The Fed: More of the Same

As the head of an independent agency subject to little Congressional or executive intervention, the chairperson of the US Federal Reserve wields an enormous amount of power over America’s economy.

By and large, the only real check on a Fed chairperson’s authority is the requirement that policy be set through the consensus of the Federal Open Market Committee (FOMC). Historically, though, the seven members of the Federal Reserve Board of Governors fall in line with the chairperson, with the only real dissent coming from the five Federal Reserve Bank presidents who also have votes on the FOMC. So what a Fed chair wants, a Fed chair usually gets.

That makes it worth noting that Janet Yellen, the current number two at the Fed and the nominee to replace Ben Bernanke when his term expires on January 31, veritably sailed through her nomination hearing before the Senate banking committee yesterday.

Some lawmakers on the committee aggressively questioned Yellen on what the Fed has done so far to ensure the stability of the nation’s banking sector and how the Fed is progressing with writing the new rules mandated by the Dodd-Frank financial reform law. However, there was none of the acrimony that so often marks confirmation battles.

Given the relative conviviality of the hearing, the committee is expected to vote to send Yellen’s nomination to the full Senate sometime next week despite the fact that Senator David Vitter (R-LA) has said that he will oppose her confirmation. And with the Senate controlled by the Democrats, several of whom signed a letter recommending her nomination to President Obama, the odds are that we’ll have a new Fed chairperson sometime next month.

That’s important to our inflation outlook. While she walked a fine line pointing out that inflationary danger lurked no matter what action the Fed took, Yellen also stressed that removing the suppo! rt of quantitative easing (QE) too soon would be devastating to the economy. She essentially hewed to the Bernanke line, saying that she would only consider ending QE once the unemployment rate fell below 7 percent.

She also asserted that she saw no evidence of an asset bubble forming as a result of QE—many believe that the rapid rise we’ve seen in equity valuations are largely a result of QE. Consequently, she shows no inclination to change the current course of monetary policy.

There’s some inflation in the economy today and by our measures it is well above the government reported 1.2 percent. We’re not staring hyperinflation in the face any time soon, but I do believe there’s a potentially massive inflationary hangover waiting for us down the road.

My greatest concern at this point isn’t just the extremely unconventional nature of the Fed’s economic intervention; it’s that our central bank isn’t the only one in the world going down this primrose path.

Two of the world’s other largest economies are also stimulating at a furious pace. The Bank of Japan is pushing trillions of yen into that nation’s economy and the European Central Bank’s recent rate cut to 0.25 percent leaves the euro zone flirting with a zero interest rate policy. There’s a lot more money than just the Fed’s $85 billion in monthly asset purchases flowing into the global economy.

This much monetary support pumping through the global economy is entirely unprecedented, so it’s tough to believe that central bankers around the world actually have a handle on the potential consequences three to five years from now. It appears that inflation is simply being baked into the cake we’ve been eating for four years.

I’m not so much bothered by the fact that Yellen looks to be coasting into the big chair at the head of the table—she had a ringside seat for most of the global financial crisis—but! by her a! pparent lack of a stimulus exit plan. When pressed on how she would identify asset bubbles or inflation forming, her response was basically that she would know it when she saw it.

The upshot for investors: Yellen’s confirmation, with her prescription for more of the same, means that we should continue to watch for signs of building inflation. When governments print more money, it reduces its value and causes prices to rise as producers need to get more for their product. And in today’s interconnected society, when one central bank prints money it impacts everyone. One need only look to the huge run up in many emerging market stocks to see the effect.