Washington, DC -- (ReleaseWire) -- 05/05/2016 --DAWN BENNETT: David Beckworth is a visiting scholar at the Mercatus Institute, as well as associate professor at Western Kentucky University. Previously he served as an international economist at the U.S. Department of the Treasury. He is also the author of a book titled Boom and Bust Banking: The Causes and Cures of the Great Recession. His research focuses on monetary policy and his work has been cited by The Wall Street Journal, The Financial Times, The New York Times, Bloomberg Business Week and The Economist. He's also advised congressional staffers on monetary policy and has written for Barron's, Investor's Business Daily, The New Republic, The Atlantic and National Review. In March of 2016 for Politico, Beckworth wrote an article titled 'The Crisis, Blame the Fed' and that's where I want to start today. David, welcome to Financial Myth Busting.
DAVID BECKWORTH: Thank you for having me on the show.
BENNETT: David, despite the Federal Reserve's unwavering confidence in America's fortunes, it just seems that if you could take a quick peak under the hood it reveals a pretty grim state of American commerce. To me the Federal Reserve has warped the American economy, in particular in the past decade their balance sheets have grown roughly from $800 billion to $4 trillion, and low interest rates seem to be the only reason why the U.S. government can manage its gargantuan debt in recent years. So my question is when Janet Yellen, who recently raised rates form 25 basis points to a paltry 50 basis points, caused the markets to tumble off a cliff, what is going to happen when the Fed raises the target rate back up to 6% like in 2000?
BECKWORTH: We'd all like to be there at some point, because if we get to 6%, it will be the sign of the healthier economy, that the economy is healthy again. And the problem is you've got to get there first with a healthy economy not with interest rates. So what Janet Yellen really wants is to see a recovery take place and then raise the rates, and the danger is she is getting ahead of the recovery. And it seems strange that just 25 basis points, a quarter of a percent, can do that. But given the state of our economy, as you mentioned it's so fragile, she has to be very careful moving forward.
BENNETT: She seems to be a little bit more timid now. Maybe I'm reading her wrong but that's what I'm seeing. And if she cuts the rate back to zero would you advise her to go further like into negative territory?
BECKWORTH: I would probably avoid negative interest rates. The Fed does need to be careful. What it does has repercussions throughout the world. And that Politico piece you mentioned, described the relationship between China and the U.S. China's currency is pegged to the dollar and whenever the Fed tinkers around with monetary policy in the U.S. it effectively sets the monetary policy in China. China has its own domestic problems and on top of that, it imports monetary policy from the Fed. So what happened starting about mid 2014 is the Fed began talking up interest rates. If you remember they were talking, "Time to raise rates, time to raise rates." The economy was doing better, Janet Yellen had just been appointed Fed chair, she had proven her inflation fighting credentials I think, and so she was going to raise rates. And so all during that time they were talking of Fed fund rates hikes. And eventually they did it. Now if you go and look at the actual market and see what the market was thinking, they were already pricing in interest rate hikes. And that effectively was the same thing as industry doing it. And we see the consequences of that in the rise of the dollar between mid-2014 and the end of 2015, the dollar rose 20% and that's what really affected China. It choked China and if you recall late last year they had big stock market troubles and again early this year. And so it's kind of the Fed policy coming back to bite us in the rear. It's tightening because we tightened domestically but then it affects the global economy which then comes back and affects us indirectly.
BENNETT: Your theory centers around the idea that the Federal Reserve's behavior affects not only the American economy but all countries whose economies are tied to the dollar. And also in your Politico piece "The Crisis, Blame the Fed," you argue that merely mentioning their intent of eventually raising rates creates chaos. But doesn't this also mean that the Fed is just simply too powerful if it's led by man, who is by definition fallible, it just seems an impossible task to keep everything humming with perfect precision, right?
BECKWORTH: Absolutely. The Fed's track record since the crisis started, or heck even before then, but let's start with the crisis, it has been ad hoc. QE1, QE2, QE3 is very much negative as we go along. Remember forward guidance on interest rates? That thing changed one meeting to the next. In real time it would be difficult, given the way the Fed is set up, for any of us to do well. And it speaks to this knowledge problem, no one person or even a committee of wise people has enough knowledge to plan an economy, and that's true for the Fed as well. So what the Fed needs, given we have a Central Bank, what the Fed needs is more rules-based approach, some kind of rule that will help guide it through different circumstances. We don't expect the Fed to forecast the future, but we do expect the Fed to respond symmetrically to changes in the economy with some predictability.
