Reduce the Fed’s Mandate

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Why do we refuse to call absurdity absurd? Meeting after meeting, news conference after news conference, it becomes increasingly apparent that we have conferred on the Fed Chair the role of economic and securities market orchestrator.  Markets typically tip-toe into Fed announcements only to explode into paroxysms of volume as algos move prices violently – often in alternating directions – in the initial moments following each announcement.  The ultimate market direction is dictated by the Fed’s dovish or hawkish tone relative to the market’s expectation leading into the meeting.  Imagine how much more orderly and intelligent it would be to have a rule-based decision-making formula that investors could monitor as new data unfold.

Because the Fed’s Congressionally-conferred mandate extends beyond currency stabilization to include maximizing employment, Fed members now scan the world for economic, monetary and securities market data, all of which now seem relevant in their decision-making process. In this week’s speech to the Economic Club of New York, Fed Chair Yellen relied heavily on global uncertainties as rationale for large doses of caution in considering future interest rate increases.

The Fed’s long history is replete with flawed judgments and policy moves. For years, forecasts of the current Fed have been far off the mark on economic growth and interest rates.  Off past performance, why would we expect this group of academics and regulators to have greater insight into domestic and world economic prospects than the broad universe of business people and investors?  It flies in the face of all logic to allow Chair Yellen and any small band of academics and regulators to wield the power that the Fed holds over domestic and world economies and markets.  Congress must take that giant club out of the Fed’s hands by reducing its mandate.

Since the general public and its representatives in Congress don’t understand this highly complex policy-making process, they vest power in a perceived wise person. They fail to recognize that any Fed Chair is less like Solomon and more like the wizard behind the curtain.

Either the Fed doesn’t appreciate the full effects of its decisions and actions, or it is simply satisfied with having rewarded Wall Street, though not Main Street. Whatever benefits accrued from history’s most generous monetary experiment have come at the expense of a generation of elderly retired who have had to choose between spending down life savings or risking those assets in historically overvalued securities.  The final chapter on how that unfortunate generation’s retirement will play out has almost certainly not been written.

Far greater pain likely lies ahead, perhaps to be borne primarily by generations which have had no role in approving the Fed’s decisions. Monumental debt loads, like today’s, have throughout history led to greatly inhibited economic growth for extended spans of years.  And many of history’s greatest securities market declines have accompanied such periods of economic lethargy.

Our unwillingness to confront the absurdity of allowing a few academics and regulators to orchestrate domestic and world economies is allowing the pain to continue for the elderly retired and to increase for future generations that will almost certainly inherit unprecedented debt burdens. We are allowing Janet Yellen to dig us deeper into a destructive dungeon of debt.  Congress and the general citizenry must make their voices heard in opposition.

Congress should immediately set about reducing the Fed’s current dual mandate to a single mandate of stabilizing the currency. Ideally, within that mandate, Fed decision-making would be formally rule-based rather than, as today, with each Fed voting member formulating his or her own non-binding and often fluctuating rules.

Let’s recognize the absurdity of the current arrangement in which any Fed Chair, essentially without veto, plays the largest single role in orchestrating the world economy.

Thomas J. Feeney is Managing Director and Chief Investment Officer of Mission Management & Trust Co., Tucson, Arizona.

For a related analysis of the inappropriate scope of Fed power, please see Tom’s immediately prior blog post “Where’s the Outrage?”.

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Where’s The Outrage?

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In 1976’s Network, Howard Beale famously yelled: “I’m mad as hell, and I’m not going to take this anymore!”

The rise of Donald Trump and Bernie Sanders testifies powerfully to the anger felt by large segments of the American population. Tragically, that anger does not extend to the ascension of the Federal Reserve as orchestrator of the U.S. economy, despite no public approval of such a “third mandate.”

The Fed’s assumption of its expanded role displays a remarkable lack of humility given the long and checkered track record of that body’s errors of omission and commission. In recent months, regional Fed presidents Charles Evans and James Bullard have highlighted seriously flawed Fed forecasts.  In almost any other context, such frequent failings would lead affected constituencies to reduce a body’s decision-making authority.  Remarkably, just the opposite has occurred over the past several years with respect to the Fed and central bankers around the world.

To solve problems brought on by excessive debt, central bankers have conducted the greatest monetary experiment in history. They have attempted and continue to attempt to solve those problems with unprecedented amounts of new debt.  While it sounds simplistic, it is a very apt analogy to compare that solution to trying to cure a hangover with more “hair of the dog.”  It flies in the face of all logic.

