By Bo Bejstrup Christensen, chief analyst at Danske Invest
To be honest - I simply don't know! Due to the simple reason that I do not know all former central bank chairpersons and their results. However, the question is, nevertheless, highly relevant (if you ask me), because Janet Yellen will be the person who will define the course for US monetary policies for the next many years to come. US monetary policies are unquestionably among the most important drivers behind global bond, equity, currency and commodity markets. If Yellen fails, we will face rough times as investors. If she will be successful, this upswing will last for yet many years, and will, hopefully, result in sound returns to us as investors. But is Yellen capable of handling the task?
Bernanke was the right man at the right time
We set back the time to 2008. Ben Bernanke took over the chair from Alan Greenspan in 2006. Greenspan had been in charge for almost a lifetime, and he had consolidated his reputation as quite an oracle. However, already in 2007 the first challenges turned up for Bernanke and after no more than two years, the US central bank, the Fed, was in a full alert situation when the investment bank Bear Sterns had to be rescued in the spring 2008. However, Bernanke's ultimate challenge did not turn up until September 2008, when Lehman Brothers' bankruptcy sent the financial system and the economy to the brink of the abyss.
Bernanke was convinced that this was the worst threat since the Great Depression (1930s), and the USA was facing a total collapse. If the financial system would collapse, it would pull the now even more debt-ridden US economy - and the rest of the world - into complete chaos.
Fortunately, Bernanke was the right man for the job. He has dedicated his entire academic life to the very study of the Great Depression, and he had reached two main conclusions: The reasons for the depression were partly the central bank easing monetary policies too late and insufficiently and partly the banking crisis resulting in a collapse of thousands of banks.
The result was a year-long recession with unemployment at 25% and a decrease in equity prices of 85% from the top to the bottom. In his recent book, The Courage to Act, which was published earlier this year, it is obvious that Bernanke was determined to ensure that these mistakes were not to be repeated.
Therefore, Bernanke played a decisive role on two fronts: Partly, the Fed eased monetary policies to an unprecedented extent; partly he supported finance minister Hank Paulson's ultimate rescue of the banking system, when Paulsen put pressure on banks to accept more capital injections from the government. So far, the result is a six-and-a-half-year upswing, millions of new jobs and unemployment reduced by 50% to 5%. And as far as most rescue attempts are concerned, taxpayers have had their money back. With interests.
En route, the Fed and not least Bernanke has been subject to strong criticism as e.g. in 2010, when a number of prominent economists and commentators wrote an open letter to Bernanke. Herein they declared that additional easing measures would send the dollar into the black hole and skyrocket inflation. As we know today, they were terribly mistaken! Bernanke's actions were not without flaws. However, in light of the challenges that he was facing, he is an enormous success story and deserves more pages in history books. In this connection, I am quick to admit that I am a big fan of Bernanke!
Yellen is the brain behind the US central bank that we have today
With Wednesday’s rate hike, the US central bank is entering a new chapter under the management of Janet Yellen. The economy no longer needs the same amount of support, and it is time to remove some of it. Critics now state that growth is too weak, or inflation is too low. Once again, Yellen addressed this at the press conference Wednesday by stressing that the economy is in good shape and that it is about to be in an even better shape and in step with decreasing unemployment, wages and consumer price inflation will increase towards the target of 2%. We will see, whether she will be right about this.
However, the decisive factor is the following: The US central bank that we have today is a completely different bank than the one we had just 15 years ago. Back then Greenspan was a master in confusing markets with his intricate rhetoric, information from the Fed was limited and inflation targets were not as clear and precise as today. The fact that we receive much more material today, including the Fed's own forecasts and a press conference each quarter is owed largely to Yellen, since she was responsible for improving workflows and communication while Bernanke was in charge. And despite a couple of foot faults here and there and the first rate hike for nine years, we to a large extent have Yellen to thank for the continuously very low interests rates and stock rates close to historical high levels. So far so good.
Yellen is the right woman at the right time
However, Yellen's greatest challenge begins now. If she tightens too much too fast, she will put a damper on growth at a time when the economy still needs some amount of support. If she postpones tightening measures too long, she will risk that inflation will increase significantly, and the Fed will then be forced to tighten its policy course, which could have serious implications on financial markets and send the economy into recession. The task does not become easier due to the fact that monetary policies are effective with some delay, and that is why the effects from today's actions will not be manifested before one or two years. Her balancing act therefore demands that monetary policies and the general financial conditions are sufficiently easy now to underpin the economy to some extent within the immediate future but also that policies are calibrated in such a way that it will not add a too strong push to the economy further into the future. Here the labour market plays a decisive role - if unemployment falls too much, wage inflation will accelerate and vice versa.
The good news is that Yellen has significant expertise within the labour market. In short, she has chosen a strategy to tighten slightly now and thus increase the pace of the process later on. And even though we believe that we at a later point in time of the upswing will discuss whether the Fed was too late in implementing rate hikes and will be forced to introduce more rate hikes than the market currently finds suitable, she is - in my opinion - currently mastering this balancing act.
Directly asked Wednesday evening whether central banks' tightening measures are not always to be blamed for recessions, she turned around the question stating that this was so because historically central banks had implemented tightening measures too late.
Thus, at half time, the score is 1-0 in favour of Yellen. The second half is the hardest one, but I believe she is well under way to winning. The result will be the longest expansionary period in the USA's post-war era - and even though government bonds will face a rough time in the US in the years to come, we are likely to experience several years with positive (however, lower) stock returns going forward. And who knows - maybe Yellen will turn out to be the best central bank chairperson ever, even though it will be difficult to knock Bernanke off his perch - at least if you ask me!
By Bo Bejstrup Christensen, chief analyst at Danske Invest
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