In today’s economy, many individuals remain largely oblivious to the strategies devised by economic central planners. For the average person, the priority lies in the simple comforts: ensuring their meals are warm and their drinks are cold rather than concerning themselves with the broader economic schemes formulated in distant capitals. However, these planners are acutely aware that an unrested populace, fueled by hunger and dissatisfaction, can quickly turn into an angry mob. This reality keeps them focused and engaged with their duties.
A primary goal of these planners is to effectively shape public perception. While their efforts often veer into the realm of futility, they approach their tasks with focus and determination.
For instance, economic reports, adorned with impressive tables, graphs, and pie charts, play a crucial role in sustaining the necessary public narrative. Planners recognize that invoking financial science at every opportunity is essential.
Statistics showcasing annual projections, especially those indicating rising exports and declining imports, are pivotal in perpetuating the desired story. One can only hope that the troubling U.S. balance of international payments can be neatly reframed in official documents… right?
Still, there’s a glaring oversight: economies consist of countless unpredictable factors. How can one accurately forecast the impact of a new discovery or technological advancement on investment and labor? How does one model the decisions of 7 billion unique individuals and represent them in an easily digestible format?
Amid the Madness
This week, Federal Reserve Chairman Jay Powell presented the latest installment of the Fed’s public update. To fully grasp Powell’s statements, some background is necessary…
Nearly a decade ago, in the aftermath of Lehman Brothers’ collapse, chaos reigned in credit markets. In a surreal turn of events, the money market shares of the Reserve Primary Fund fell below the critical $1 mark, dropping to $0.97 per share.
During this tumultuous time, Ben Bernanke, then Fed Chair, made a series of controversial decisions, which he later described as courageous. He drastically reduced the federal funds rate to nearly zero and began purchasing large quantities of toxic mortgage-backed securities and Treasury notes, ballooning the Fed’s balance sheet from approximately $900 billion to over $4.5 trillion by early 2015.
Fast forward to today, and it’s Powell’s responsibility to address the aftermath left by Bernanke and Janet Yellen. This cleanup process has generally unfolded as follows:
In December 2015, after seven years of a zero-interest-rate policy, the Fed incrementally raised the federal funds rate by a quarter of a percent. This was repeated in December 2016. In the past year, the federal funds rate was increased three times by a quarter percent each time, with two further hikes planned before the year concludes.
But Powell’s responsibilities don’t end there. Beginning in October 2017, the Fed initiated a process to reduce its $4.5 trillion balance sheet. According to their stated guidelines, this should entail a monthly reduction of $50 billion. Curiously, updates on this ongoing balance sheet contraction are notably absent from FOMC meeting statements.
Chasing the Wind
On Wednesday, against this backdrop, Powell delivered the latest remarks from the FOMC. True to expectations, the federal funds rate was raised by a quarter of a percent, moving to a range of 1.75 to 2 percent. The Fed also indicated its intentions for two additional rate hikes this year.
Powell reiterated the Fed’s commitment to promoting maximum employment and price stability, which they define as a 2 percent inflation rate. However, he overlooked a crucial, unspoken mandate: to ensure that large banks remain adequately supplied with credit while maintaining a risk-free environment where they can borrow short-term at low rates and lend long. This arrangement enables them to profit from the essential service of debt creation—further inflating asset bubbles without restraint.
While this may seem favorable for lenders, it relies on the flawed assumption that the Fed’s attempts to manage the economy fall within their control, which they most certainly do not.
History over the past century has repeatedly shown that the economy resists central control. In fact, interference through credit market manipulation often leads the economy into unpredictable convulsions.
Raising the federal funds rate and shrinking the balance sheet undeniably siphons off liquidity that has inflated stock market indices and skyrocketed residential real estate prices beyond comprehension. The question remains: what will happen to these inflated asset values once the supporting liquidity diminishes?
Currently, Powell raises the federal funds rate so he can lower it again when the economy experiences its inevitable contraction. Similarly, he’s contractively managing the balance sheet for future expansion when the yield curve inverts and the major banks require assistance yet again. The tightening measures undertaken today will likely lay the groundwork for future crises.
These are the realities we face in 2018. The Fed is essentially chasing the wind, leading us all on an unpredictable and chaotic journey.
Sincerely,
MN Gordon
for Economic Prism
