Is it Time for El-Erian to be a Fed President?

Mish

Economic advisor Mohamed A. El-Erian discusses Fed goals and the methods to achieve them. He has a much different take than the current set of groupthink members.

Feasible vs Desirable

Please consider The Fed Must Weigh What’s Feasible Versus Desirable, a Bloomberg op-ed by El-Erian.

Reacting to growing indications of a moderating recovery, some economists and Wall Street analysts are pushing the Federal Reserve to provide even more stimulative “forward guidance” at its policy meeting this week. The Fed is easily able to do so, and not only under the auspices of its long-established operating paradigm of data dependency and insurance mindset. Last month’s framework revisions have structurally built in more flexibility by allowing for a higher inflation target in periods such as now.

Yet what is operationally feasible is not so clearly desirable. The more the Fed goes down this road on its own, the greater the risks to economic well-being and its own credibility. Also, the challenges are not limited to domestic problems.

Credibility? What Credibility?

The Fed has missed targets on inflation, growth, and issues related to unemployment for many decades.

It has relied on models proven not to work such as the Phillips Curve and inflation expectations.

The Fed calls forward guidance a primary tool.

But forward guidance is little more than a proven opportunity for hedge funds and market makers to front run Fed operations with leverage.

The result of this incredible mess has been three economic bubbles in succession, with increasing amplitude each time.

Credibility aside, El-Erian comes up with five issues with the path the Fed is taking.

El-Erian's Five Issues 

  1. Monetary policy has repeatedly shown limited effectiveness in countering the negative impact of the economic pressures emanating from the Covid-19 shock. This is especially true given that what policy can achieve – ensure smooth market functioning – is not an issue.
  2. Even looser monetary policy is likely to result in further disconnecting financial markets from the real economy (the issue of prosperous Wall Street versus struggling Main Street). This could easily amplify the view that the Fed is aggravating inequality. Indeed, many signs of excessive financial risk-taking are already flashing yellow or red on the back of the continuously reinforced market notion of a deep, always in-the-money “Fed Put.”
  3. The threat of a surge in inflation in one to two years cannot be ignored as easily as in the recent past. The data are picking up increased evidence of uneven higher price formation.
  4. Greater Fed activism could well contribute to delays in Congressional actions on economic policy initiatives. Specifically, Republican lawmakers and the White House are less likely to seek a compromise with Democrats if the stock market continues to do well. And the closer we get to the November election, the louder the political blame game gets, and the smaller the window for compromise.
  5. Loose Fed policy is pushing yet another round of flighty foreign portfolio capital to them in search of higher returns (or, more accurately, escaping very low returns in the U.S. and other advanced countries). This additional turn in the “feast-famine-feast” foreign capital phenomenon for emerging markets comes at a time of higher debt, reduced policy flexibility and increasing probability of a “paradigm of non payment.”

What About Inflation?

I agree with El-Erian on points 1, 2, 4, and 5.

The problem with 3 is how to define it. Inflation is running rampant already if one considers asset prices and junk bond bubbles as key components.

Moreover, the mere substitution of actual home prices in the CPI instead of owners equivalent rent would show inflation is already hot. 

The Fed's focus on "Consumer Inflation" rather than "Inflation" is the problem. 

When asset bubbles burst, they bring about debt deflation which is what the Fed should be worried about but isn't.

BIS Deflation Study

The BIS did a historical study and found routine deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.

Deflationary Outcome

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

The inflation that El-Erian see's in the future is now, and the future will be another bout of deflation. 

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Breath of Fresh Air

Overall, however, El-Erian provides a much needed breath of fresh air.

He has a far better grasp of things than Jerome Powell or any of the Fed presidents all clamoring to let inflation run hot to make up for inflation allegedly running too low. 

Tweet Exchange

El-Erian made a Tweet the other day in which he said "The Fed should do nothing."

I replied that there should not be a Fed in the first place.

Feasible vs Desirable Take II

It would be highly desirable to not have a Fed at all. Instead, we should have 100% gold-backed money, end fractional reserve lending, and let the market (not a group of clueless central planners) set interest rates. 

However, It is not be feasible right now to get rid of the Fed. It is  more feasible to end Fed group-think mentality.

On those grounds, I support gold-advocate Judy Shelton for the Fed as discussed in Controversial Gold Advocate Advances for a Fed Appointment. 

Right now, she may be a vote or two short.

The Fed Should Do Nothing

El-Erian was more correct than not when he Tweeted "The Fed Should Do Nothing", a Tweet now deleted. In a private exchange he says he does not remember deleting it.

Three successive economic bubbles clobbering the middle class with the Fed bailing out the banks and the wealthy provides ample evidence of the need to end the Fed.

Doing nothing would be a huge step in the right direction.

In the spirit of diversity and feasibility over what's truly desirable (ending the Fed), I support the appointment of El-Erian (or anyone "do nothing" views) to to the Fed.

A Fed chair appointment would be even better.

Mish 

Comments (20)
No. 1-14
Casual_Observer
Casual_Observer

Doing nothing isnt an option because of derivatives. This shadow economy and market is bigger and the elephant in the room

Eddie_T
Eddie_T

I like El-Erian too. One of the few economists who makes any sense to me.

I doubt we live to see the Fed ended.....maybe if they do cause a real long term deflationary depression. Likewise, I think a return to gold backed money is just so difficult to do for political reasons.....it takes away the punchbowl for Wall Street. I doubt Judy Shelton will get on the Fed, but even if she does I don't see her turning the tide.

