Global Market Commentary

November 21, 2013

Janet Yellen As Fed Chair — What Does It Mean for Investors?

Dr. Janet Yellen is a Keynesian and monetary dove. According to her writings, her speeches, and now her confirmation hearing, she believes that the U.S. economy is not operating at capacity, and that Federal Reserve activities can improve economic activity to make it operate much more close to its potential capacity.

She is joined on the board by a dovish majority who believe that continued monetary stimulus and a slower tapering of QE are the best medicine for the economy until it has further strengthened. She has stated that she does not believe in permanent QE. She is very committed to seeing unemployment fall substantially, and she states that faster GDP growth will help achieve this goal. We believe that her idea of strengthening the economy is to encourage lower unemployment and faster GDP growth, even if inflation reaches 2 percent. Until the 2 percent level is breached, QE may be moderated, but it will not be withdrawn. All of the trillions of dollars of QE from the last few years will remain in the system. We would not be surprised if she tolerated inflation above 2 percent to achieve her full employment goal.

Janet Yellen’s speeches indicate that she believes government intervention in the economy is useful and required. She received her doctorate at Yale, studying under the Keynesian James Tobin. During a speech at Yale in 1999, she said:

“The Yale macroeconomic paradigm provides clear answers to key questions dividing macroeconomists, along with policy prescriptions. Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not… On the question of whether monetary and fiscal policy can succeed in moving the economy toward full employment Yale answers yes in both cases, except in exceptional circumstances such as a liquidity trap… Do policy makers have the knowledge and ability to improve macroeconomic outcomes rather than make matters worse? Yes, although there are lags and additive and multiplier uncertainty with which to contend.”

Clearly she is an activist and a liberal Keynesian.

Tapering is Not Tightening

To use an inadequate analogy, we can think of the trillions in QE added to the U.S. economy for the last several years as a giant pool of liquidity. U.S. tapering only means adding to the pool at a lower rate. Only when we are no longer adding to the pool, will the Fed have completely tapered. As of today, the Fed has not even begun to taper.

Why We Believe GDP, Corporate Profits, and Velocity of Money Will Rise In 2014

The QE program for the last few years has been somewhat successful, but it has not produced the large improvement in economic activity that the Federal Reserve had hoped. It has created some moderate improvement.

We believe that more rapid improvement has not occurred partly because of fear on the part of borrowers (especially corporate borrowers). They have been afraid to borrow. Were they to gain more confidence that the opportunity for economic growth is more likely than adverse economic consequences, they would borrow more and thus expand the velocity of money as it circulates in the economy. In short, the growing pool of liquidity is not being drawn on, and the money is not being recycled — and as a result the velocity of money is very low. In our view, Dr. Yellen’s positions are pro-QE and pro government support and intervention in the economy. Indirectly, these positions will help the stock market, but could eventually end up hurting the nation’s economic performance. Our personal economic views may differ from hers, yet we are aware that she will have a profound effect on the investment world, and we believe that for the near future, her decisions will support higher stock prices.

In our opinion, as the velocity of money increases, GDP growth, corporate profits and stock prices will all increase. Currently, the velocity of M2 (a money supply measure) is extremely low, as low as it was in 1932–33 and lower than in 2008–09. In our opinion, as confidence in a sound economy returns, borrowing will increase and the velocity of money will rise. For this reason we expect a pick-up in the velocity of money in 2014.

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