Grading Janet Yellen After 7 Months At The Helm

 |  Includes: UDN, UUP
by: John M. Mason


Overall Janet Yellen's time as the Fed Chair has not been bad.

However, as federal government deficits loom large in the future and with $2.8 billion in excess reserves in the banking system, the pressure on Yellen to tighten Fed policy grow.

One doesn't see the gritty persistence in her to tighten Fed policy in a way that a Paul Volcker might.

Next Wednesday, September 3, Janet Yellen will have been the chairwoman of the Board of Governors of the Federal Reserve System for seven months. This is her "Fed" now and we can make an early check on how she is doing.

As readers of this post know, I have, in the past, attempted to reflect on the performance of Federal Reserve chairmen in order to see how they have protected the United States economy.

The standard I use is one suggested by former Fed chairman Paul Volcker. In a book written by Volcker and former vice minister for international affairs in the Japanese Ministry of Finance titled "Changing Fortunes: The World's Money and the Threat to American Leadership."

Mr. Volcker, on page 232 of this book, presents this statement: "a nation's exchange rate is the single most important price in its economy" for "it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore any government to ignore large swings in its exchange rate."

Mr. Volcker gets good marks for what happened to the price of the United States exchange rate during his tenure as the chairman of the Board of Governors. Using the index constructed by the Federal Reserve System that captures the trade-weighted value of the US dollar against major currencies, we observe that the value of the US dollar rose by 6.4 percent while Mr. Volcker was the chairman, August 6, 1979 until August 11, 1987.

Actually, this performance really stands out for the value of the dollar has actually declined during the tenure of all other Fed chairs since the dollar was allowed to float in 1971 and the Fed series was first introduced in January 1973. From that date until August 22, 2014, the trade-weighted value of the US dollar against major currencies has fallen by almost 28 percent.

During this time period, the economic philosophy of the United States government was one of credit inflation to keep the economy as close to full employment as possible and to promote home ownership to as large a segment of the population as possible. And, this philosophy was reflected in both Republican and Democratic administrations.

Mr. Volcker's time as Fed chair was an exception for leaders of the Federal Reserve.

Under his successor, Alan Greenspan, the value of the US dollar fell by more than 16 percent. However, the volatility of the dollar was greater under Greenspan than under any other Fed chair since 1973.

While Greenspan was chair before Clinton took over the US dollar lost value of 10 percent. During the Clinton administration, where the government's budget deficit was eliminated, the value of the US dollar rose by 14.5 percent. After the Bush 43 administration took over and introduced tax cuts and pumped up budget deficits again, and until Greenspan retired, the US dollar lost value of 19 percent.

The US dollar also fluctuated substantially under the leadership of Ben Bernanke, but overall, the trade-weighted value of the US dollar against major currencies fell by just over 8 percent. Against the euro, the US dollar dropped by almost 11 percent.

Now, for Ms. Yellen's performance so far: the trade-weighted value of the US dollar against major currencies rose by 0.8 percent. Not much, but there was a rise in value.

One should note that these are unusual times for not all currency areas are moving in the same direction. For example, during the time that Ms. Yellen has been the chair, the value of the US dollar has risen against the euro by 2.2 percent. The eurozone has basically experienced no growth during the period she has been in this position while disinflation continues to be of major concern.

Two other countries seem to be doing better economically, than the United States. The currencies of both these countries have risen in value relative to the value of the US dollar. The value of the US dollar has fallen against the British pound by 1.6 percent. The value of the US dollar has fallen against the Canadian dollar by just over 1.0 percent.

Ms. Yellen has not seemed to give must weight to the value of the dollar in policy discussions. Her background has been more in the area of labor markets within the macroeconomic environment. This emphasis came out quite strongly in her speech at Jackson Hole, Wyoming last Friday.

Still, what finally happens under the guidance of a Federal Reserve chair allows one to make a judgment on the overall performance of that Fed chair.

Paul Volcker stands out because, even in a period of substantial governmental budget deficits, he was able to see the value of the US dollar rise.

The period Alan Greenspan was chair mixed. During the time when President Bill Clinton was President, and Robert Rubin was the major policy-setter at the US Treasury Department, the US economy experienced one of the longest periods of economic expansion in US history, even while the government's budget deficits were being brought under control and the value of the US dollar was increasing against other major currencies. Credit inflation seemed to be under control.

When there was less control over the federal government's budget, the value of the US dollar declined significantly. During these other periods, credit inflation dominated.

Ben Bernanke faced the Great Depression and produced the greatest expansion in base money in US history. Given the lack of control of federal budgets along with this monetary ease, the value of the US dollar declined as credit inflation was ruling policy decisions.

And what will Janet Yellen face?

Well, the budget deficits of the federal government are expected to persist as far as one can see. The US banking system seems to possess about $2.8 trillion in excess reserves. It is hard to argue against the fact that credit inflation seems remains the reigning philosophy of the federal government.

It seems from the precious history examined above that the value of the US dollar might rise either when the government gets its budget deficits under control and monetary policy is accommodative (as in the Clinton era), or when monetary policy is extremely tight and budget deficits are quite large (as in the Volcker era). It should be noted that in both times, economic growth was relatively good.

If Janet Yellen's Fed cannot keep monetary expansion under control while at the same time government budget deficits are substantial, it is hard to imagine that the value of the US dollar will remain strong or strengthen.

The first seven months of the Yellen era at the Fed have been relatively quiet - economically - while the eurozone has weakened. This environment has resulted in a slight rise in the trade-weighted value of the US dollar against major currencies. Unfortunately, I don't see Ms. Yellen as one that will create the tight money needed to keep up the strength of the dollar. The dollar may stay strong against the euro - but this will not be the case with other currencies.

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