What’s In the Fed’s Love Letter to Biden?
Posted August 31, 2021
At the founding of the Fed in 1913, there were two big pitches.
Number one: The Fed would be independent of politics. This is essential, they said, because government has long abused the money and banking system to enrich itself. The Fed would be apolitical, they promised. Oh, plus it would be decentralized with offices all over the country so that Washington alone would not rule. This would not be a national bank!
Number two: it would stop inflation and other forms of instability. Sound money would rule the day!
That was a century and eight years ago. Nothing of those early promises panned out. The Fed has been hyper-political even from its opening. It’s unlikely that the US would ever have entered the Great War (WWI) without the Fed’s promise to back US debt with the power to create new money out of thin air. As for inflation, we know the story there — all too well.
In this sense, Jerome Powell’s much-anticipated speech, associated with Jackson Hole, Wyoming, where they did not physically gather due to the virus (Delta, don’t you know!). His speech was nothing if not obsequious. He offered not one word of criticism of the current fiscal policy, even though it is insane by any definition of the term. Nor did he point out that the existing labor dislocations are mostly caused by ridiculous federal sloth subsidies. No, hinting that the Biden administration might be lacking in the perfection department could be dangerous.
Instead Powell offered up a job application. Yes, he said, the Fed would tamp down on its bond purchases but it would not reduce its balance sheet. Nor will it raise interest rates. Nor is it particularly worried about inflation because all that we’ve seen so far, he opined, is related to the pandemic and the opening. It’s transitory. It will be gone before you know it, except that we’ve heard that for many months and it keeps not being gone. It keeps getting worse and creeping around in weird ways (shrinkflation, housing-price explosion, frothy financials).
As proof that this is not really inflation, Powell pointed to “The absence so far of broad-based inflation pressures.” But here is the problem. No inflation in world history has hit every sector evenly. It starts somewhere, spreads somewhere else, and only gradually affects nearly everything. The idea of a price level rising like the sea is purely a statistical archetype of economic modelling. It has nothing to do with reality.
You see, Powell is faced with getting re-nominated. This speech was a pitch to keep his job. The people in the Biden administration, to the extent they have any economic theory at all, are wedded to a view (sometimes dubbed Modern Monetary Theory) that the Fed has magic powers to improve everyone’s life at essentially zero cost. All they have to do is keep the spigots open. Powell is not a stupid man; he is a very savvy politician, one you did not elect but one who believes in his awesome powers.
What Can the Fed Do?
The office of the Fed has long been infused with a kind of mystical reputation. It’s deserved only in part. After all, the Fed can legally do what you and I would be convicted in criminal court for doing, namely, counterfeiting via the power to create money out of nothing. It’s an odd thing about governments generally, that they are entitled and adored for exercising powers that would otherwise be considered unethical, intolerable, and prosecutable if the same were done by private citizens. And for this, its agents are adored and revered.
It’s true that the Fed has tremendous powers to do tremendously bad things. But what about its powers to reverse course? Here the problems are both technical and political. Technically, it is not easy to stop an inflation once it kicks into gear. Rising prices are not dictated by the Fed; they are a consequence of specific decisions among producers and consumers in response to a flood of new cash hitting the streets. Those decisions in turn are influenced by psychological expectations of the public, over which the Fed has little control.
Money For Nothing, Then Worth Nothing
Many economists and commentators are playing it safe right now, refusing to sound the alarm of some impending inflationary disaster. This is because we’ve not seen such a thing in 40 years, despite very reckless Fed policies in 2000 and 2008. As a result, many pundits have lost confidence in their own ability to discern a predictable relationship between monetary aggregates and price instability.
And yet, it’s best to take a step back and look at what’s happened to us over 18 months. The country nearly shut down completely and the Fed attempted the impossible: to provide a full substitute for a functioning economy. Congress got into the act and shelled out trillions by dropping stolen and/or inflated money into everyone’s bank accounts. That money is now hot on the street pushing up prices of everything. The sheer frivolity of spending today is everywhere on display.
Powell’s own speech hints at the absurdity: “In a reversal of typical patterns in a downturn, aggregate personal income rose rather than fell, and households massively shifted their spending from services to manufactured goods. Booming demand for goods and the strength and speed of the reopening have led to shortages and bottlenecks, leaving the COVID-constrained supply side unable to keep up.”
How can you experience the worst economic crisis in more than a century and have that followed by an incredible spending spree? That’s pure alchemy courtesy of the Federal Reserve. It’s an impossible illusion. Powell didn’t mention that part. And I guarantee you the following. If this inflation keeps up and worsens, everyone who is currently on the sidelines will step up and claim that he or she predicted this from the beginning; indeed, it was inevitable.
Another reaction I had reading Powell’s speech: for a man who thinks inflation is no big deal and on its way out, he sure does talk about it a lot!
The Fed Will Not Do This
The Fed has one really blunt tool in its toolbox: it can raise interests as they pertain to lending within the banking system. The trouble here is that this can panic markets, kick off selling among financials, dramatically raise the cost of debt service by government, and tamp down lending and borrowing in the private sector. It is a wise move during an unsustainable boom, one that looks to create the ground for a future of sustainable prosperity.
The last time we saw that level of courage deployed by the Fed was half a century ago. It’s been a very long time since we’ve seen wise, far-seeing, and bold leadership of this sort at any level of government. The current fashion is for doing whatever it takes to survive for now. And the Democrats are in survival mode right now. The president’s popularity is falling dramatically, and we are already seeing suppressed public anger appear in wild ways that the ruling class has tried to prevent.
Evidence of anger without precedent in our lifetimes is the political trajectory in California. The recall effort to oust governor Gavin Newsome was declared quixotic when it began earlier this year. Now it is taken very seriously. Even center-left publications are admitting now that something has gone very wrong for them. More astounding is the candidate who could take his place: Larry Elder. He has promised to immediately repeal all Coronavirus restrictions in the state, a line that draws wild applause and standing ovations. More than that, he is “a liberal nightmare,” according to the New York Times.
An Elder victory in California would be a sign of political revolution on its way, one way overdue, and one that would rock the political establishment to its very foundation. There are other signs of intense anger out there. Kids are finally back in school, but in many places in the country, they have been forced to mask up, despite the existence of any evidence that they are in danger of catching or spreading Covid. This is a sure path toward infuriating parents of all political orientations. Don’t mess with the kids, lest you want to pay a heavy political price.
All of this public fury today would be present even in the absence of continued inflationary pressure that outpaces wages and productivity. If that happens and worsens, we will be out of historical comparisons. We are only left with metaphors involving timbers, gasoline, and matches. We would be in the realm of unpredictable madness.
Jerome Powell may rue the day he worked so hard for his reappointment.