Financial media pundits have been breathlessly speculating lately about who the next Fed Chair will be. Will it be Yellen again? Will it be Cohn? Will it be Warsh? Or will it be somebody else?
I have a pretty good idea, and if I were handicapping this race, I’d give Warsh 3-2 odds.
Among the names that have been floated to replace Yellen, there have been no radicals except perhaps Yellen herself. The rest of the horses in the race are all members of the Washington-Wall Street-axis-establishment echo chamber.
If there’s a radical in the crowd, it’s Madame Chair. Yellen, who is the shortest Fed Chair in history, even shorter than Bernanke, is growing in stature in my eyes.
Here’s why Yellen is a hero – and why her legacy will remain even if Trump says, “You’re fired!” on his current reality show production.
Why Yellen Is Truly a Revolutionary
In a nutshell, Yellen has set the Fed on “autopilot” (her word) to reduce the size of its balance sheet. That will shrink the monetary base and take money out of the banking system.
This is a big deal. Remember Rule Number One: Don’t fight the Fed.
In the end, regardless of who will be the next Fed Chair, Janet Yellen has set in motion a momentous policy. It’s the kind of policy that, when its effects are finally felt in a year or two, will make the establishment economists say, “But nobody could have foreseen this,” just like they did during and after the financial crisis.
In fact, a few people understand what the new policy means and have warned about it.
Yellen is a true revolutionary in my book. She moves shyly, but slyly. Initially watching her press conferences, I felt that she gave the impression of an absent-minded professor. She reminded me of my soft-spoken, often-mumbling 80-year-old 9th-grade home room teacher, Miss Kinore. Watching Yellen, I thought, “This is terrible theater,” as she answered the softball questions that the Wall Street-captured media threw at her. She mumbled and meandered and added absolutely nothing that we did not already know.
But over time, as she very gently and gradually moved policy toward real tightening, not by raising interest rates, but by actually removing money from the system, my opinion changed. I think it was an act to disarm people. And it worked.
Yellen has moved Fed policy to its most hawkish position in history. Never before has the Fed pronounced that it would proactively and automatically remove cash from the system on a systematic prescribed basis. This is just as revolutionary a move as quantitative easing (QE) itself. In fact, it is more revolutionary because it involves immense risk. The Fed instituted QE in 2009 QE out of sheer panic. The Fed thought QE would be the firehose that would put out a raging fire.
This policy could start one, and Yellen almost certainly knows that. Attempting to keep markets calm, Yellen is soft pedaling what the new policy means by using euphemistic code words like “unwinding” or “normalization.” She uses innocuous, calming words instead of the more accurate, but potentially alarming truth.
The truth is that “normalization” means tightening. It means draining money from the banking system and the markets. Yellen is beginning the process with tiny baby steps by removing just $10 billion a month from the banking system for the first three months. Again, it’s a calming measure. The initial effect will be subtle. But the real effect will be felt when the initial baby steps ramp up toward the objective of removing $50 billion per month from the system.
In fact, by the time the worst effects are felt, Madame Chair will have left the building. She has left dealing with the fallout to whoever follows her.
Yellen reminds me a bit of Ike. Eisenhower played the kindly old uncle out playing golf and enjoying life, while not paying too much attention to the Presidency. It made people forget that he defeated the greatest killing machine in the history of the world. Then, in the Presidency, behind the somewhat bumbling avuncular façade, Ike was the, calculating cold-warrior, working behind the scenes to restrain both the Soviets and the U.S. “military-industrial complex” that he warned of at the end of his term.
Similarly, I believe that Yellen’s bookish, absent-minded-professor act is just that, an act. She is really a cool, calculating strategist, who knows where she wants U.S. monetary policy to go and how to move policy in that direction with the least possible initial disruption.
Yellen is moving the Fed back to old-time religion. That’s a good goal even if we never fully get there.
Yellen Is Trying Her Best to Clean Up Bernanke’s Mess
And we probably won’t get there. Bernanke’s money-printing bad precedent will now and forever be a policy option. When the going gets tough, the Fed’s money printer cadre will panic and will ultimately rule. As the impacts of the Fed’s balance sheet “normalization” take a heavy toll, the Fed eventually will reverse course.
But first, we’ll have to face the music of “normalization.” It will be a slow moving Wagnerian dirge that will take several years to play out. Wall Street will chant a refrain, “Never sell, never sell, never sell” as the dirge plays on. While most investors fall into a trance, never selling, we must prepare to profit.