BENNETT: Again, economies that are tying themselves to the dollar, and what's been even going on in the U.S. economy, why would they do that anymore? Take China, for example, they're getting stronger and they've had quite a rise in their stock market over the last three to four years. I don't think a lot of listeners know, it's up almost 600%. So the small correction that they've actually felt has been minor. Why would China even need to tie themselves to the dollar anymore?
BECKWORTH: Initially they want the certainty of having a fixed exchange rate. So if for a big part your growth model is trade, you want some certainty that how much it'll trade, how much it will be priced in dollars, won't change a lot. So it facilitates easy trade, it's nice that way. Another reason is they don't want to quickly get off the dollar because everyone has built in the expectation that the dollar will be linked the Yuan. So that's becomes consequential because the number of contracts in China, debt contracts, have been denominated in dollars, so there's a number of private firms who have taken out dollar denominated debt under the belief that this exchange rate will hold. Now, to be clear, the exchange rate has fluctuated a little bit, they've allowed a little bit of depreciation, and it's not as rigid as used to be, but it's still firm enough that whatever happens in the U.S. gets transmitted there.
BENNETT: If that is the case, why has China been picking up so much gold tonnage over the last number of years? The speculation is that they're going to be backing their currency, not necessarily 100% of it but at least partially, why do you think that is?
BECKWORTH: I would have guessed purely this is for the investment reasons, maybe speculative reasons. Their currency has a long way to go before anyone would trust it as a major reserve currency. They recently did become a part of the SPR, which is a unit account that IMF holds and puts in a few key currencies from around the world. But it really doesn't mean anything in terms of the significance of the Chinese currency. And in order to be a currency that other countries want to hold, that people want to trade in, you have to be big, which they are, but you also have to have deep capital markets, have fairly decent rule of law, predictability, and all of those things are lacking there. It will be a long time before their currency gets to the level where it would be anything as a pound or as a dollar in terms of international exchange.
BENNETT: I think you wrote that the Fed must immediately begin easing, either by lowering rates or another round of quantitative easing. Is the idea behind that merely to weaken the dollar relative to other currencies, or do you believe this will help America stave off the recession many of us fear we're already in.
BECKWORTH: One way to think about that is there's some interest rate that reflects the fundamentals of the economy. So there's some amount of borrowing and saving based on people's true preferences for investments, for starting business, for paying their way through college. And if you net all that out there's something that would naturally emerge in the absence of a Federal Reserve. And what the Fed wants to do ideally is to place its target interest rate at that market-clearing, what we call natural interest rate level. But clearly we don't know that, it's not observable, but they try to estimate it. And many people think, given the weakness, given the uncertainties from a number of place, that that marketing-clearing, that natural interest rate is pretty low. So the danger is again that the Fed might get ahead of it. They may raise rates faster than the market-clearing rate would be. And again maybe because of the Fed's own decisions in the past, because of the things in Congress or the President, or because of concerns about the global economy, oil prices, but the Fed since it tinkers with interest rates it better tinker in the right way. Ideally be rule-based, much more predictable. But in the absence of that, it's better to do it right if it's going to mess around like it does.
BENNETT: You've also argued that the Fed turned the most recent recession into a great recession due to not lowering rates fast enough, and you specifically cited examples that the economy was falling apart while the Fed was talking about raising rates. How does the Fed know when to stop? Presumably there would have been a recession regardless, so how do you know how much to cut and how fast?
