braggadocious, belligerent, rude to hostile questioners, promising things he cannot deliver, but doing so in clear, easily understood terms – build a wall, raise tariffs, torture our enemies. Turn to a financial channel and there is Federal Reserve Board chair Janet Yellen, petite, white haired, modest in demeanor, calm, polite to a newly skeptical press, seeming to promise the economic effects that central bankers can no longer deliver, but unlike the plain-speaking Trump, in opaque Fedspeak that leaves even skilled translators scratching their heads.
I leave an explanation of the political wannabee to my betters in the political columns, and try here to explain what Yellen is doing, believes she is going to do, and the condition of the American economy as the nation prepares for what is shaping up to be a battle for control of the executive branch of our government between Hillary Clinton, representing an increasingly left-leaning Democratic Party, and Donald Trump, representing an inchoate-if-not-incoherent set of economic policies he would institute given the opportunity.
Start with the facts, which would seem to point to a growing economy capable of withstanding the four interest-rate increases Yellen suggested in December 2015 was on the Fed's 2016 agenda. In the past six months the economy has added jobs at a monthly rate of 235,000, bringing the headline unemployment rate down to 4.9 percent, just about the Fed's target. The labor force participation rate has increased by 0.5 percentage rates from its September low, leaving few couch potatoes available to enter what Goldman Sachs calls "a very hot labor market." The Fed's preferred inflation indicator is running at an annual rate of around 1.7 percent, close to the Bank's target of 2 percent and the fastest rate in three years. Share prices have regained all the ground lost this year and then some, and the wild volatility of a few months ago has become a boring, slow increase, with occasional hiccups. U.S. households entered this year with the equity in their homes at the highest level in a decade, reflecting a rise in house prices and continued low interest rates. In 2009 over 12 million homes were "underwater" – no, not due to climate change, but to the fact that outstanding mortgage debt exceeded the value of the homes. That number has shrunk to 4.4 million. Despite this good news, the Fed announced last week that it would raise rates this year only twice, rather than four times, and then only maybe.
Here's why. As the Fed's monetary policy gurus see it, the labor market had not yet shown sufficient strength to drive wages higher; inflation is not yet at its 2 percent target; business investment remains low; net exports have been "soft"; retail sales fell in the first two months of this year; and "global economic and financial developments continue to pose risks." The main worries on the latter score are three:
China's banking system might collapse under the weight of unrecoverable loans made to insolvent state-owned enterprises (SOEs) in order to prevent lay-offs. The regime's decision to force banks to accept newly issued shares of SOEs, the dinosaurs of the industrial world, in lieu of cash repayment of loans merely lumbers the banks with still more "assets" of questionable value.
In order to stem capital flight that totaled $1 trillion last year, a rate some experts believe it cannot sustain beyond this year, the regime might be forced to engineer a sudden and severe (at least 15 percent according to Anne Stevenson-Yang and Kevin Dougherty, of J Capital Research Ltd. and KDF Asset Management, respectively) devaluation of its currency, rattling financial markets, driving investors to the relative safety of the dollar, driving it up with predictably unpleasant consequences for exporters.
The European Central Bank, the Bank of Japan and other central banks that account for about 25 percent of world GDP will drive interest rates even deeper into negative territory, causing a flight to the dollar that drives the greenback up and exports down.
Yellen has always denied that recoveries such as we are experiencing, now 6 and half years old, die of old age. The Federal Reserve Bank of San Francisco's research team agrees. Recoveries, write its research team, like Peter Pan "appear to never grow old". They are, say many economists most often murdered by a Fed too eager to raise interest rates for fear of allowing the economy to over-heat and inflation to replace recession as the enemy of prosperity. Yellen is making no such mistake. She saw before her the dagger being proffered by the critics of her too-loose monetary policy, but refused to grasp it and slaughter the recovery, for two reasons. First, central bankers have learned in recent years that it is very difficult for monetary policy, even one that includes negative interest rates, to accelerate the pace at which a recovering economy is moving forward. Such stimulus depends on central bankers' ability to drive down the value of their currencies by lowering interest rates, a transmission mechanism that no longer seems to work well, if at all. Far easier to nip incipient inflation in the bud by raising interest rates, which are believed to continue to have the power to take inflation off the boil. So better to risk inflation than another recession or, worse still, the sort of deflation that has afflicted Japan for decades and seems immune to the nostrums of prime minister Shinzō Abe and his compliant, money-pumping, central bankers.
Most important, Yellen has left herself enormous flexibility. There will be two modest increases in interest rates this year – unless there won't. "Policy is not on a pre-set course," projections are not "a commitment", she told the press, advising that considerable uncertainty attaches to the forecast of each of her colleagues. If the economy shows any significant sign of slowing, which it might if the recent softening in auto sales continues; or if the banks run into more trouble because the billions they are rushing to set aside to cover losses from loans to energy companies prove inadequate, and the delinquency rate among subprime car loans continues to increase; or if the international situation worsens, Yellen & Co. will again stay their hands. Yellen has no intention of confronting the incoming president and the new congress in 2017 charged with the murder of the current recovery. She can plead that she did not push interest rates up too much, or too soon, or too rapidly and, equally important, she can call as her witness the pre-eminent financial paper of record, The Wall Street Journal, which reported concerns that "the world's central banks … are losing the ability to wield control over financial markets". Yellen might add, "Since I have been disarmed of any recovery-killing weapon, you politicians who have run up huge debts and unsustainable entitlement programs should begin your search for the murderer with a look in the mirror."