Recently, Federal Reserve Chair Jerome Powell announced the impending cessation of quantitative tightening. Notably, this will occur long before the Fed’s balance sheet approaches the $4 trillion mark, which was its state prior to the extensive money printing triggered by the COVID-19 pandemic.
Between 2020 and 2022, the Fed dramatically expanded its balance sheet to $8.9 trillion, creating credit from nothing and lending it to the U.S. Treasury by purchasing Treasury securities. This strategy is known as quantitative easing.
The Treasury utilized these debt infusions to distribute multiple rounds of stimulus checks, contributing to consumer price inflation reaching levels not seen in four decades.
The expectation that consumer prices could revert to pre-2020 levels has evaporated. Over the past three years, the Fed has reduced its balance sheet to approximately $6.6 trillion, yet it seems ready to abandon the effort before it has made substantial progress.
During a speech at the National Association for Business Economics conference in Philadelphia last week, Powell stated:
“Our long-stated plan is to stop balance sheet runoff when reserves are somewhat above the level we judge consistent with ample reserves conditions. We may approach that point in coming months…”
“Normalizing the size of our balance sheet does not mean going back to the balance sheet we had before the pandemic. In the longer run, the size of our balance sheet is determined by the public’s demand for our liabilities rather than our pandemic-related asset purchases.”
The conclusion of quantitative tightening is poised to coincide with upcoming cuts in Fed interest rates. At that point, it won’t be long before the Fed embarks on another round of balance sheet expansion through quantitative easing.
However, this new expansion will start from a balance sheet of $6.6 trillion rather than $4 trillion. By the end of the decade, it’s likely that consumer prices will seem incredibly high compared to today’s rates.
Kicking the Can
For central planners and proponents of large government, inflation serves as a convenient short-term solution. It’s akin to hitting the snooze button—providing immediate relief but deferring inevitable chaos. Inflationary fiscal and monetary policies offer an alluring escape from pressing challenges.
Central planners often choose the path of least resistance. When confronted with difficult situations, such as a looming recession or budget deficits, the temptation to print more money, maintain artificially low interest rates, or expand budget deficits becomes compelling. This approach provides a temporary solution to complex issues.
Inflation remains the default remedy for central planners. While it provides immediate relief, it lays the groundwork for long-term consequences. By postponing problems, they pass the burden onto their successors.
For instance, if the economy shows signs of slowing and unemployment rises, political leaders might face the challenging choice of allowing the market to recalibrate. Alternatively, they could choose to tackle the root causes, such as excessive regulations and taxation.
This method typically requires time and effort, often involving a recession or depression before recovery can take place. It necessitates a willingness to endure hardship before improvement can occur, making it politically unpopular despite its potential long-term benefits.
The preferred, expedient option for central planners is to inject new funds into the system—via low interest rates or Fed asset purchases—to quickly rejuvenate demand. This tactic supports struggling entities and may stave off a credit crisis, allowing politicians to maintain their positions.
Duct Tape
Inflation operates as a silent but effective lubricant, smoothing the economy’s functioning. It facilitates government funding, debt repayment, and sector bailouts without the politically unpalatable need for tax increases or spending cuts.
For private enterprises, it lowers borrowing costs, which encourages growth and investment even in fundamentally unsound projects. This reliance on borrowed funds allows both government and business to sidestep the harsh realities of their own poor choices.
Instead of confronting an unsustainable spending landscape, the government and economy lean on the central bank—specifically the Federal Reserve—to generate more money and credit. This enables escalating levels of debt and inflation.
These policies of dollar debasement serve as a temporary fix for lingering issues. Inflation merely becomes the duct tape used to cover the structural deficiencies of the economy. Unfortunately, this does not resolve the underlying problems; it exacerbates them over time.
Simultaneously, it distorts prices throughout the economy. For example, five years ago, the Fed flooded the market with money in response to the self-inflicted issues resulting from COVID-19 lockdowns. The economy has since become reliant on this inflated money supply, which cannot be curtailed without triggering a credit crisis and subsequent recession. This is why the Fed cannot return its balance sheet to $4 trillion.
This pattern has been observed multiple times this century. The Fed previously provided cheap credit to mitigate the repercussions of the dot-com crash in the early 2000s, ultimately leading to a devastating housing bubble. When that bubble burst, the Fed resorted to quantitative easing and zero interest rate policies, inflating numerous speculative bubbles across various asset classes, including stocks, real estate, and cryptocurrencies.
Dollar Debasement as Permanent Policy
After each instance, the Fed has been unable to restore the economy on a stable foundation characterized by solid monetary principles and realistic interest rates. Instead, it perpetuates a cycle of printing money or keeping rates low to avert economic collapse and the bursting of bubbles.
Presently, the Fed finds it necessary to prioritize inflation and ongoing dollar debasement to stave off a potentially disastrous crisis. Such policies have persisted for over a century, leading to a fundamental decay in economic conditions.
It’s essential to note that inflation functions as a hidden tax on savings, quietly eroding the purchasing power of every dollar held by workers and savers. It redistributes wealth from the diligent to the politically influential or those in debt.
When money is abundant and inexpensive, businesses often allocate resources inefficiently. Investments are based on the ease of credit availability rather than legitimate, sustainable demand, resulting in bubbles and poor utilization of resources, which in turn diminishes overall productivity.
In this sense, inflation muddles the critical information provided by price signals, which inform businesses about production decisions and consumers about purchasing choices. If it’s unclear whether a price increase stems from genuine scarcity or merely from monetary expansion, rational decision-making falters.
The trend is evident: the Fed is once again opting for the easier route of inflation, choosing not to undertake the challenging task of fully normalizing its balance sheet and allowing the economy to benefit from necessary adjustments.
Yet, this should not come as a shock. Inflation has become the permanent strategy for central planners seeking to temporarily mask deeper structural problems through monetary injections. By favoring short-term political and economic relief, they ensure enduring long-term damage.
As we move forward, we are likely to find ourselves in a reality where today’s prices appear remarkably low in comparison.
[Editor’s note: Subscribe to the Economic Prism mailing list and receive a complimentary copy of an important special report titled, “Utility Payment Wealth – Profit from Henry Ford’s Dream City Business Model.” For an exclusive trial offer of MN Gordon’s Wealth Prism Letter, you can access that here.]
Sincerely,
MN Gordon
for Economic Prism
Return from Dollar Debasement as Permanent Policy to Economic Prism
