New Fed governor Janet Yellen “represents a strain of interventionist thinking that has not found expression at such a high level in Washington in decades,” gleefully announces Michael Hirsch in the National Journal.
On the other hand, Larry Kudlow writing in the Daily Caller warns that “Yellen has a Phillips-curve reputation, and is guided by a trade-off between unemployment and inflation. This could bring her to an excessively dovish stance.”
What a world in which one appointment could either save or ruin the entire economy! This is the legendary power of the central bank, vested with the awesome task of printing more money per day than most people will make in a lifetime.
What an appointment! What power to make or break the whole of history!
That Yellen can do these things is somehow never questioned in all the punditry surrounding her appointment. It sort of makes you wonder why we have elections at all!
But what if none of it is true? What if the Fed lacks anywhere near the capacity to do either marvelous or horrible things?
If you think back to the promises the Fed made in 2008, we were long ago supposed to be on the road to economic nirvana. In those days, too, people warned from both sides of the aisle about impending glory or disaster. Neither happened.
For my part, I joined the chorus of sound money people who warned of coming hyperinflation. Whoops. At the same time, it was pretty clear that the Fed was doing its best to manufacture an inflation that, five years later, hasn’t arrived.
“Quantitative easing” in all forms was designed to pump up the economy with massive injections of new money. But when you look at what has actually happened, you notice something remarkable. No real discernable pattern exists in the pace of actual money creation (as measured by “money of zero maturity”). You see dramatic fluctuations up and down but no consistent trend.
If the Fed set out to flood the world with dollars, it didn’t really succeed. And a major clue as to why is revealed in the least-noticed money supply statistic: its velocity. This is the pace at which money changes hands in the real world. The Fed can do nothing to control velocity. It is entirely a function of consumer choice.
Why does it matter? Because it takes real-life spending to generate price inflation. Its postwar high was during the great inflation of 1979, for example. Velocity even matters for money creation itself because money has to move through the banking system in order for the credit system to enable money creation.
So what happened to velocity after 2008? It had already been in a downtrend since financial deregulation of the early eight. But after 2008, velocity fell off a cliff as consumers and businesses became extremely risk averse. By the time the recession ended, it was at a historic low. What’s more, confidence never returned. Velocity kept falling. And falling. In all the years on record, it’s never been lower.
The low rates at which money changes hands seriously affects the power of the Fed to bring about macroeconomic results. In other words, the Fed can pull its levers all it wants but so long as lenders, borrowers, and consumers don’t cooperate, the Fed is denied any real manipulative power at all.
What, then, is the point of quantitative easing? Where does all this new money land if not in the real world? Take a look at the following chart, which reveals the entire answer. This shows bank reserves held by the Fed. It is a proxy for how banks themselves are capitalized and therefore economically solvent.
For all the hoopla about “Quantitative Easing”, here is where you see the real effects, not on the street, not in any large aggregated macroeconomic trend but just right in the heart of the banking system itself. The Fed’s money-packed helicopter flew right over the banks and recapitalized the entire banking system with newly printed money, which in turn was deposited right at the Fed.
In other words, the only real power the Fed has shown itself to have over the last five years has been to take care of its friends in the banking world. Forget the dual mandate about unemployment and economic growth. It’s really just about sustaining the industry it serves.
If the Fed can’t really control effective money supply or velocity or inflation, much less manage the macroeconomy, what about interest rates? Doesn’t the Fed control those? It claims to but many people have doubts. “In a globalized world of open economies,” writes Jeffrey Rogers Hummel, “the tight control of central banks over interest rates is a mirage. Central banks remain important enough players in the loan market that they can push short-term rates up or down a little. But in the final analysis, the market, not central banks, determines real interest rates.”
It is for this reason that the appointment of Janet Yellen matters very little at all, and her own views on the right and wrongs of the monetary system even less so. The much-vaunted power isn’t what it used to be and probably hasn’t been since financial deregulation. The Fed will neither save us nor wreck us, at least not under prevailing institutional conditions.
Of course Washington wants to believe that there is some institution down the street from the Capitol and the White House that is capable of making up for all the failures of politics. But once you strip away the aura and mystique, what you find at the Fed is not that different from any other K-street firm: it is there to serve itself and the industry it represents.