Stocks rise as Yellen agrees to pause taper if economy softens

BROOKINGS, Ore. - Feb. 28, 2014 - PRLog -- Yellen testified before the Senate Banking Committee stating it was too soon to know if the latest disappointing economic data was related to recent cold weather. However, if the economy softens the Federal Open Market Committee (FMOC) would consider a pause in tapering its purchase of bonds..

Critics such as Senator Rand Paul and Congressman Jeb Hensarling believe the Fed is following a haphazard, discretionary policy of interest rate suppression. They want Yellen and her colleagues to adopt a rule-based approach that they say would be more reliable and more market oriented.

Yellen has a Phillips-curve orientation, and is guided by a trade-off between unemployment and inflation. Her critics believe her excessively dovish stance could cause her to focuse too heavily on unemployment and lose sight of the Fed’s dual mandate of monetary stability. Many believe the real problem with this economy is not lack of liquidity, but a lack of incentives to grow, invest, and start new businesses.

Yellen told Hensarling’s committee in a Feb. 11 hearing that rules like the “Taylor Rule” are not applicable now because “the conditions facing the economy are extremely unusual”. However, critics argue the debate over hard and soft money was argued by the British parliamentarians debating the structure of the Bank of England in the 19^th century. It was also argued by politicians in France, Germany, Rome and Greece. The gold standard is seen by many economists as the “ultimate monetary-policy rule”.

“This is not your father’s Federal Reserve,” Hensarling has stated. “The extraordinary measures of 2008 have seemingly morphed into the ordinary measures of 2014”. Hensarling supports Paul’s proposal to subject the Fed’s operations, including its monetary policy, to a full audit. Yellen has opposed such a move, saying it would interfere with the central bank’s independence to set policy. Conservatives such as Senator Mike Lee want to restrict the Fed to investing in Treasury securities and prevent them from investing in mortgages and stocks.

Some Keynsian economists such as Paul Krugman believe the Fed now has the ability to fine tune a “Goldilocks economy” that is not too hot (inflation) or too cold (recession). However, critics such as James Rickards believes the Fed balance sheet has passed $4 trillion and they have become trapped with no exit.

Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective because interest rates are at zero. A central bank implements QE by buying specified amounts of financial assets with fiat money (not backed by gold). In December, 2013 the Fed reduced it purchase of bonds from $85 billion a month to $75 billion. Currently, the consensus estimate is the Fed will reduce QE to $65 billion a month at Yellen’s first FMOC meeting March 19-20, and will wind down QE3 by the end of 2014.

Critics such as Marc Faber and Peter Schiff believe the equities markets and the U.S. economy have become addicted to QE. They believe a tapering of Fed bond purchases will eventually stall the recovery, and will require a pause in the taper. Many believe the Fed will be forced to implement QE4, QE5, etc.

Yellen has testified that the Fed will not exit its bloated balance sheet by selling bonds, but will hold them until maturity. Tyler Durden, with Zero Hedge, believes the Fed’s portfolio shift to a longer average maturity means the Fed is unable to reduce its balance sheet only be letting securities mature. He believes it would take 10 to 15 years to burn through its portfolio. Because they now control much of the Treasury and mortgaged backed securities (MBS) markets, they would swamp the thin markets if they tried to sell. Many believe the Fed is trapped.

Supporters of Fed policy argue the Fed is not printing money. They are effectively retiring bonds in circulation by creating offsetting bank reserves, which do not necessarily lead to an increase in credit and inflation. This is correct, except that an increase in the monetary base does tend to increase the price of monetary assets such as gold and equities. The other problem is the Fed may believe they are in control and can adjust the monetary temperature, however, if the Fed stimulates enough to increase inflation expectations, they can lose control very easily. Excess banking reserves in themselves are not necessarily inflationary. However, if velocity picks up due to economic stimulus, the monetary base can be multiplied many times through the fractional reserve system. If the Fed pauses or increases QE, the Fed can lose market credibility and lose control of credit creation. While the Fed may believe “this time is different”, Austrian legendary economist Ludwig von Mises established that all monetary booms caused by unsustainable increases in credit result in eventual busts. Booms are caused when the public believes a credit expansion will continue forever, and rush to exchange money for goods. However, plans which appear to be feasible during the early phase of a boom will eventually be revealed to be in error when the credit expansion is reduced because of the consequences of inflation.

Ecclesiastes 1:9, “What has been will be again, what has been done will be done again; there is nothing new under the sun".

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