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OpEdNews Op Eds    H2'ed 7/20/17

Janet Yellen, facing Ben Bernanke's boomerang

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Message Jean-Luc Basle

A lot has been written about quantitative easing -- a policy initiated by the Federal Reserve Bank in answer to the subprime crises. It is nothing more than an extremely lax monetary policy. The time has come to make an assessment.

The verdict is mixed, as of today, but worrisome if one looks to the future. In triggering this policy in November 2008, Ben Bernanke, then Governor of the Federal Reserve Bank, tossed a boomerang to his successor, Janet Yellen.

Quantitative easing did not meet expectations. It's not for lack of trying. In the three months following the subprime crisis, the Federal Reserve lowered its target rates from 2% to 0.125%. Meanwhile, Congress approved a series of high budget deficits. Yet, the American economy didn't react as planned. The annual growth rate averages 1.3% against 3.1% for the two preceding recoveries. It took seven years for employment to return to its pre-crisis level against four years for the previous cycle and two and a half years for the one before. Same scenario for inflation. It was at 3.8% in 2008 and fell below zero in 2009. It rebounded to 1.3% in 2016 and rose to 1.6% in June 2017, nearly nine years after the crisis -- a figure which remains below the Federal Reserve's 2% objective.

Why didn't quantitative easing live up to expectations? Because it rests on a postulate, because its main objective was to rescue the banks, because banks did not play along, and finally because consumers chose to pay down their debts.

In 2002, in a speech which later became famous, Ben Bernanke, the future governor of the Federal Reserve, stated that an inordinate increase of the money supply would crush any deflation. He was referring to Milton Friedman's allegory. The economist once suggested that a government faced with an intractable recession should drop $1,000 bills from a helicopter to restart the economy. In a manner, this is what Bernanke did the day after Lehman Bros. went bankrupt -- the point of departure of the subprime crisis. Fearing a crisis of magnitude, he bought $1,400 billion of banks' financial assets within three months, from September 17 th to December 17 th , 2008, tripling the size of the central bank -- an unprecedented move in the history of finance! This manna whose first goal was to strengthen the banks' balance sheets, was also meant to trigger consumption. But, the banks decided to deposit the cash received from the sale of their financial assets on their account at the Federal Reserve instead of lending it, in effect "sterilizing" Ben Bernanke's money flow. As for the gullible consumer who had believed the bankers' lies on real estate prices going up to the sky, he chose to reduce its indebtedness. Quantitative easing failed because it addressed the symptoms rather than the root causes of the crisis.

On the other hand, it produced exceptional results on financial markets. The S&P which had risen to 1,192 on September 15th , 2008 -- the day Lehman Bros. went bankrupt -- lost nearly half its value in the following six months, reaching its lowest point on March 9th , 2009, at 672. The quantitative easing's first tranche brought it back to its September 2008 level in April 2010. It then rose regularly thanks to the following two tranches. It reached 2,440 in July 2017 -- double its pre-crisis level. There is something worrisome about this level. It is in no way justified by the American economy's performance. Its growth rate should fall from 2.1% in 2018 to 1.9% in 2019 and 1.8% in 2020, according to the International Monetary Fund's forecast. While cautious, this projection is nevertheless optimistic. The recovery is in its seventh year -- the average length of American recoveries. Are the financial markets subject to an "irrational exuberance"? According to Robert Shiller's calculations -- the economist who fathered the expression -- the cyclically adjusted price-earnings ratio is near its 1929 level! The risk of a new financial crisis cannot be ignored.

This omen has not escaped the Federal Reserve. It has led Janet Yellen who replaced Ben Bernanke in February 2014, to raise the target rate in small increments to bring it into a 1% to 1.25% range on June 15, 2017. This cautious policy is due to the American economy's vulnerability -- too strong a rise would kill the recovery. But, it is not the short term interest rates which matter as much as the long term rates over which Janet Yellen has little if any leverage. The financing of the American economy has known a blissful period over the last twenty-five years in contradiction to the fundamental law of supply and demand. Treasury bonds' long term interest rates fell regularly while the public debt rose. This unexpected turn of events was the result of an immoderate appetite on the part of foreign investors for American financial assets. Since 2015, they have reduced their purchases at the margin, forcing American investors to fill the gap. Long term interest rates are rising again, as the fundamental law predicts. The rise will continue as long as the Federal debt increases. Ultimately, it will push the American economy into recession, or worst a financial crisis.

Hence, quantitative easing -- the much vented new monetary policy -- is no miracle solution to the American economy's problems. Rather, it is an illusion, a deception, or a trap. In its final phase, it is taking the form of a boomerang aimed at Janet Yellen. No wonder she did not respond when asked by Senator John Kennedy* on July 13th whether she would accept a second term in February 2018.

*No relation to the John F. Kennedy family

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Former Vice President Citigroup New York (retired) Columbia University -- Business School Princeton University -- Woodrow Wilson School

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