Tag Archive for: JeromePowell

The Renewed Politicization of the Federal Reserve

Estimated Reading Time: 4 minutes

Economic research shows that monetary policy works best when conducted by an independent central bank. After Fed chairs in the 1960s and ‘70s caved to pressure from American Presidents, those who followed sought, at least to some degree, to reestablish the Fed’s independence. Until now, that is.

Since 2019, the Fed has politicized its activities in virtually every way: through its monetary policy goals, the use of its enhanced balance sheet, its regulatory actions, and its emergency lending activities. Each of these changes has pushed the Fed further from being an effective and independent central bank toward becoming a purely political institution, which prevents it from choosing the best policies for Americans and the US economy.

Monetary Policy: “Inclusive” Employment and (Flexible) Average Inflation Targeting

Fed officials, including current Chair Jerome Powell, have acknowledged that monetary policy is a broad tool that cannot be used to address the problems of racial and income inequality. Despite this admission, however, the Fed has injected the issue of inequality into its monetary policy goals.

In August of 2020, the Fed rewrote its statement of goals and strategy to emphasize employment ahead of inflation. The new language described the maximum employment goal as “a broad-based and inclusive goal that is not directly measurable.” Chair Powell cited racial differences in unemployment rates as a motivation for the change. This shifted the Fed’s goal from focusing on the best outcome for most Americans to a purely discretionary target, which the Fed admits is impossible to measure.

At the same time, the new objectives stated that the Fed would target a rate of two percent inflation averaged over time, giving Fed officials greater ability to deviate from the prescribed rate of two percent annual inflation. Moreover, Fed officials have since revealed that they only intend to seek an average of two percent when it has previously been below target. When inflation is above target, in contrast, the Fed will allow it to remain so and will not bring it down enough to return to the previous price-level trend.

Taken together, these two changes relax the traditional constraints on the Fed’s ability to engage in overly-expansionary monetary policy. When warned that the policy is too loose, they can point to their expanded employment goal to justify the policy. Then, when inflation rises above two percent, they can claim that it is temporary and will not affect the average rate of inflation in the future.

The irony is that such an approach would likely produce exactly the opposite of what is intended. To the extent that emphasizing maximum employment (in the broader sense) and ignoring temporary periods of above-average inflation results in overly-expansionary monetary policy, it risks recessionary corrections and even lower employment than would have occurred had the Fed stuck with its previous policy.

In early 2021, for example, Chairman Powell testified that the Fed planned to keep its interest rate targets near zero until the economy reached maximum employment, a policy it maintained throughout 2021 despite record inflation. Powell now says the US labor market is “unsustainably hot,” but the Fed has taken only minimal action to calm the labor market or bring down inflation. Many commentators are already expressing concerns about a looming recession.

Balance Sheet Activities: Fiscal Accommodation

Through the use of large-scale asset purchases (LSAPs), also known as quantitative easing (QE), the Fed has massively expanded its balance sheet from less than $1 trillion in 2008 to almost $9 trillion today. While the federal government increased fiscal spending by $5 trillion in response to the Coronavirus pandemic, the Fed bought up more than $3.4 trillion in Treasury securities since 2019, effectively monetizing a large portion of the fiscal deficit.

While some economists applauded the Fed’s fiscal accommodation, debt monetization is not a prudent action of a responsible central bank. Those that engage in such activities encourage profligate spending by their fiscal authorities, which often ends up in fiscal default. Such massive purchases of Treasury securities were enabled by the Fed’s enlarged balance sheet and would not have been possible in the pre-2008 system.

Emergency lending: Everyone Gets a bailout!

One traditional function of central banks is that they act as emergency lenders in times of financial crises. Although the Fed’s 2008 emergency lending deviated from the rules of the classical lender of last resort, former Fed Chairs Bernanke and Yellen respected the limits of the Fed’s authority as understood by economists and stated in the Federal Reserve Act.

Not so for Jerome Powell. Despite the fact that 2019 was not a case of “unusual and exigent” circumstances in terms of bank failures or shortages of financial liquidity, the Fed initiated a variety of emergency lending facilities beyond those of the 2008 crisis. The Fed lent to non-financial companies and state and local governments, which former Fed chairs said it should never do.

These actions disturb the efficient allocation of capital in the financial system and further heighten the Fed’s political profile.

