Sorry, Wall Street. Janet Yellen is no doveSeptember 17, 2013: 11:30 AM ET
The notion that Janet Yellen is some sort of easy money "dove" and that Larry Summers is a tight-fisted "hawk" has no basis in reality.
By Cyrus Sanati
FORTUNE -- The equity markets and liberal Democrats may rue the day they ever cheered for a Yellen-led Federal Reserve. Both the S&P 500 and the Nasdaq soared close to new highs Monday on the news that Larry Summers had withdrawn his name for consideration to be the next chairman of the Federal Reserve, leaving Janet Yellen as the only viable candidate for the position. Apparently, Yellen is seen by the markets as being more "accommodative" than Summers when it comes to printing money to drive growth, which Wall Street has interpreted as being good for the stock market.
But the notion that Yellen is some sort of easy money "dove" and that Summers is a tight-fisted "hawk" has no basis in reality. Unfortunately, this simplistic contrasting construct, which has been accepted lock, stock, and barrel by both the markets and the media, has managed to irreparably damage the search for the next Fed chairman and has effectively handed the keys to the vault over to Yellen. But now that she is the front-runner and Summers is out of the way, it would be wise for investors to take a much closer look at Yellen's record. Contrary to what has been largely said and written, this sweet dove may prove to have very sharp talons.
Larry Summers shocked the markets when on Sunday afternoon he announced that he was withdrawing his name for consideration to be the nation's next Fed chief. Political pundits spent most of Monday speculating as to why Summers bowed out and what this all meant in reference to President Obama's influence level with Congress and his party.
While the pundits duked it out in Washington, the equity markets soared on Wall Street. Apparently investors and traders had got into their heads that Summers would be "hawkish" if he were in charge of the Fed. The term "hawkish" is confusing but in this context it meant that if he was put in charge he would be less likely to continue the "easy money" policies of his predecessors and would prefer to fight inflation even though it would cause economic growth to decelerate and unemployment to shoot up.
Liberal Democrats gasped with Republican-like false outrage over the prospect that Summers would hurt the nation's so-called economic recovery by essentially turning off the printing presses. In reality, though, they were more worried about the Fed being run by a guy whom most of them hated for being one of the biggest boosters of deregulation in the late 1990s -- despite the fact that it occurred under a Democratic president. Many also distrusted his perceived "close relationship" with Wall Street. With the Fed being the regulator of the big banks, having Summers at the helm was seen to be akin to allowing the proverbial wolf to guard the chicken coop.
So you had two completely opposite groups, Wall Street and liberal Democrats, united in their opposition for Summers for two completely different reasons. This is probably the only time in recent memory that these two disparate camps have agreed on anything. Summers, it seems, never had a chance.
Yet while Wall Street and liberal Democrats were turned off by Summers, they were both strangely, in love with the second person on President Obama's short list -- Janet Yellen. Apparently, Yellen has given the impression that she's not so hot on the idea of austerity when it comes to fighting a crisis and would be more likely to make decisions aimed at stimulating the economy and keeping unemployment low, despite the impact such moves would have on the money supply. Therefore, it was seen that she would be more likely than Summers to continue the recent Fed tradition of expanding the money supply through the purchasing of bonds, known as quantitative easing, and would resist "tapering" until the unemployment rate fell to some "acceptable" level.
Wall Street liked her focus on growth, as that is one of the main drivers of the stock market, while the liberal Democrats liked that she would aim to keep unemployment low. They also believed that she would be tougher on the banks and that she would force them to be more prudent in their lending habits by forcing them to hold on to more capital, thus buffering them from a bank run.
It is hard to say for sure if any of the assumptions made by either camp in regards to Summers or Yellen would hold true if either one of them was put in charge of the Fed. This notion that Summers is hawkish and that Yellen is dovish seems to better reflect their public demeanor -- Summers is a boisterous loudmouth who speaks his mind while Yellen is far more reserved. But when it comes to economic theory they are basically on the same wavelength.
For example, both believe that the markets are not "self-correcting," meaning that government regulation, to some degree, is needed to keep the markets from imploding. Neither has been an advocate of total deregulation, as some libertarian-minded Republicans would support, nor has either one advocated a strictly planned economic model. While it is true that Summers supported efforts to deregulate parts of the financial system in the late 1990s, he wasn't nearly as distrusting of the government as former Fed chairman Alan Greenspan and maintains that government has a role to play in the economy.
Yellen was the head of the Council of Economic Advisors during all of the deregulatory efforts of the late 1990s so she is no "outsider." Indeed, one can say she is the ultimate insider. If liberal Democrats wanted a champion for regulation they are backing the wrong woman. They should really support Brooksley Born, who, as head of the Commodity Futures Trading Commission at the time, openly fought the administration's efforts to keep derivatives in the dark. Born was censured and ultimately sidelined because of her opposition. Yellen moved on to become the head of the Fed's 12th district, headquartered in San Francisco.
That district incorporates California, Arizona, and Nevada -- basically ground zero for the housing bubble, which ultimately sent the nation into the great recession. She told the Financial Crisis Inquiry Commission in 2010 that she didn't see the risks associated with securitization, which led to the housing bubble, until the bottom fell out. If she didn't see any problem with securitization then it is safe to say, given her economic viewpoint, that she probably wouldn't have been an advocate of stronger regulation during the time when the nation needed it the most. This should dispel the notion that Yellen is some sort of pro-regulation angel. She may say now that more regulation may be needed, but that's all talk. While in positions of power she was silent.
As far as the markets are concerned, all this regulatory talk is simply politics. Wall Street is more interested in what Yellen would do when it comes to interest rates. While she has made a few speeches that would indicate she is "dovish" when it comes to monetary policy, that doesn't mean she will always maintain that viewpoint. What we know from her record is that Yellen is not an ideologue and that she isn't keen on rocking the boat. That means she would probably strive to keep rates low as long as unemployment was high and economic growth was low.
But it would be unwise to assume she would continue that policy if inflation starts to creep up. Bernanke has by the grace of God or by the foolishness of some investors, whichever you believe, been able to print trillions of dollars out of thin air for years without any real inflationary pressure. The truth is the U.S. is sitting on an inflationary time bomb that could go off any second, and it will be up to the Fed to contain the blast. If you think that Yellen would keep interest rates low if confronted with the prospect of hyperinflation, think again.
"The FOMC is determined to ensure that we never again repeat the experience of the late 1960s and 1970s, when the Federal Reserve did not respond forcefully enough to rising inflation and allowed longer-term inflation expectations to drift upward," Yellen said in a speech in 2011. "Consequently, we are paying close attention to the evolution of inflation and inflation expectations.
Yellen lived through the stagflation of the late 1970s that ultimately forced the Fed to push rates up to as high as 20%. She saw how this drastic, but necessary, action caused the markets to tumble and unemployment to skyrocket. Yellen doesn't want to be the person to hike rates out of necessity so you can bet that if there is a whiff of hyperinflation she will move to slow down the printing presses.
In the end, Larry Summers, fairly or unfairly, was simply too controversial a figure to head the Fed. But controversial doesn't mean "hawkish." In the same vein, being soft-spoken and totally clueless doesn't make Yellen a "dove," either. Both are part of an economic establishment whose policies allowed for the formation of not one, but two major economic bubbles to form in the last 20 years. To believe that either would respond radically different if confronted with a similar problem would be foolish.