I tend to think a little differently than you....in that I think the Fed is very aware of the possibility of a deflationary crash...but they think QE and low rates are the way to keep it from happening. It is an arrogant position, no doubt.But they've gotten themselves painted into a corner now.

I built my financial house to profit from inflation...so I'm okay with it, as long as they can keep the party going....but I agree with you that the specter of a deflationary collapse is always with us these days.

Sechel
Sechel

El-Erian is right but he'd still be a disaster at the Fed. Once there he'd be expected to solve the world's problems and wold commit the same errors as his predecessors. I agree with El-Erian when he says we're expected the Fed to solve problems best left to lawmakers

PecuniaNonOlet
PecuniaNonOlet

45 days till election. We have reached a point where we need radical thinking on just about everything: banking, finance, fed, government, education, criminal justice, healthcare, etc. None of it is working for most people.

Curious-Cat
Curious-Cat

Seems that there are a number of people, here and elsewhere, who know what needs to be done regarding the FED and the other oligardists but lack the organization and resources to ever begin the needed changes. Without an organized effort these conditions will continue to fester and grow. I would be interested in any ideas to change that situation. (But I will be surprised if I get any.)

Webej
Webej

Regardless of what happens ...
If they helicopter in money to support spending, people will see prices they cannot afford.
If they don't, prices might fall but people will still see prices they cannot afford.
They will instead waver, afraid to lose control if they shower money, more afraid that the whole ponzi credit/derivatives scheme will implode.

RayLopez
RayLopez

Mish says: "I replied that there should not be a Fed in the first place." - which is not a bad idea. I firmly believe money is neutral short term and long (Google this at Investopedia), with the caveat money is not neutral during fiat money hyperinflation, and a gold standard or fixed money supply would not be a bad idea. The "no Fed" pre-1913 economy was not so bad at all. George Selgin, at Cato, also advocates a sort of no-Fed economy, with crowd sourcing of the money supply. Again, IMO, it's not a bad idea. What is the real power of the Fed? They go crazy, print money and we have hyperinflation. Once money is hyperinflating, it no longer is neutral. It costs money in both menu costs and shoe leather costs when prices are doubling every thirty minutes.

ColoradoAccountant
ColoradoAccountant

What happened to the old idea that the Federal deficit should be equal to the change in GDP? This creates the dollars needed to equal the additional goods and services available. Then neither inflation or deflation.

Nickelodeon
Nickelodeon

End the Fed....

Dodge Demon
Dodge Demon

Mish, he already has a great job at Allianz Insurance Company. Good people there.

phatmaster
phatmaster

End the Fed!

YuShan
YuShan

I think that we are slowly moving into a full reserve fiat system (as opposed to credit money that we have now, with money creation by commercial banks).

You already see that happening: the Fed (and other central banks) just monetise all the money the government wants to spend (i.e. fiat money). If sometime in the future inflation would show up in the CPI and threatens to go out of control, they will have to limit credit creation, i.e. lower the multiplier. That makes traditional banking unprofitable, so that will disappear.

In the end you'll just have a full reserve fiat system with a massive central bank balance sheet and commercial banks will be redundant. You'll deposit your money directly with the central bank and borrow directly from the central bank (the central bank will create the money or destroy it at will and sets the interest rate as it likes.)

I see the signs already here (Europe). Several of my bank accounts have recently been terminated by the banks themselves because they are not interested in your savings anymore. Borrowing from the central bank is cheaper and with deeply negative interest rates on reserves savings accounts are losing them money.

Flatlaxity
Flatlaxity

There’s little doubt, although you wouldn’t think so in reading the popular press and listening to pundits, we’re going to get disinflation and probably deflation. The 2% game established by the Fed is a joke; talk to the Japanese about trying to achieve that in a sustained way – even with Abenomics. The inflation effects (to goods and services – not assets) of the huge, huge Fed and Administration/Congress largesse launched this spring, is about to taper off – perhaps with a bang if bubbles are allowed to bust.

Right now the Fed is on hold: 1) short term rates are being held at zero; 2) The continuing $120B/mo purchase of treasuries ($80B) and MBS ($40B) is balanced by the maturation of the huge Fed asset pool. The balance sheet has held constant since late May.

Any more in the way of largesse should come from the fiscal side. The Democrats aren’t going to enact anything until after the election; Trump is still benefitting from the effects of this spring’s Government infusions. We should see some sort of passage during the lame-duck session.

Regarding inflation, both recent and distant history, has shown we’re headed for deflation – unless, given the expected frustration of unfruitful future Government money infusions, we ultimately switch over to hyperinflation. It’s like taking dope; you always need more.

However, with our gov’t debt/gdp at 120+% and growing to 150%, we’re substantially below the Japanese at 250% (and growing under Suga.) Their economic growth rate since 1990 is 40% below ours; they’re constantly mired in fighting deflation. Fed QE1, QE2, QE3 and now QE4, have yet to provide anything but a floor under our reduced/misaligned economy; moreover, this floor comes at a cost of slower growth and low inflation.

tnguy1450
tnguy1450

I really try hard not to put Muslims in power over me or anyone else in America. Their Koran tells them to kill, tax, or convert all infidels. Why would I want a person with such a world view in the Federal Reserve, which I agree, needs to be ended?


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