Don’t envy the next Fed chair

With less than five months left before Janet Yellen’s first term as Federal Reserve chair expires, market speculation is rife as to who might replace her. Will it be former Fed Governor Kevin Warsh, White House Advisor Gary Cohn, Stanford Professor John Taylor or Columbia Professor Glenn Hubbard? Or maybe in the end, President Trump will choose to give Janet Yellen a second four-year term, despite the many disparaging remarks that he made about her stewardship on the campaign trail.

Such speculation in the markets is perfectly understandable. After all, the choice of the next Fed chair must be expected to have an important and immediate influence on bond and stock market prices. However, it would seem to be the wrong question for Main Street to be asking. The more apposite question for Main Street would seem to be whether or not President Trump will have the wisdom to choose as Fed chair a person who might have the experience and independence to handle the enormous challenges that he or she will almost certainly have to face during his or her four-year term. As important is the question as to whether or not the president will choose someone to head the Fed who will avoid the mistakes of past chairs who dealt with crises by setting the stage for yet another and more serious crisis down the road.

{mosads}In 2006, on the eve of Alan Greenspan’s replacement by Ben Bernanke as Fed chair, the Economist magazine ran a cover that would seem to be particularly poignant for the appointment of the next Fed chief. It had Greenspan and Bernanke together in a relay race. However, instead of having Greenspan pass Bernanke a baton, it had Greenspan pass him a stick of lit dynamite. That cover proved to be all too prescient. Barely 18 months after taking office, Bernanke faced the “once in a hundred years” Lehman financial crisis that spawned the worst global economic recession in the past 70 years.

Sadly, there is every reason to think that whoever might replace Yellen in February will also be handed a big stick of dynamite with a short fuse. Among the more compelling reasons to think so is that never before has there been so much money printing in such a short period as there has been since 2009. Nor have we had before as large a global asset market bubble as we have today as a direct consequence of that money printing.

While it took the Fed almost 100 years from its founding in 1913 to increase the size of its balance sheet to $800 billion, it took the Fed barely eight years to increase its balance sheet further to a staggering $4.5 trillion. Making matters worse was the fact that the Fed was not alone in massively expanding the size of its balance sheet. The United States was joined by the European Central Bank, the Bank of Japan and the Bank of England.

As Greenspan recently warned, the highly expansionary monetary policies of the past several years have given rise to a global government bond market bubble. He might usefully have added that this bubble has hardly been confined to the world government bond market. Indeed, global equity price valuations are now at very lofty levels that have only been experience three times in the past hundred years, while there are signs of bubbles in all too many housing markets across the globe. Meanwhile, interest rates have been driven down to very low levels in the U.S. high-yield debt market and in the corporate debt markets of emerging economies as investors have desperately stretched for yield.

Heightening the chances of a full-blown global economic and financial crisis within the next three years is an unusual confluence of adverse factors. Beyond the likely bursting of the global asset price bubble, these include the fact that the world economy is now drowning in debt, which is being grossly mispriced by the markets. At the same time, there appears to be no shortage of fault lines in the global economy with several of these fault lines concentrated in countries of systemic importance like Brazil, China and Italy.

One has to hope that in choosing the next Fed chair, President Trump is fully cognizant of the major risks now facing the U.S. and global economies. Maybe then we can hope that he does not yield to the temptation of choosing a Fed chair who will keep interest rates unduly low but rather he will choose someone in the mold of Paul Volcker, who did not shrink from talking truth to power and from making very difficult and unpopular monetary policy decisions. If not, we should reconcile ourselves to an endless round of economic booms and busts that are hardly in our country’s best interest.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director of policy development at the International Monetary Fund and the chief emerging markets economic strategist at Salomon Smith Barney.