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Can Yellen Keep the Boom Going?

Yellen, like notorious previous Fed chiefs including Strong, Martin, and Greenspan, can now claim success in having prolonged and strengthened an asset price inflation which otherwise may well have been about to enter its severe end phase. If history is any guide, the result of that success is to be feared.

Asset price inflations — always characterized by monetary disequilibrium empowering irrational forces — go through a mid-late phase where speculative temperatures fall sharply in some markets which were previously hot. Overinvestment, falling profits, and a discrediting of once popular speculative hypotheses are the usual trigger to such quakes. The central bank can respond by fresh monetary injection and this sometimes brings a new round of speculative enthusiasm even possibly in the recently bust sectors. Symptoms of a sudden climb of goods inflation may emerge. The eventual denouement of crash and recession and the cumulative economic damage are very likely worse than if there had been no late-cycle inflationary stimulus.

The Fed Abandons Plans to Raise Rates

The present Fed resolved to apply the course of monetary injection in early 2016, backtracking from its program of once a quarter 25bp rate hikes heralded in late 2015. The catalyst was a New Year mini-crash in US equities alongside a China currency shock all in the context of a bust in the oil sector and a US growth cycle downturn (2015 and early 2016). In response to the weakening of the dollar the ECB and BoJ intensified their monetary experimentation whilst Beijing pumped up its state credit bubble. In December 2016, amidst evidence of a strong global and US growth cycle upturn, Yellen announced a resumption of tame sporadic “data-dependent 25bp rate rises with no balance sheet reduction.” Such a cautious rate trajectory could be consistent with further aggravation of monetary disequilibrium — in effect a strengthening of late-cycle monetary injections.

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