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The Fed’s Easy-Money Era

Is there any hope for a change in U.S. monetary policy as a result of the 2016 federal elections?

The Federal Reserve has been locked into a zero-interest rate policy (ZIRP) for nearly seven years, and there are few signs that the world’s most influential central bank will adjust its easy-money strategy anytime soon.

Still, there is some hope, however slim, that the events of Tuesday, November 8, 2016, could usher in necessary change.

You see, despite the fact that the current course was charted by Ben Bernanke, an appointee of Republican President George W. Bush, prominent voices within the GOP advocate a policy reversal.

The question is whether the change of government in January 2017 will produce no change at all, minor tweaks, or an outright reversal.

Who’s on the Bench

Let’s run down the major players and set some context for this monetary drama.

If Hillary Clinton wins in November 2016, it’s likely that there will be little change to the monetary policy.

Janet Yellen is a liberal Democrat predisposed to low interest rates and monetary “stimulus.” And presidential policy in a third Clinton term will likely tend toward this “easy money” bias. Yellen’s reappointment in January 2018 for a second four-year term as Fed chair is a certainty should Hillary win the White House.

If Republicans maintain majority control of the U.S. Senate, Yellen’s reconfirmation hearings will be testy, but grumbles will be insufficient to topple her.

Monetary policy is less likely to become an issue in the 2016 election than it was in 2012, because the risk/reward of addressing it is different.

You see, during the 2012 presidential cycle, voter discontent with the economy and Bernanke’s easy-money policy was palpable. When Rick Perry said in a GOP primary debate that citizens would “treat Bernanke pretty ugly in Texas,” it resonated with the Republican base.

This time around, the economy’s performance isn’t much better. In fact, in some ways, it’s worse.

But the stock market is much more extended, so any substantial monetary tightening would produce a massive stock market crash. “Vote for me and crash the stock market” is simply not a vote-winning strategy for Republican candidates. (Elizabeth Warren’s fan base, on the other hand, might very well go for such a slogan.)

Candidates hoping to eventually “bully pulpit” the Fed toward a new, harder direction will have to take a stealth approach – unless the market crashes before November 2016, in which case tighter money may quickly come back in fashion.

A Fork in the Road

There are two approaches that a Republican elected to succeed Barack Obama might take.

One would be to essentially stay the monetary course, but, through appointments to the Federal Reserve Board of Governors, gradually strengthen the “hawk” faction on the Federal Open Market Committee.

Any recession would be met by further “stimulative” purchases of Treasury and U.S. government agency bonds and prolongation of the ZIRP.

Considerations of bipartisanship might result in Janet Yellen being reappointed in January 2018, though this would basically kill any chance of significant change to monetary policy until 2022. This would almost certainly be the scenario if, for example, Jeb Bush were to win the Republican nomination and the presidency.

The other approach available to a successful Republican candidate would be to reject the monetary policy of Janet Yellen and Ben Bernanke – indeed, to radically alter the course we’ve traveled since the latter half of Alan Greenspan’s term.

Getting off the easy-money intoxicant that stimulated the credit-fueled boom that began in early 1995 won’t require reestablishing the gold standard. It would, however, mean abolishing the Fed’s “dual mandate” so it focused only on inflation and not unemployment.

Congress could also pass legislation establishing other protections compelling the Fed to follow tight-money policies typical of Paul Volcker’s reign as Fed chair from 1979 to 1987.

For example, the Fed could be required to increase broad money supply at a pace not to exceed the rate of nominal growth in gross domestic product, which is currently about 3% to 4% per year. Note that we’ve seen an average annual increase in the broad money supply of 6% since 2009.

Under such a structure – except in moments of extreme financial stress, such as during 2008 to 2009 – the federal funds rate could be expected to fluctuate in the 3%-to-6% range unless inflation took off.

Such moves would undoubtedly make it impossible for Yellen and most of the current members of the Board of Governors to continue at the Fed. They’d simply be unwilling to operate under such a system.

It would also cause an initial collapse of stock and asset prices, which would be very unpopular. (Ideally, such a collapse would have happened of its own accord, bankrupting the old policies before the new ones were introduced.)

Up to Bat

Thus, it would require a presidential candidate of considerable political courage who took office with a mandate from the electorate sufficient to get Congress to pass the necessary legislation.

Among current Republican candidates, Rand Paul, like his father, has supported a massive Fed overhaul. Rick Perry supported it in 2011 and 2012, and might do so again.

Most candidates – including Marco Rubio, Scott Walker, Carly Fiorina, and John Kasich – will likely deem this particular battle not worth making. Others, such as Mike Huckabee and Rick Santorum, appear likely to support the Fed’s current policies.

Should the stock market crash before November 2016, the political risks of supporting tight-money policies would be greatly reduced.

But as the months go by, the chances of another historic selloff happening before Americans go to the polls to elect their next president appear to be diminishing.

Good investing,

Martin Hutchinson