Regulation: Climate and Industrial Policies

Bank regulators have increasingly used their regulatory powers to discourage banks from supporting politically unpopular industries, such as oil and gas, firearms, and medical marijuana. These punitive measures often take the form of discretionary enforcement actions, which lack the transparency and immutability of rules passed through the regulatory process.

Fed regulators have now turned their sights to climate change and the supposed threat it poses to US banks. The Fed subjects banks to “climate stress tests” and has joined international central banks’ Network for Greening the Financial System (NGFS), whose stated goal is to “support the transition toward a sustainable economy.” While these changes are ostensibly made in the name of limiting banks’ risk exposure, their result in practice will be to harm the US economy by preventing banks from lending for specific purposes such as the production of energy and fossil fuels.

The Fed’s Politics Threatens Its Independence

Fed officials have gone beyond policy discretion into overt political activism. President of the Minneapolis Federal Reserve Bank Neel Kashkari has been reprimanded by Senator Pat Toomey for his recent political actions. In 2020, former New York Fed President Bill Dudley argued that “Fed officials should consider how their decisions will affect the political outcome” by potentially withholding monetary accommodation in order to prevent the re-election of President Donald Trump. Such actions reveal these officials to be political opportunists rather than independent central bankers.

Independent central banks tend to deliver better monetary policy. But independence can only be maintained by focusing on the narrow goals assigned by Congress. By straying from its mandate, Fed officials have chosen to base their decisions on politics rather than on sound economics.

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This article was published by AIER, American Institute for Economic Research, and is reproduced with permission.

Has The Federal Reserve Broken The Economy?

Estimated Reading Time: 5 minutes

Book Review: The Lords of Easy Money: How the Federal Reserve Broke The American Economy

Christopher Leonard. Published by Simon and Schuster

Upon receiving the book, at first, a bit of eye-rolling occurred as the dust jacket touts “The New York Times Bestselling author of Kochland.” He also authored Meat Racket, which takes a critical look at the corporate concentration taking place in the food industry. Perhaps Mr. Leonard sees himself in the mode of the socialist Upton Sinclair of a previous era. At any rate, the professional Left has had issues with the Koch brothers because of their occasional support for conservative or libertarian think tanks and efforts.

To be sure, the perspective in this book is that of a journalist left of center.  In many ways, it echoes William Greider, a left-leaning journalist in the late 1980s who voiced similar concerns about the Federal Reserve in his books Secrets of the Temple and later, Who Will Tell the People.

At least traditional Liberals of the day and Conservatives shared a concern about the concentration of immense power in the hands of an unelected elite, that has close ties to Wall Street interests.

Leonard is particularly concerned with the development of Quantitative Easing, the Federal Reserve operation to buy large quantities of government debt to be held on its own balance sheet and its close association with ZIRP, or zero interest rate policy.

To tell his story, he concentrates on following one of the few FED governors who often dissented, Thomas Hoenig of the Kansas City Fed. To some extent, it is the tale of the clash between professional economists like Ben Bernanke and actual bankers like Hoenig. Also getting an honorable mention is Richard Fisher of the Dallas FED.

What Leonard sees as a problem is that Quantitative Easing morphed from being a program to deal with financial emergencies to a policy that is used in good times as well. The background to the latter really was pushed by Bernanke, who felt the Fed needed to move to stimulate the economy because Congress was unable to act.

It is a story of mission creep. The FED by law is supposed to deal with somewhat two contradictory goals derived from the errors of Keynesianism. It is supposed to balance price stability with full employment. These are the primary goals enshrined in law.

It was felt that higher inflation must be tolerated to get full employment as per the Phillips Curve. We say the errors of Keynesianism because the stagflation of the 1970s and 1980s showed that high unemployment and slow growth could coexist with high inflation, and full employment could exist with low inflation in the 2000s,  which is not at all the relationship Keynesians espoused.

Nevertheless, there is a structural political risk when an unelected board decides to take bold actions that affect every American (and the world) because that agency feels Congress is dysfunctional and cannot act appropriately. No one voted for them to fill the void. And there is an additional risk when Congress imposes more tasks on the FED such as engaging in the Left’s view of social justice and environmental reforms.

The FED is supposed to be independent of such things, but increasingly it is simply becoming another institution corrupted in its purpose by the Left.

QE as it is called injects bank reserves and lowers interest rates, giving retail banks, investment banks, and hedge funds an ever-increasing supply of cheap capital, thus enriching the financial food chain that lives off the nourishment of the FED.

