Economic policy uncertainty, Yellen at treasury

FRED Economic Policy Uncertainty Index

We live in uncertain times - an assertion supported by the Federal Reserve’s economic policy uncertainty index. This index is found within the Fed’s vast economic research database (FRED). It is produced by a team of academics from Stanford and the University of Chicago economics departments to “estimate the level of uncertainty about economic policy by accounting for newspaper references to uncertainty, tax codes, and disagreement among forecasters.” In the Fed’s words, they use the index to measure the public’s general understanding of economic policy, and the likely future outcomes.

Unsurprisingly, the index recorded a record surge in March and April of 2020. Following the recent nominations made by the president-elect and his transition team, the index rose once again. Interestingly, this economic uncertainty index refuses to settle back down within the pre-pandemic range (see chart below). Even as the real economy and financial markets have attempted their recoveries (nominal asset prices being the most successful), it looks as though we are heading toward a future with ever-higher economic policy uncertainty being the norm. With “easy money” Janet Yellen set to take the helm at the US Treasury, it is a big question mark whether the US dollar can maintain its world reserve status and avoid a severely inflationary outcome. Foreigners have significantly reduced their purchases of US Treasury securities this year, and it’s unlikely Yellen’s appointment will bolster foreign demand.

How do today’s elevated levels of US economic policy uncertainty compare to the past? Observe the chart below, going back to the 1980s. This is both a warning that the 2020 pandemic has created a more severe economic shock than others in the past 40 years (1987, 2000, 2008) and its impacts will weigh on Americans for quite some time.

Notice the seemingly moderate level of economic uncertainty during the 2008 recession compared to the present spike. Additionally, note how in the wake of the 2008 recession, more frequent and extreme spikes in the index began to occur. It’s as if the economic system was left with lingering and unresolved pressures following the 2008 housing crisis, even though central planners have claimed their policy responses reduced systemic fragility.

Today we wait for clues as to how Biden plans on bolstering the economy once in office, but strong headwinds are a challenge for the next administration. Inequality, social unrest, the climate, geopolitical risks, monetary policy, trade, are some of the most pressing barriers to overcome. The confluence of such issues makes it very difficult to imagine that the heightened anxiety people feel about the economy’s future will subside. For avid Fed-watchers and macroeconomic analysts, the combination of Biden’s choices of Janet Yellen as Treasury Secretary and (perhaps) Lael Brainard at the Fed introduces great uncertainty with the potential for extreme “MMT” policies and deficit spending that could get out of control.

What about global economic policy uncertainty? It seems the rest of the world began feeling an even greater squeeze over the last decade than did the US. The next chart, produced by the same group of economists as previously mentioned, shows an alarming uptrend since 2008. More of their work can be found on their website: “policyuncertainty.com.”

This observable increase in global economic policy uncertainty began following the worldwide central-bank driven monetization of government debt in 2008. For a central bank policy observer, this naturally begs the question - perhaps there is an observable correlation between greater central bank monetary policy interventions (QE, etc) and higher global economic uncertainty? Moreover, the fact that the US holds the title of world reserve currency could explain why the rest of the world felt a heightened level of policy uncertainty following the 2008 recession, while the US felt it to a lesser extent (at least in the official data).

The following is perhaps not so shocking for those who recognize the dilemmas introduced by today’s Keynesian central bank and fiscal policies gone awry. Economists grounded in reality have brought up the inequalities created by the Cantillon Effect (see my previous article on the mechanics of the Cantillon Effect). Below, we can observe a direct correlation between the European Central Bank’s balance sheet expansion (red), and the rise in the economic policy uncertainty index (blue) for the EU!

The same is true for the United States, where more frequent spikes in greater economic policy uncertainty follow closely alongside the Fed’s balance sheet increases (red).

Rising volatility and the frequency of such volatility in these indices coincide directly with the expansion of central bank balance sheets. As central banks monetize government debts, the unintended consequences from their encouragement of systemic leverage leads to uncertainty in the general public. Widespread malinvestment, greater wealth inequality, and debt financing for more “zombie companies” are just a few of the unintended consequences of extreme Keynesian policies. The future seems more uncertain beyond 2020, with not only draconian lockdown measures dampening the recovery, but record fiscal deficits expected to continue and no doubt be financed by central bankers. More debts will be piled onto already overburdened balance sheets in the coming years. The same problems weighing on the real economy since 2008 are about to be exacerbated, with households set to shoulder the burden of higher taxes, stagflation, and malinvestment encourages by central planners.

The coming inflationary squeeze created by the elite’s global monetary policy regime will be understood by few, yet felt by the masses. The asset-owning class and those most closely connected to the central planners and their money printers will comfortably thrive as heightened economic policy uncertainty and volatility weigh on the public. If we’ve learned anything since 2008, it’s that central bankers cannot kill volatility with their “modern” monetary practices. Rather, they are only capable of displacing it - just sweeping it under the rug only for it to appear with even greater force in the future.

With Yellen’s Treasury appointment secured and Brainard’s likely next up for Fed chair, investors seeking protection must think of where they can preserve purchasing power. Assets with limited supply and tangible value are the likely winners in the coming years. I predict we are not entering a repeat of the roaring ’20s, instead, this will be remembered as the tangible ’20s.