Likely because monetary economics is a highly complex study, the general public and their representatives in Congress have little understanding even of its broad strokes, much less its intricacies. As a result, there has been only mild opposition by those most impacted today – a generation of retirees who have so far been able to earn no risk-free return for half an expected retirement span.  And, of course, there has been no objection from future generations who will inherit the monumental debt levels we have generated to paper over problems of our own creation.  If we actually understood the problem, who among us would deliberately improve our own wellbeing and demand that our children, grandchildren, even great grandchildren pay the bill?  So we silently allow central bankers to conduct what they themselves characterize as experimental monetary policies.  But this is not a small experiment.  Should the world’s monumental debt burdens unravel in an uncontrolled fashion, central bankers will be seen to have bet the world’s economy and the wellbeing of generations on little tested and certainly unproven policies.

Who are these people to whom we have defaulted such power? They are, virtually without exception, academics and regulators.  By all appearances, each is intelligent, well-intentioned and respected in his or her field.  But they are academics and regulators, unsullied by any practical experience in running even a single significant business, much less the world’s largest economy.  Regardless of their academic credentials, few, if any, would qualify for senior management roles in major domestic or international corporations.  Individual Fed members could certainly be blended with experienced business people to comprise capable boards.  Shareholders of any large corporation, however, would have every reason to be appalled by a board restricted solely to Federal Reserve Board members.  Where’s the real world experience, the appreciation of the profit and loss consequences of regular decision making?  Where’s the breadth of experience required to appreciate the effects of a company’s actions on both its customers and on the broader citizenry its actions affect?  Their academic and regulatory pursuits leave them remarkably sheltered from a real world appreciation of the breadth of the effects they create.  Yet we have allowed them to assume far more extensive power than exists in even the world’s most prestigious corporate or non-profit boards.  It can only be from ignorance or from a deplorable lack of concern that we as a citizenry have permitted central bankers to acquire such a powerful role in picking society’s winners and losers.  The mandate they have assumed is entirely too large.

In fact, the dual mandate given the Fed by Congress is responsible for the current overreach. Virtually anything unfolding in the domestic or international economies arguably affects domestic employment.  Consequently, the mandate to maximize employment effectively charges the Fed with monitoring and responding to massive numbers of potentially critical variables.  Recent quotes from several Fed members make it clear that monitoring and responding to the world’s financial markets falls well within the Fed’s perceived purview.

Wall Street is nothing if not ingenious and capable of creating its preferred market picture. In an era of rampant spoofing and bluffing, it’s hardly a stretch to expect self-interested, financial megacorps to paint the picture they want the Fed to perceive leading up to important central bank decisions.  When experienced investment pros misread market signals with some regularity, what are the odds that a group of academics and regulators are going to read them accurately?  At best, it’s an exercise fraught with hazard.  We’re asking Fed members to make decisions far beyond their areas of experience and competence.

Allowing the Fed to wield the power it now has is also creating massive stock market distortions. So much market reaction flows from Fed proclamations that analysts spend an inordinate amount of time attempting to interpret the slightest variations in language or attitude of Fed voting members.  For many strategists this has become even more important than the analysis of underlying fundamental conditions.  That dynamic becomes blatantly obvious whenever we see markets surge on an announcement of disappointing economic news, as the prospect for more stimulus increases–a clear distortion of traditional free markets.

In recent years, Fed Chairs Bernanke and Yellen have gone to great lengths to promote the idea of Fed transparency. At the same time, we are subjected to Fed members repeatedly performing like traditional two-handed economists with the apparent intent of keeping upcoming decisions unclear.  A rule-based system to determine monetary policy would certainly be preferable to the frequently flawed Chair-led decisions heavily influenced by personal perceptions and biases.  The arguments against relying on a rule-based system typically involve pointing out how such a system would have led to an arguably unacceptable monetary position in one or more instances– as if the existing system itself has not placed the country in an extremely dangerous position.  If a rule-based system appears imperfect, improve the rules.  Clearly, each voting member of the Fed relies on his or her own set of rules in making monetary decisions.  They are not, however, publicly known, so we are left to speculate on how voters, especially the Chair, will make their decisions.  The securities markets would be far better served if analysts knew the rules on which monetary decisions would be based.  Strategists could abandon the psychological analysis of voting members and their probable decision-making patterns and return to an analysis of how the data align.

If we are not to turn to a formularized rule-based monetary system, we need to expand the influence of the many constituencies affected by monetary decisions. Obviously, any decision-maker would need a strong background in monetary economics.   Additionally, it’s only fair that they represent the many segments of society that will be impacted by those decisions: large and small businesses, employees, elderly retired, investors, non-profits.  The current Fed has much too broad a mandate and is woefully unqualified to pursue the many objectives on its plate.

Notwithstanding the best of intentions, the Fed in recent years has bet America’s future on a flawed (now failed) experimental monetary policy. Until we speak up loudly, we remain at risk of their experiments further decimating the future economic prospects of our nation and coming generations.

Difficult and confusing as this subject is, Congress needs to step up now and rein in Fed power. It’s important for all of us to recognize that this king wears no clothes.

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