Being wrong with conviction is a trademark of President Donald Trump. Perhaps that makes Kevin Warsh, his new perceived favourite to replace Janet Yellen as Federal Reserve chair, an ideal candidate.
Warsh was a Fed governor between 2006 and 2011, during the depths of the financial crisis and Great Recession. He was previously a Morgan Stanley banker who now “advises several private and public companies, including serving on the board of directors of UPS,” according to his biography at the Hoover Institution, where he is a distinguished visiting fellow in economics.
Warsh is also, importantly, on one of Trump’s remaining business councils, and is one of the few high-profile figures not to have condemned the president’s equating neo-Nazis to those protesting them in Charlottesville. Warsh is married to Jane Lauder, the billionaire heiress of cosmetics giant Estee Lauder, a major Republican donor and a childhood friend of Trump’s.
Warsh declined to comment for this article.
Back in 2009-2011, while still at the Fed, Warsh was keenly worried about inflation at a time when consumer price growth was actually deeply undershooting the central bank’s 2% target and unemployment remained very high. His concerns, since reiterated in the occasional opinion piece, have proven deeply misguided since the Fed continues to undershoot its inflation goal to this day. Indeed, bond investors have palpable doubts about the Fed’s plans to continue raising interest rates next year and in 2019.
Vocal critic of bond buys, low rates
While Warsh never dissented against the policies of ex-Fed chairman Ben Bernanke, he was always quick to warn of their risks.
“I am less optimistic than some that additional asset purchases will have significant, durable benefits for the real economy,” he said in November 2010, when the Fed was just about to embark in the second of three rounds of bond purchases that helped stimulate the economy and bring the jobless rate sharply lower to its current 4.4%.
“Expanding the Fed’s balance sheet is not a free option,” he warned. “There are significant risks that bear careful monitoring. If the recent weakness in the dollar, run-up in commodity prices, and other forward-looking indicators are sustained and passed along into final prices, the Fed’s price stability objective might no longer be a compelling policy rationale. In such a case — even with the unemployment rate still high — the FOMC would have cause to consider the path of policy.”
That’s not what took place, thank goodness for the US economy. In fact, growth, employment and indeed inflation itself would require substantial additional support from the Fed.
Critics argue that such asset buys, also known as quantitative easing or QE, have distorted financial markets, driving stocks and other assets to new records and potentially creating bubbles that could come back to haunt the economy.
However, the net benefits of the Fed’s easy money policies, particularly given inaction on fiscal policy, have been indisputable. In fact, the absence of wage growth and continued undershooting of the central bank’s inflation target suggest Fed officials should actually reconsider continued interest rate increases.
The Fed has hiked rates four times since December 2015 to the current range of 1.00% to 1.25%. It is expected to hold off this week while it announces plans to start reducing the $US4.4 trillion balance sheet that Warsh fretted so much about.
Investors are on the fence about whether the central bank will hike rates again in December.
Warsh’s mistaken policy views are especially egregious since he was brought into the Fed specifically for his purported expertise in financial markets, which were still sending panic signals even as Warsh tried to strike a more inflation-hawkish, sanguine tone.
And he’s kept it up, almost as if auditioning to be an eventual candidate for Fed chair under a Republican administration. He’s done a good job of it, and appears to be leading the pack following Trump’s newfound distance from Gary Cohn, his top economic adviser.
After one Warsh editorial, former Obama economic advisor and Clinton Treasury Secretary Larry Summers felt compelled to weigh in, in the harshest of terms.
“My friends Mike Spence and Kevin Warsh, writing in yesterday’s Wall Street Journal, have produced what seems to me the single most confused analysis of US monetary policy that I have read this year,” Summers wrote in a blog post.
“Unless I am missing something — which is certainly possible — they make a variety of assertions that are usually exposed as fallacy in introductory economics classes.”
Sam Bell, a Fed watcher who works at a Washington, DC non-profit focused on social issues, has done a great job of documenting the extent of Warsh’s flawed policy record.
“His service was a disaster,” Bell writes in a Medium post. “He was tasked with keeping tabs on Wall Street but instead preached about the wonders of financial innovation right up until it exploded the economy; he helped save the big financial institutions — including rescuing his former employer, Morgan Stanley — but was ready to pull the plug on help for the real economy before it even hit rock bottom; and he wrongly warned of catastrophic consequences from Fed policies.”
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