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This is not your father’s Fed

First published at RGJ.com http://www.rgj.com/story/money/business/2014/05/30/robert-barone-fathers-fed/9728075/

The tools available to monetary policy have large impacts and affect wide swaths of the financial terrain. This has always been acknowledged in the financial community, and, as a result, monetary policy has not been used to target social issues. Until now.

Labor markets

Fed Chairwoman Yellen has made it clear that she wants to see a reduction in what she has termed “disadvantaged workers,” which she defines as the long-term unemployed and those working part-time but wanting full-time jobs. This appears to be a prerequisite to move monetary policy away from its ultra easy stance.

But, recently released Federal Open Market Committee minutes (special strategy meeting) indicate that in many Fed districts, labor markets appear to be tight. Anecdotal evidence collected in these districts indicates that businesses are finding that jobs are hard to fill and that many jobs go unfilled due to a lack of qualified candidates.

Furthermore, we have now seen several fairly strong employment reports in a row, even despite the harsh winter, and weekly new claims for unemployment continue to flirt with the 300,000 level, where it was during the boom economy prior to the financial meltdown.

The real debate here is whether or not such “disadvantaged workers” are structural or cyclical. If they are structural, i.e., they simply don’t have the skills needed to get today’s jobs, then monetary policy is powerless to have any impact.

On the other hand, if they are cyclical, as Yellen must believe, then an economy that is rapidly growing would be able to reabsorb these so-called “disadvantaged.” If Yellen is wrong and this is a structural issue as many economists believe, then she is risking both the Fed’s credibility and the financial health of the economy.


Besides targeting the labor market, the Yellen Fed also appears to be targeting housing. And certainly, the Fed is hoping that lower rates will reignite that market.

Unfortunately, government regulations have crippled traditional lenders. 1) Under Sarbanes-Oxley, lenders are legally prohibited from making loans to people they know do not have the capacity to repay; 2) In addition, Fannie Mae and Freddie Mac, which together account for more than 90 percent of today’s mortgage funding, now have three years to “put” loans back to originators.

Most loans that default do so within such a time period. Because originators have no place else to go to sell their mortgages, they are forced to eat any loans that Fannie or Freddie put back to them.

For both reasons cited above, mortgage lenders are enforcing much higher underwriting standards than they did 10 years ago. So, a return of a robust housing market seems unlikely. Yet, under the Yellen Fed, the blunt tools of monetary policy appear to be aimed at something that only specific congressional or regulatory actions can accomplish.

Inflation: Head in the sand

In 1979 and 1980, when the Consumer Price Index was rising at a double-digit rate (1979 = 13.9 percent; 1980 = 11.8 percent), the then-newly appointed Fed Chairman Paul Volcker, killed inflation by raising interest rates to unseen levels. (The effective Fed Funds rate was more than 19 percent in the summer of 1981). While a severe recession ensued, the death of inflation ushered in a golden age for America, and from June 1982 to August 2000, the Standard & Poor’s 500 rose at an average annual rate of 15.7 percent.

The way the CPI was constructed in 1980 is very different from the way it is formed today. John Williams of ShadowStats.com has calculated that if the 1980 CPI construction were still in use today, then we would have officially seen a rate of inflation of 8.9 percent in 2010, 10.7 percent in 2011, 9.7 percent in 2012, and 9.1 percent in 2013.

But today, near double-digit rates of inflation (using the same calculation method) are ignored, and the Fed tells us that deflation is a bigger threat.

America’s middle class suffers from a falling real wage rate because the inflation measures are so biased to the downside and cost of living wage increases are nowhere near what is needed to preserve the purchasing power of the wage earner.

I suspect that we wouldn’t be having the debate about the minimum wage or the strikes against the fast-food industry if the official CPI in 2010, ’11, ’12 and ’13 had shown John Williams’ results.

Today, policy makers worry about deflation coming from a long-term downtrend in population growth. But they ignore the real threat of economic stagnation coming from the bogus inflation numbers which reduce the purchasing power of the wage earner, and they ignore the potential for inflation, which comes from out of control money printing policies.

This Fed clearly isn’t your father’s Fed. I suspect that, before this is over, we will need another Paul Volcker.

The investment horizon

Current monetary policy puts risk into the markets. As long as the Fed continues with ultra-easy policies, there is little chance of a mega downdraft in equity prices (although a correction is long overdue).

However, when the markets wake-up and recognize inflation, interest rates will have to rise to cover the inflation premium, and that is when market risk will be high. It is inevitable that this will occur; the trillion-dollar question is when.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, a Registered Investment Advisor.  Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.  Robert is available to discuss client investment needs. Call him at (775) 284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV  89521.  Ph: (775) 284-7778.


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