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March
02
2019

The Danger Lurking In The Fed's Monetary Policy
James Grant

William McChesney Martin, top left, the Fed’s boss in the ‘Fifties and ‘Sixties, probably wouldn’t have liked the policies of the central bank’s current chairman, Jerome Powell, bottom right. 

Last Monday, the Federal Reserve embarked on a yearlong listening tour to discover the concerns of the American people. The whole shebang of modern monetary methods - manipulated interest rates, levitated asset values, the supposed necessity of a 2% inflation rate - is on the table for constructive criticism.

But you know how it is with constructive criticism. The friend who asks to hear it really doesn’t want any. So it is with Richard H. Clarida, the Columbia University economist turned vice chairman of the Federal Reserve Board.

In a Feb. 22 speech, Clarida invited the public’s comments as the central bank undertakes a top-to-bottom reappraisal of the way it does business. Then he said this: “The fact that the system is conducting this review does not suggest that we are dissatisfied with the existing policy framework.” A comprehensive description of that framework duly followed. So admirably clear was his message that it might have curled your hair.

It might, indeed, except for 10 years’ familiarity with once-heretical ideas. “Quantitative easing” seemed wild-eyed enough at the time it was hatched in 2008. Who objects now?

Clarida acknowledged no doubts. He said that radical monetary policy has worked, that it will continue to work, and that it may well become more radical. He contended that low interest rates are here to stay and that new policy “tools” must be sharpened and kept at the ready. As to potential adverse consequences of administered rates and the mind-control games meant to “anchor” our collective expectations of the future, he mentioned none.

The Mike Pence of the Fed, Clarida was pushing no novel agenda of his own. His interest-rate worldview is the institutional one. It springs from the contention that the natural level of rates since the financial crisis has naturally and irresistibly fallen.

Certainly, rates are astoundingly low - Bank of America Merrill Lynch recently was able to count $11 trillion of bonds worldwide quoted at yields of less than zero. Clarida said that the decline in the so-called neutral rate of interest “is widely expected to persist for years.”

Just who has made bold to forecast the course of this conceptual rate of interest (you can’t see it and you can’t trade it), Clarida didn’t say. But he did warn of the consequences of its collision with the so-called zero bound.

At zero percent, he said, the Fed would be hard-pressed to ensure that the inflation rate stays put in the neighborhood of 2%. That you can’t have no inflation, the vice chairman takes as a revealed truth.

Creditors, and any who lived through the Great Inflation of the late 1960s through the early 1980s, might disagree. They might prefer an inflation rate of nil.

William McChesney Martin, the longest-serving Fed chairman, said in August 1955, “We can never recapture the purchasing power of the dollar that has been lost.” Martin, who, in the Great Depression, witnessed an actual, virulent deflation, was nonetheless adamant that defending the integrity of the currency was job No. 1.

Whether the policies of the current Fed, led by Jerome Powell, are well or poorly advised is, to a degree, a matter of opinion. But the value proposition confronting today’s bondholders is a question of fact. At a 2% rate of inflation, the real, after-tax return on a 2.68%-yielding 10-year Treasury note is hardly enough for the tip jar.

Nor are the monetary-policy options now under discussion calculated to improve the lender’s odds. Batting around big ideas, the policy makers are weighing the advisability of seeking to deliver a 2%-plus rate of inflation over the course of the business cycle. Shortfalls from the target in recession would be neutralized by overshoots during the subsequent expansion. “Persistent inflation shortfalls carry the risk that longer-term inflation expectations become poorly anchored or become anchored below the stated inflation goal,” Clarida tried to explain.

Yet the term “persistent inflation shortfalls” from that 2% target exactly describes the postcrisis record of Fed policy making. Still not doubting their ability to control events, the mandarins keep searching for a bigger bag of tricks.

Clarida broached the idea of establishing a “temporary ceiling for Treasury yields at longer maturities by standing ready to purchase them at a preannounced floor price.” It was, in fact, how the Fed operated during World War II. Listening to the economist talk about emergency measures, it’s easy to forget that the nation is no longer fighting a two-ocean war.

