Replacing Ben Bernanke

Briton Ryle

Updated June 10, 2013

A king from centuries past was troubled by the risks of succession.  “Some other person will control everything I worked and studied for. And I do not know if that person will be wise or foolish,” he lamented.

Even if Dr. Ben Bernanke is not as overly concerned over the upcoming succession to his post as Chairman of the U.S. Federal Reserve, countless others in the upper levels of the federal government, including the President himself, definitely are.

January 31st, 2014—less than 7 months from now—will likely see a change at the Federal Reserve’s helm as Bernanke’s second term as its Chairman expires.  What will his successor do with all of Bernanke’s hard work and careful planning?  Will he/she continue it?  Or radically mix things up and implement a new plan?

America’s economic recovery—along with investors’ plans—may very well hinge on this one single personnel change.

Bernanke’s Legacy

In observing Bernanke at conferences and hearings, we note his remarkable calm, collected, methodical, and steady nature, characteristics that also distinguish his tenure as Federal Reserve Chairman among all others.

The graph below superimposes U.S. GDP (upper and right) overtop of U.S. interest rates (lower and left) from 1971 until present.  Bernanke’s steady hand since his appointment as Fed Chairman in 2006 pulled U.S. GDP out of a serious dive in 2008 and stabilized it at around +2% by his insistence that interest rates be kept unshakably steady at a fraction above zero. 

GDP vs interest ratesSource:

Whether you agree or disagree with his stance, you have to be impressed with the results he has delivered in view of the roughness of the seas he has had to navigate.  That steady line you see at the right of the graph is Bernanke himself in a nutshell.

But “steady Benny” is not interested in a third term as Fed Chairman.  Although he has said nothing about his future plans, neither has he dismissed the rumors circulating about his departure next January—rumors which grew louder with his absence from the last Jackson Hole economic summit in August, making him the only Fed Chairman to miss the annual event in 25 years.

What he leaves to his successor is a steadily growing economy.  But some are arguing that FOMC policies under Bernanke’s chairmanship are sowing seeds that will upset this steady growth in very quick order unless changes are made now, including a decrease in stimulus and an increase in interest rates.

The next chairperson to the post will likely have an even more difficult task than Bernanke has had until now… having to plan not only when to unwind 5 years of emergency policy measures, but also how.

The Candidates

The economy’s new monetary policy quarterback will require someone with a great deal of fortitude and conviction to carry out plans in the middle of an ever-intensifying debate in which everyone predicts the collapse of American capitalism if his or her ideas are not implemented.

Probably the most understandable replacement would be Janet L. Yellen, current Federal Reserve Vice-Chair since October 2010.  Considered as much an inflation dove as Bernanke himself, Yellen would almost assuredly continue Bernanke’s plan, though undoubtedly with gradual stimulus reduction as time advances.  Any adjustments, however, would likely retain the highly accommodative and expansionary leaning of current policy.

Likewise on the dovish roost sits another possible candidate, Larry Summers, former Treasury Secretary and former head of President Obama’s National Economic Council.  Not surprisingly, Summers’ views are close in line with the President’s, sharing his prioritizing of employment which would preclude interest rate hikes any time soon.

Another former Treasury Secretary, Timothy Geithner, would likely be positioned with one foot on the dovish roost and one foot on the hawkish were he to be nominated.  Having already expressed his concerns over instability and inflation incubated by a continuation of current policy, he would likely hatch plans to gradually slow monetary easing and pursue rate normalization sooner than the previous candidates would.

Other rumored choices for the post include Donald Lewis Kohn and Roger W. Ferguson, both former Federal Reserve Vice-Chairs.  Where Kohn is considered to be a moderate dove, Ferguson has not been publicly outspoken on his leanings.

Future Fed Policy Expectations

With the successor to Bernanke’s post to be named as early as September, markets could be impacted long before the new Fed Chair takes office in January.  Every report between now and September’s nomination will be critical in shaping the new course of the FOMC, if a new course should even be plotted at all.

Prior to the release of Friday’s jobs data, analysts were already reducing their estimates of by how much the Fed would begin tapering bond purchases and when, settling most recently on a reduction of $20 billion (from $85 billion to $65 billion) of stimulus per month as soon as the October FOMC meeting.

But Friday’s jobs number at 175,000 was solidly below the 200,000 per month many say is required to justify reducing stimulus, and the unemployment rate rise to 7.6% is solidly above the 6.5% the Federal Reserve wants to see before raising interest rates.

Given these and other unimpressive numbers of late, it is unlikely any change to Fed stimulus will be introduced for the remainder of this year.  Any change in policy may have to wait until the new Chair takes over in January.

Likely Market Reactions

Were a dovish candidate to take Bernanke’s post, markets would likely enjoy continued vigor and zeal.  If the successor is more hawkish, markets could be in for a tumble unless the economy posts some really strong numbers between now and the new candidate taking office.

Yet despite the Chair’s placement on the policy spectrum, we must not overlook that the Federal Open Market Committee that sets interest rates and other monetary policy is comprised of 12 voting members, only 1 of whom is the Chair.  Moreover, the input of the remaining 7 non-voting regional bank presidents is also considered at all discussions.  Although the Chair is undoubtedly influential, the member is only one voice in the room.

Whatever the economy does between now and the new appointment, one certainty is that Federal stimulus cannot go on forever.  At some point, current policy will cause inflation to rise.  It is extremely likely that Fed policy will change during the 4-year term of the next Federal Reserve Chair.  As that happens, the initial reaction of equities will be a settling downward to the market’s true valuation based on underlying economic fundamentals without the lift from stimulus.

Investment portfolios may still have a few quarters of robust growth in the meantime.  But at some point, investors will have to become more defensive as the FOMC becomes more hawkish.  After so much “levitation” and “artificiality” (as Nouriel Roubini and Jim Rogers put it) introduced into the market place by monetary stimulus, we can expect substantial volatility when the time comes for the markets to find their true valuation levels.  We can expect to overshoot to the downside and then bounce back up like an adventurer on a bungee cord.

Whether the new Fed Chairperson shares the same policy leanings as current Chairman Bernanke or not, the new chair will most assuredly need to share Dr. Ben’s remarkable steadiness, fortitude, and conviction.

Joseph Cafariello


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