Giving Credit Where Credit Is Due

Includes: SPY, TIP, XHB, XLK
by: Eric Parnell, CFA


I have been a vocal critic of the U.S. Federal Reserve over the last several years.

When levying such repeated criticism, it is also worthwhile on this latest Fed day to give credit where credit is due.

Janet Yellen was dealt a challenging hand when taking over the Federal Reserve, and she deserves credit for turning policy in what I believe is the right direction.

I have been a vocal critic of the U.S. Federal Reserve over the last several years. This does not mean that I think those running the Fed are bad people, however, as I respect the challenging nature of their work and responsibilities and believe that they are well intentioned with their actions. Nor do I universally disagree with all of their actions. Instead, my criticisms are based in what I believe makes for good debate, where one has respect their opponent even though strongly disagree with their point of view. And when levying such repeated criticism, it is also worthwhile on this latest Fed day to give credit where credit is due.

Not Bad Given The Circumstances

Janet Yellen has been running the U.S. Federal Reserve as Chair since February 2014. During her nearly two-and-a-half-year tenure, she has been widely regarded as continuing the extraordinary and aggressively easy monetary policy implemented by her predecessor at the Fed in Ben Bernanke. But while she certainly has been both cautious and tentative with her policy actions thus far, I would contend that she deserves credit for the following key point - at least she has been consistently moving monetary policy in the right direction.

A Quick Look Through Fed History

Serving as Chair of the Fed is certainly no easy task.

You are appointed by the President and approved by Congress to perform a more technical and highly academic job that most to whom you are reporting really do not understand. At the same time, you must at times navigate the complex waters of heavy political pressure from those that are more concerned with promoting an economic environment that helps them get reelected than what might be best for fostering sustained full employment and price stability.

You also hold a tremendous amount of power given that your policy decisions with the global reserve currency are not subject to the same checks and balances that exist on the fiscal policy side with the three branches of government. As a result, you can respond swiftly when needed during times of crisis, but you can also really screw things up if you end up making the wrong policy call, particularly if you do it over an extended period of time. Such misguided flexibility helps to explain the high inflation (NYSEARCA:TIP) of the 1970s, the inflation of the tech bubble (NYSEARCA:XLK) in the late 1990s and the housing (NYSEARCA:XHB) bubble in the mid 2000s.

Over the years, we have had Fed Chairs both good and bad. Those that had the most success including William McChesney Martin and Paul Volcker were able to successfully lean against political influence and carry out the Fed policy that the economy needed at any given point in time, even if proved quite painful for an extended stretch along the way. Others such as Arthur Burns buckled under extreme and pointed political pressure with problematic results. A few such as William Miller were simply not fit for the job, which is how your term as Fed Chair lasts only a year and a half. And those such as Alan Greenspan and Ben Bernanke were arguably accommodative to a fault, falling victim to the tragic flaw of believing that if they provided fiscal policy makers with the windows of opportunity to carry out effective fiscal policy, they would actually follow through. Such is how epic asset bubbles inflate and subsequently burst as we have already seen twice since the turn of the millennium and may once more before the decade is out.

Starting Under Challenging Circumstances

When Janet Yellen assumed control of the U.S. Federal Reserve in February 2014, she was left to play the difficult hand dealt to her by her two predecessors. Dating all the way back nearly three decades to the late 1980s, monetary policy in the United States has been predominantly easy.

Fed Chair Alan Greenspan began his twenty-year tenure by establishing the Fed 'put' for the stock market (NYSEARCA:SPY) and hence the hyper awareness by the Fed of what stock prices are doing on any given day. He then embarked on two prolonged easing cycles that generated tremendous economic growth for a time, but by lowering interest rates too far and keeping them too low for too long resulted in first a technology bubble and then a housing bubble that both burst.

But then came Fed Chair Ben Bernanke in January 2006, who ultimately quadrupled down on Greenspan's easy ways. In response to the financial crisis, he not only slashed interest rates to 0%, but he entered into stimulus programs that ultimately sextupled the Fed's balance sheet from just over $800 billion to more than $4.5 trillion. In the process, he paved the way for other major global central banks around the world such as the European Central Bank and the Bank of Japan to follow suit with their own unprecedented policy moves. All the while, we have scant evidence that any of the extraordinary policy moves after the global economy was stabilized by the summer of 2010 have worked in generating economic growth other than successfully inflating artificial asset bubbles that will now need to be resolved once more at some point in the near-term future.

Janet Yellen - Subtle Hawk

So by the time Janet Yellen took the reins of the Federal Reserve in February 2014, she was left with policy ammunition completely stripped bare, a grossly bloated balance sheet, a stimulus program in QE3 that was still effectively running at full throttle and capital markets trading at artificially high valuations.

Given the state of affairs when Ms. Yellen took over the Fed, it is easy to see why so many have viewed her as ultra dovish. But a review of her policy accomplishments since taking over the Fed deserve more credit than that. For despite some tentativeness along the way, she has leaned on the hawkish side if anything else.

Over her 2+ years as Fed Chair, she has managed to accomplish the following. First, she was able to completely wind down the QE3 stimulus program launched under her predecessor, which was arguably the most aggressive of Bernanke's three forays into asset purchases. And she did so with few adverse effects from already artificially inflated global financial markets along the way (remember how markets reacted after QE1 and QE2? In a word, it was ugly). She was also able to replenish at least a trace amount of the Fed's policy arsenal by raising interest rates off of the zero bound for the first time in nearly a decade in December 2015.

Could she have ended QE3 sooner? Sure. Could she have moved earlier in raising interest rates? Certainly. And could she have been more aggressive in raising interest rates once getting started? Absolutely. And it is on all of these points that I have strongly disagreed and criticized the Fed since the start of 2014. But with that said, Ms. Yellen still deserves credit for at least moving policy in what I believe to be the right direction over the past couple of years. Does she still have a long way to go in normalizing monetary policy? Indeed. But with that said, it could be far worse today, as we could be down right now with the European Central Bank and the Bank of Japan with deeply misguided negative interest rates and even more futile asset purchases.

Bottom Line

I have been critical of the U.S. Federal Reserve over the years. And it's likely that I will continue to do so in the months ahead. But despite my criticisms, the merits of what the Fed has accomplished under Fed Chair Janet Yellen should also be recognized and commended. Has it been perfect in my view? Far from it. But it has been much better than what preceded it. The Fed under Janet Yellen has come a long way in dialing back the Fed's easy ways. And she appears determined to move deliberately to keep policy moving in a more restrictive direction for as long as possible to the long-term benefit of capital markets and until the next economic storm rolls in. For that, she deserves credit where credit is due.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: I am/we are long TIP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.