This column would opine that artificially low interest rates never fail to store up trouble - facilitating leverage, they promote not growth, but larger balance sheets. It would opine, further, that the central bank is playing with fire by actively seeking to depreciate the dollar, a currency that, whatever its current lofty status in the world, is a piece of paper of no defined value. And it is our opinion thatthe Federal Reserve should at least consider the appealing course of letting the market alone.

As for the absence of anything resembling a margin of safety in vast portions of today’s fixed-income markets, it’s no opinion, but a most worrisome fact.

James Grant was born in 1946, the year interest rates put in their mid-20th century lows. He founded Grant’s Interest Rate Observer, a twice-monthly journal of the financial markets, in 1983, two years after interest rates recorded their modern-day highs.

Born in New York City and raised on Long Island, he had thoughts, first, of a career in music, not interest rates—french horn was his love. But he threw it over to enter the Navy. Following enlisted service aboard the U.S.S. Hornet, and, as a newly minted, 20-year-old civilian, on the bond desk of McDonnell & Co., he enrolled at Indiana University. There he studied economics under Scott Gordon and Elmus Wicker and diplomatic history under Robert H. Ferrell. He graduated, Phi Beta Kappa, with a Bachelor of Arts degree in economics in 1970. Next came two happily unstructured years at Columbia University that produced a master’s degree in something called international affairs but, more importantly, the privilege of studying under the cultural historian, critic and public intellectual Jacques Barzun.

In 1972, at the age of 26, Grant landed his first real job, as a cub reporter at the Baltimore Sun. There he met his future wife, Patricia Kavanagh, and discovered a calling in financial journalism. It seemed that nobody else wanted to work in business news. Grant served an apprenticeship under the longsuffering financial editor, Jesse Glasgow. He moved to Barron’s in 1975.

The late 1970s were years of inflation, monetary disorder and upheaval in the interest-rate markets—in short, of journalistic opportunity. It happened that the job of covering bonds, the Federal Reserve and related topics was vacant. In the mainly placid years of the 1950s and 1960s, those subjects had seemed too dull to care about. But now they were supremely important—even interesting—and the editor of Barron’s, Robert M. Bleiberg, tapped Grant to originate a column devoted to interest rates. This weekly department, called “Current Yield,” he wrote until the time he left to found the eponymous Interest Rate Observer in the summer of 1983.

Grant’s books include three financial histories, a pair of collections of Grant’s articles and three biographies.  The titles are these: “Money of the Mind” (Farrar, Straus & Giroux, 1992), “The Trouble with Prosperity” (Times Books, 1996) “Minding Mr. Market” (Farrar, Straus & Giroux, 1993), “Mr. Market Miscalculates” (Axios Press, 2008) and “The Forgotten Depression, 1921: the Crash that Cured Itself” (Simon & Schuster, 2014), which won the 2015 Hayek Prize of the Manhattan Institute for Policy Research.

Also, “Bernard M. Baruch: The Adventures of a Wall Street Legend” (Simon & Schuster, 1983), “John Adams: Party of One” (Farrar, Straus & Giroux, 2005) and Mr. Speaker! The Life and Times of Thomas B. Reed, the Man Who Broke the Filibuster” (Simon & Schuster, 2011).  
 
Grant’s television appearances include “60 Minutes,” “The Charlie Rose Show,” Deirdre Bolton’s “Money Moves” program on Bloomberg TV and a 10-year stint on "Wall Street Week". His journalism has appeared in a variety of periodicals, including the Financial Times, The Wall Street Journal and Foreign Affairs, and he contributed an essay to the Sixth Edition of Graham and Dodd's “Security Analysis” (McGraw-Hill, 2009).

Grant is a 2013 inductee into the Fixed Income Analysts Society Hall of Fame. He is a member of the Council on Foreign Relations and a trustee of the New-York Historical Society.

He and his wife live in Brooklyn. They are the parents of four grown children.

 

 www.grantspub.com