BECKWORTH: Great question, and I've got a lot perspective on that. It's the same idea that there were some signs back in 2007-2008 which reflected the fundamentals of the economy, and the Fed just didn't keep up with it. So the way for the Fed to do better, maybe to course align itself with what the market wants, is to look at asset prices, what does the market say. For example, if you look at breakeven inflation, which is the bond market's anticipated inflation you get from looking at different between regular treasuries and TIPS, it's a signal of what people who have skin in the game, people who trade bonds with real money, for a living think is going to happen in inflation. If you look at that expected inflation from the bond market, it was sharply falling in 2008. The Fed in 2000, if you go back to look at their records, look at their speeches, the big thing they were concerned about was rising inflation. So the market was screaming, "We're going over a hill, we're in trouble," and the Fed thought "We've got to jack up interest rates." I think that was like the straw that broke the camel's back. You're absolutely right, there would have been a recession in any event, it's just how severe did it have to be. And this goes back to your earlier point, the Fed trying to be discerning across all situations is impossible, it's very difficult to know in real time. The best they can do is look at asset prices, what is the market saying, because really it's you and me, it's investors, if we're going to panic, the Fed needs to see that and it needs to respond to that, not respond to the CPI which reflects last month's measure, which might reflect changes in oil prices coming from China. It needs to be forward looking, and the best way to do that is look at the asset prices from the bond market and other places.
BENNETT: Wouldn't it be just easier to go back to an economy that's driven by capital, innovation, hard work? All of this central bank micro managing to me is so easy to get wrong, and it appears more complicated than it's worth, and in our opinion here on Financial Myth Busting it's not really working. Why not just let the markets create wealth rather than the printing press?
BECKWORTH: I would argue that it's a great idea but that would be very difficult to do in one fell swoop. I do want to get there and move in that direction. So something I've proposed and some other colleagues at the Mercatus Center have proposed is to go to a nominal GDP target, and I'll explain what that means. It means instead of the Fed trying to tinker with inflation and trying to divine the latest developments, simply try to stabilize the amount of money spending. So try to keep money neutral. And that's the best they can do given we have a central bank, keep money neutral, and keep the path of money spending neutral. And if you can do that, so you're stabilizing money spending, it doesn't grow too fast, it doesn't go too slow, kind of grows in the pace of the economic growth, money and Fed issues would fall into the background. We would be more concerned about structural development. Those are the things we're talking about, what can we do to make our productivity go up, what can we do to make labor markets clear faster. I do think it's a problem, I agree with you, I think it's a distraction, I'm guilty of it myself. Every time a Fed official says something, we wait with bated breath on what Janet Yellen is going to say. We've gotten to that point in a statement of how perverse our monetary system has become. But given that we have it I think we need to move in the direction of something like a nominal GDP target rule.
BENNETT: Janet Yellen last week said the U.S. economy is on a solid path and there are no signs we're in a bubble. But how can we ever know if we're in a bubble or not, if interest rates are being set by market forces? What do you make of her statement?
BECKWORTH: The Fed has a pretty terrible forecasting record. So if you are concerned about your own portfolio, you definitely get a second opinion, like you would with any doctor, get a second opinion. But look at what the market is signaling. Earlier this year the market was signaling they were very, very worried. Stock markets were going down, the yields on 10 Year Treasuries were falling which is a sign that people are racing for something safe and secure. Those are the things I go to before I trust the wisdom of the Fed. Look again at inflation forecast from what the bond market is seeming, it's called the breakeven inflation, as in TIPS. Those are the things I would look at before the Fed. Of course what else could you say. I don't want to be too harsh here, I'm reminded of a speech that Ben Bernanke gave in 2006. And at the time the treasury yield curve was inverting, as you know that usually signals a recession is coming, and Bernanke gave a speech and said, oh, no, no, no, it's different this time, don't worry about it, its different reasons. Even though in the past an inverted treasury yield curve normally signaled recession, it's different this time. Well, you should have gone with the market forecast as opposed to him. The point I want to bring up is that even if he believed there was a recession he couldn't say that. So even if Janet Yellen does know some things we don't she will be pretty guarded on what she says. So at the end of day get a second opinion.
BENNETT: David Beckworth. Thank you for being on Financial Myth Busting.
For over a quarter century, Dawn Bennett has been successfully guiding clients through the complexities of wealth management. Dawn Bennett provides individual investors, corporations and foundations with holistic investment strategies. Her unique vision and insight into market trends makes Bennett a much sought after expert resource with regular appearances on Fox News Channel, CNBC, Bloomberg TV, and MSNBC as well as being featured in Business Week, Fortune, The NY Times, The NY Sun, Washington Business Journal in addition to her highly regarded weekly talk radio program - Financial Mythbusting. Through prudent and thoughtful advice, Dawn Bennett has strived to consistently provide the highest quality of guidance.
About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com.
She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
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