Jerome Powell, the newly appointed Chairman of the Federal Reserve, is just completing his third week in office. With little time to familiarize himself with basic office tools, he remains inexperienced in navigating the complexities of a crucial economic role. Nonetheless, people worldwide are already sharing their opinions on how he should perform his duties, even weighing in on potential future outcomes.
For instance, a recent article from the South China Morning Post offered the following insight:
“President Donald Trump may have inadvertently helped Janet Yellen by not granting her a second term as Chairwoman of the Federal Reserve. Jerome Powell, her successor, might be facing a poisoned chalice. The Fed must expedite U.S. rate hikes to avoid being labeled as lagging behind the curve if inflation rises.”
On Powell’s first day at work on February 5, it was commonly believed that the Federal Reserve would raise the federal funds rate three times this year, with each increase set at 25 basis points – or 0.25 percent. However, given the current circumstances—annual consumer prices rising at 2.1 percent and average hourly earnings increasing at a rate of 2.9 percent—a massive two-year budget deal passed by Congress, and economists are reconsidering whether three hikes will suffice to manage inflation effectively.
In recent weeks, the demands for four hikes in 2018 have intensified. Goldman Sachs has even introduced the prospect of five hikes.
This focus on minutiae illustrates the struggles policymakers and analysts face in a planned economy. The reality is that whatever choice Powell makes—whether he opts for three, four, or even ten rate hikes—someone will inevitably deem it the wrong decision. Here’s why:
Chronic Shortages
The economy is akin to a complex living organism, constantly evolving, with relationships that shift from moment to moment. Supply and demand perpetually adjust to reflect market conditions.
In a moderately free market, these adjustments ensure that shortages do not linger—bakeries, for instance, don’t run out of bread when faced with a wheat crop shortage due to adverse weather. Instead, the price of bread rises, prompting consumers to alter their spending habits.
Conversely, centrally planned economies suffer from recurring and acute shortages. Bureaucrats, relying on extensive reports and graphs, are ill-equipped to set accurate prices for everyday goods and services. Their attempts invariably lead to mismanagement.
With noble intentions, planners make informed guesses about price controls. However, these guesses often go awry.
It is possible for the supply of goods to be adequate, but when artificially low prices are enforced, consumers can engage in wasteful buying practices, leading to empty store shelves.
While uniform standards are beneficial for units of measurement and crucial for consistency in manufacturing and communication, they fall short in many other areas.
Haunted by Ghosts of the Old Eastern Bloc
The pursuit of fixed prices for goods and services by central authorities has historically proven to be disastrous. This lesson is vividly illustrated by the experience of the old communist Eastern Bloc economies in the second half of the 20th century.
Unfortunately, price controls extend beyond just commodities. The United States, Europe, and Japan have all been striving in the early 21st century to show that issues once limited to the Eastern Bloc have also taken root in credit markets.
Credit, similar to any good or service, has a price—specifically, the interest rate a lender charges. Just as fixing the price of goods falters under central planning, so too does the imposition of interest rate controls by entities like the Federal Reserve or the European Central Bank.
Observers can witness multiple troubling trends: Housing prices dramatically outpacing income levels, total household debt reaching $13.5 trillion, and an entire generation of Millennials accumulating $1.4 trillion in student loan debt for degrees that have diminished in value compared to what high school diplomas once represented.
These issues reflect significant misallocations of capital, which would not have occurred to such an extent without the Fed’s interference in credit market prices.
Chairman Powell is faced with an uphill battle. His predecessors, Bernanke and Yellen, oversaturated the economy with cheap credit. Now, Powell is tasked with reversing this trend through higher interest rates. However, the U.S. economy, burdened by record levels of debt, cannot cope with increased rates.
Powell will eventually identify the breaking point. When the next major liquidity crisis arises, it will not be a failure of free-market capitalism; rather, it will highlight the pitfalls of central planning and the systems that have been put in place.
Sincerely,
MN Gordon
for Economic Prism
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