Gavyn Davies on Bernanke’s change of heart

keeping inflation low

Since the tenure of Paul Volcker began over thirty years ago, the mantra of the Federal Reserve has been to do what is necessary to keep inflation under control.  Over time, this morphed into the narrower target of keeping inflation under 2%, but the intent has always been to drive inflation lower.  Yes, the Fed has a “dual mandate,” both to conduct monetary policy in a way to achieve maximum sustainable GDP growth and to promote employment.  But the former has invariably trumped the latter.

…until now

In the September 12th pronouncement from its Open Market Committee, the Fed unveiled new monetary stimulus measures targeted at reducing unemployment.  For the first time, they are open-ended both in terms of time and of money.


…especially when there’s a lively debate, even within the Fed, over whether we are in fact already at full employment.  If so, the new measures won’t create any new jobs.  It will only ignite wage inflation, as companies poach employees from rivals in order to expand.

Personally, I don’t know.  I think that if the Fed decision has any immediate implications for financial markets, they’re positive for stocks and neutral (at best) for bonds.  So arguably as an equity investor, I don’t need to know.

Still, I’m curious.  The best I can do is to fall back on the old saw that inflation is better than deflation, since the world’s central bankers have plenty of experience dealing with the former but have gone 0-for when confronted with the latter.

the Davies answer

Gavyn Davies, former chief economist for Goldman Sachs and now a blogger for the Financial Times, has a better answer in his 9/16 post for the newspaper.  It’s worth reading.

The thrust of the post is that, in Davies’ view, Mr. Bernanke’s QE3 decision implies he believes the US is at a tipping point with the chronically unemployed.

As workers remain out of the workforce, the theory goes, their skills gradually erode–and, with them, their chances of finding new employment.  At the same time, former workers’ enthusiasm for the job search effort also wanes.  Eventually, they drop out of the workforce permanently–becoming unfulfilled as persons, burdens on the rest of society for decades and–crucially–inhibitors of future GDP growth.

Recent surveys by the Labor Department suggest the “dropout” rate in the US is starting to accelerate, putting into motion the downward spiral just described.  In Davies’s view, this is what has changed the balance of risks in the Fed’s mind.

is the US job market taking on a European look?–why this is important


The Wall Street Journal is arguing in its Monday print edition that the US job market is–at least in the sense that the US may be facing the type of chronic high unemployment that has bedeviled Europe for decades.

In an earlier online version of the same article, the WSJ pointed out that, despite an unemployment rate approaching double digits, there’s actually a shortage of workers in some specialties in the US.  Wages in these areas are rising significantly, meaning employers can only fill these positions by poaching from rivals, not from dipping into the sea of unemployed.  It also gave machinery-related examples–but it’s now lost in cyberspace.

The JOLT (Job Openings and Labor Turnover Survey) complied by the Bureau of Labor Statistics points out the same phenomenon.  As of the latest JOLT reading (September 2011), there are 3.4 million unfilled job openings in the domestic labor market.  That figure has risen pretty steadily since July 2009, when there were 2.1 million such openings.

Also, the head of the Federal Reserve Bank of Minneapolis, Narayana Kocherlakota, made a much-publicized speech on this topic in August 2010 (see my post), in which he said that the Fed doesn’t have the means to change construction workers into manufacturing workers.  Retraining does this, not easy money policy.

Of course, the roots of European unemployment have been mostly caused by very rigid labor laws that make it very time-consuming and expensive to fire a worker, once hired.  In the US, in contrast, (the smaller) part of the issue is that scared Baby Boomers have stopped retiring at normal rates, and are thus not freeing up jobs for younger workers.  In addition, globalization has moved unskilled labor jobs to emerging markets.  This has been going on for a long time, but adjustment in the US was put on hold during the housing bubble that lasted half a decade.  So the US labor force has a lot of catching up to do.  That’s the main problem, in my view.

why is this important?

Two reasons:

economic policy

It’s probably right to use money policy to stabilize the stock market, so that Baby Boomers will move into the retirement phase of living, freeing up jobs for younger workers.  But, as Mr. Kocherlakota observes, low interest rates can’t retrain workers.   Legislators can–but so far won’t.

stock market

The main reason I’m writing this is that I think most American investors believe the domestic economic recovery is somehow broken because it isn’t following a typical post-WWII pattern.  They continue to think that high unemployment is a business cycle signal that all is not well.  As a result, they’re suspicious of any strong corporate earnings reports and are only willing to pay low multiples for what they regard as “broken” profits.

I think the WSJ article I cite above is interesting because it suggests that, as I’ve been writing for a year or more, that for 90% of the US, the economy is expanding, jobs are secure and the future is bright.  I think that’s why Black Friday and Cyber Monday have been so strong this year.

If this is correct, we should see resumption of wage increases on a wider scale next year.

Frictional unemployment is, say, 4% of the workforce.  This means that 5% of the workforce wants work and can’t get it (I know this figure excludes the underemployed and discouraged workers).  Normal retirement patterns by Baby Boomers might clip 1% from that number, leaving 4% of the workforce to receive government support and retraining assistance.  Yes, that’s still a big number.  But it’s doable.  And denial–or nostalgia for the 1950s, when the US had the only industrial base untouched by WWII–won;t help.

From a Wall Street point of view, however, I think recognition of the structural nature of current high unemployment would mean the gradual expansion of the price earnings multiple investors award to the market.