Looking back, we now know that Ben Bernanke left a giant $4.5-trillion albatross in Yellen’s lap. His evil plan was to make sure the banking system would always be so awash in cash that interest rates could never rise materially. Bernanke is Mr. Easy Money. No Fed Chair in history is remotely close. Bernanke knew that for practical purposes it would be impossible to return to tight money without crushing the markets.
He was right about that. The markets will prove him right over the next few years.
Bernanke made the choice that speculators and bankers would be the winners, and that hardworking, honest, and thrifty savers would be the losers. My mom and dad (and maybe yours, too) worked hard all their lives, saved a few hundred-thousand dollars, and hoped that the interest from that nest egg would supplement their social security to tide them over for the rest of their lives.
Bernanke robbed them of that with zero interest-rate policy (ZIRP), and he robbed the U.S. economy of the spending that would have come out of that income. Instead, he gave people the choice to speculate or suffer, to consume their principal, lower their spending and standard of living, or both.
Many who could not or would not speculate suffered grievously financially. Many of us have borne the financial burden of caring for our elderly parents when their savings ran out. I was one of those people. I know other people who were in the same boat. Bernanke chose millions of middle class familes, our families to be the losers.
Yellen wants to change that. And that makes her the true revolutionary here. Bernanke knew that removing the $2.7 trillion in excess bank reserves which QE had created could not be done. At least, he knew it could not be done without causing bear markets in stocks and bonds, which in turn would have set off another financial crisis and more economic chaos. So he thought that no Fed Chair would ever attempt it.
But Yellen, to her eternal credit, has chosen to take those excess reserves out of the system
I like to think of this “normalization” as a return to good, old-time religion, where thrift and rational investment receive fair and just returns. The days of wild, riskless speculation with endless flows of free money that causes massive asset inflation will end. We could then return the U.S. economy to a sound footing based upon rational risk/reward calculations with fair, low-risk returns to retirees and savers like our parents and even some of us.
Maybe Yellen does not realize the pain in moving toward that goal. It will be the pain of a bear market. It will affect not only the investment markets, but it will also take a toll on the U.S. economy. But, if she is aware, she has chosen to take the risk. It is a risk worth taking.
Wall Street is worried about this, and its spokespeople are trying to divert your attention with media circuses to keep you buying what it is selling.
The Wall Street-captured media’s function is to divert you from focusing on what really matters. In this case, what matters is that the Fed has declared its intent to end the stock market bubble.
But if you and everybody else in the public are selling, who will Wall Street sell to? How will the sharks and shakers of Wall Street get their long positions whittled down to a manageable size? How will they build up short positions so that they can profit when the bear finally emerges from his den? They need to keep the public on the buy side of those trades.
Meanwhile, we will be looking for opportunities to get on the same side of those trades as the dealers. That means that we’ll be looking to short the stock market by selling short the SPY or buying certain inverse ETFs or even buying puts. Success in short-selling or put-buying requires good timing. It’s still too soon. But the time is coming. I’ll alert you here to when the time looks right.
Meanwhile, continue to systemically sell stocks regularly with the goal of raising a substantial cash cushion by January.
Fortunately, no matter who Trump picks, Yellen’s legacy should last.
The Next Fed Chair Will Follow in Yellen’s Footsteps
Yellen has clearly enunciated that the reduction of money in the system under “normalization” will be on autopilot. It won’t change unless there’s a material adverse event. Obviously, that material adverse event, which at the very least would need to be a GABS (Generally Accepted BS) 20%-down bear market, is still over the horizon.
New Fed Chairs have always respected the precedent set by their predecessors until the situation has become untenable to do so. Whoever Trump appoints as the next boss will most assuredly follow the policy of the old boss. Yellen laid down the law. There will be no material easing of policy until there is a “material adverse event.”
The Fed will tighten the screws until that material adverse event happens. Bond prices will fall; yields will rise. Stock prices will fall. Interest rates will rise. And they will continue to do that UNTIL THERE IS A MATERIAL ADVERSE EVENT!
Rule Number One is eternal and unyielding: Don’t fight the Fed! The bear is coming. He’s just over this hill that the market is now climbing. Over the next six months, systematically and steadily continue to sell stocks, toward the goal of raising a substantial cash cushion by January.