In that deservedly-famous 2006 CNBC debate between Peter Schiff and economist
Arthur Laffer (in which the latter manages to be both arrogant and wrong about
literally everything), Laffer celebrates the fact that "we are outsourcing
our monetary policy to China" (minute 5:17).
Alert listeners probably wondered what he meant by that, and also probably
found the idea vaguely disturbing. But whatever it was we were doing, it turned
out to be bad because within a year the global economy was in free-fall.
And now that strange, ominous concept has returned. But this time around we've
apparently put our monetary fate in even less-stable hands:
Yellen
Outsources U.S. Monetary Policy to the Financial Markets
(Bloomberg) - Fed Chair Janet Yellen told the Economic Club of New York
on Tuesday that policy makers had scaled back the number of interest rate
increases they expect to carry out this year after investors did the same.
She argued that the downgrading of rate expectations in the market had led
to lower bond yields, providing the economy with needed support in the face
of weaker growth overseas. The Fed then followed suit this month by reducing
its anticipated rate hikes in 2016 to two from four quarter-percentage point
moves projected in December.
"That's a good thing," said Lou Crandall, chief economist at Wrightson ICAP
LLC in Jersey City, New Jersey, commenting on the sequence of actions. "Monetary
medicine gets into the blood stream faster if the public can anticipate what
the Fed's response to an economic shock will be."
There are pitfalls. Investors may become so impressed with their ability
to influence Fed policy that they'll press for more stimulus than the central
bank is willing to supply.
Forcing Fed
"The risk is that markets' perception of such continued accommodation will
embolden them even more to try to force the policy hand of the Fed," Mohamed
El-Erian, chief economic adviser at Allianz SE and a Bloomberg View columnist,
said in an e-mail.
Indeed, investors in the federal funds market are betting that the central
bank will raise rates just once this year, not the two times policy makers
envisage.
The Fed's experience over the last six months also shows how difficult it
can be for the central bank to align investors' view of optimal monetary
policy with that of its own.
"It's a constant learning process by both the Fed and the markets," said
Joachim Fels, global economic adviser for Pacific Investment Management Co.,
which oversees $1.43 trillion in assets.
Automatic Stabilizer'
Yellen used her spoken remarks though to extol the symbiotic relationship
between the central bank and the financial markets. "This mechanism serves
as an important 'automatic stabilizer' for the economy," she said.
Her comments come against the backdrop of continued criticism from Republican
lawmakers and economists that the Fed is following a discretionary monetary
policy that investors don't understand and is hurting the economy as a result.
They want the Fed to follow a monetary policy rule, such as the one espoused
by Stanford University professor John Taylor. It uses a simple equation to
link changes in interest rates to movements in inflation and the economy.
With her remarks on Tuesday, Yellen was "implicitly defending the Fed's
approach in the rules versus discretion debate as being one that's systematic" and
understood by the markets, Crandall said.
I'm not going to try to explain (or even understand) any of this, except to
say that putting oneself at the mercy of financial market sentiment seems a
bit risky, given that Mr. Market is a well-known manic depressive.
It's also an inversion of the proper relationship between "money," or more
accurately the monetary environment, and the players who act on that stage.
Placing monetary policy in the hands of stock, bond, and derivatives traders
is like putting the definition of meters and seconds into the hands of Olympic
athletes: Within a few years the self-interest of the participants will make
past records meaningless.
Some other fun analogies: putting criminals in charge of the legal system,
putting kids in charge of the dinner menu, putting car makers in charge of
auto safety testing, putting food companies in charge of nutritional reporting.
All are recipes for incoherence if not disaster.
Apply the same process to interest rates and currency creation and the price
signaling mechanism of the capital markets will go haywire. And without accurate
price signals, modern market-based capitalism descends into chaos.
