Meet the new boss – same as the old boss

The current boss of the US central bank, Janet Yellen, is stepping down.

Her replacement, Jay Powell, is set to take over as the most powerful human being in the global financial system.

Yellen could have served a lot longer.

But I suspect she’s getting out at just the right time…

A short history of modern central banking

Alan Greenspan – formerly known as the “Maestro” – set the template for modern-day central bankers. He talked a big game on free markets, but under his watch, they were really only free to rise.

I subscribe to the view that Greenspan’s constant interventions to save Wall Street from the consequences of its own worst instincts paved the way for the financial crisis.

Greenspan bailed out Wall Street when the massive hedge fund LTCM went under. Before that, he’d stepped in to calm the 1994 bond market panic. He slashed interest rates after the dotcom bubble burst, even though the wider fallout from that particular bust was not especially systemically risky. In doing so, he created the US housing bubble.

He consistently opposed tighter financial regulation throughout his career. There are strong, logical philosophical reasons for doing so. Regulation creates spaces for loopholes, it makes systems less efficient, and badly-written regulation can also encourage risk-taking.

If you force people to consider and bear the consequences of their actions, rather than micromanaging their behaviour, then you shouldn’t need such tightly defined rules. People will self-regulate and self-correct, because the system will give them negative feedback whenever they do something stupid.

Trouble is, that only works when there are consequences. Greenspan made sure that there were no consequences. By putting a big safety net under financial markets (the “Greenspan put”), he encouraged rampant risk-taking then feigned bafflement when “free markets” didn’t do what they were meant to do.

Greenspan rather left Ben Bernanke carrying the can when he headed out of the door. And whatever else you want to say about Bernanke (I’ve certainly never heaped praise on his head), he had the toughest job. And 2008 didn’t give rise to a repeat of the Great Depression, although the methods he deployed to avoid that – just an absolutely massive version of the Greenspan put, basically – may yet destroy the financial system.

Here we go again

Then came Janet Yellen. And if I was her, I’d feel pretty pleased. She didn’t have to do anything overly controversial. She didn’t face any real pressure to take the punchbowl away, because inflation stayed utterly tame. The market has been pretty well behaved. And by going incredibly slowly on interest rate rises, she’s managed to maintain the Greenspan put nicely.

The timing means she’ll escape any blame for what comes next.

So what’s the new guy like? A chip off the old block basically. He’s not an economist – so he’s got that going for him – but other than that, it’s business as usual. The FT describes him as a “safe pair of hands”, which suggests that the Greenspan put will remain firmly intact.

Indeed, one reason for the latest burst of exuberance in the S&P 500 was the view from Powell that the rules governing the banking system are now “tough enough”. He’s not arguing for de-regulation. But he’s not into introducing more regulation either.

Isn’t it fascinating? As human beings, we are so impatient to see the cycle turn, that when it doesn’t move fast enough, we start to write it off and imagine that the old rules don’t apply.

Yet here we are. Just at the point in the cycle when everything’s booming again, and we have people talking about deregulating rather than tightening up. The predictability of our pro-cyclical behavioural bias is breathtaking, and yet very few of us can properly take advantage of it because we’re too impatient.

Anyway. Powell is not going to have it so easy. He’s very likely going to be the post-crisis Fed chairman who has to face up to the mismatch between stronger growth, rising inflation, and current levels of monetary policy.

Chances are, he’ll be the man in the hot seat when the Fed is told to choose between inflation and loose monetary policy. Given his pedigree, I’d bet pretty heavily on him favouring loose monetary policy.

Hang on to your gold. Alan Greenspan always thought that was a good idea.

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