This allows for leverage deal-making, huge stock buybacks that support equity prices, as one investment banker washes the hands of another.

Thus, a whole industry, that can direct the investment direction of the country, grows in wealth and power from the actions of an unelected board of so-called experts at the FED. These experts in finance migrate back and forth from the financial industry to the regulatory body that supervises them, demonstrating “regulatory capture.” It is hard to know where the role of the FED begins and the power of Wall Street ends.

A good example is the current Chair of the FED, Jay Powell. He formerly was a Wall Street lawyer and leveraged deal maker with Carlyle Group. Ironically, Powell at times was critical of QE and he is now in the uncomfortable position of trying to reign it in.

QE makes asset price inflation possible, something the FED actually promotes because it is supposed to create a “wealth effect.”  However, other than making a certain class of asset owners famously wealthy and powerful, there is scant evidence it has helped the entire economy grow.

Asset price inflation is hard to contain as it can spread and now has spread to consumer price inflation. Consumer price inflation impacts the masses.

Zero interest rates do more than that, however.  Leonard spends considerable time discussing arcane things such as “leveraged loans” and “collateralized mortgage obligations.”  In short, the FED has supplied the cheap and copious quantities of money for all manner of financial engineering, which has made hedge funds like Bain and Carlyle (both close to political power) very rich, while promoting the offshoring of American jobs to Mexico and China.

He gives some case studies such as Rexnord, an industrial firm from Milwaukee, that is leveraged up multiple times by investment bankers (Jay Powell himself), all the while shutting down production in the US.

He follows the experience of John Feltner who worked as an engineer for Rexnord, became a union leader, and later lost his job as the plant closed when the jobs were shipped to Mexico.  Feltner as a union man is shown hoping that a Republican Donald Trump, might be able to save his job.  Who looks after the interests of the working man?

This is one of the areas where at least the moderate Left and the MAGA right have interests that intersect. The MAGA right also worries about such power in the hands of unelected elites and does not think it acts in the interest of America. America and American workers should come first, not hedge funds creaming profits from leveraged buyouts.

Both sides worry about asset bubbles created by the FED, and both sides worry about the concentration of political and economic power in the hands of a few bureaucrats and big businesses.

The MEGA right believes in free enterprise, not cartels that get special favors and cheap capital from quasi-government agencies.

Neither side has given enough attention to this problem.  If the government was forced to borrow in the markets the huge deficits it is generating, interest rates would already be higher.  The FED by buying all this debt, and covering up the negative consequences, has enabled a spending drunk Congress to massively increase the size of government. The liberal sees the same process and sees increased corporate power. In a sense, both are correct.

It has made the asset owners of stocks, bonds, and real estate richer while making those that rent poorer, those that use bank deposits poorer, and those on fixed incomes poorer. In short, the FED has engaged in a massive transfer of wealth from the poor to the rich, all while following the orders of Congress and politicians from both parties that claim laughably that “they are for the little guy.”

So, if you are a moderate liberal or a conservative with populist leanings, this book offers arguments and case studies where the two sides might agree more than one might think.

One certainly walks away with a better understanding of how the FED has become the secret arsonist that works for the fire department.  They get to blow huge financial bubbles and then are tasked with cleaning up after them and then remarkably, they get to start the process over again. The arsonist is never arrested.  All this, of course, is in the name of “financial stability” and oversight by experts.

Although the book can’t cover the entirety of this great monetary experiment, the book narrowly focuses on the U.S. While the FED is the central bank of the U.S., it also actually functions as the central bank of the world, lending money to foreign banks in trouble through swap lines and intellectual leadership. Yet all major economic systems from Japan and China to the UK and the EU, are pursuing similar policies. The lords of easy money rule most of the world. Unfortunately, they may be breaking more than just the American economy.

One can’t know for sure, but because of certain shared viewpoints, one would suspect Christopher Leonard and former Congressman Ron Paul might very much enjoy having a discussion over a cup of coffee, or something stronger.

 

 

 

 

Needles and Bubbles

Estimated Reading Time: 5 minutes

Last August we presented a two-part series about the investor’s dilemma (The Investor’s Dilemma: Part 1, The Investor’s Dilemma: Part 2).

That series was intended to warn our readers that the level of speculation in various investment sectors had reached what appeared to us to be a fever pitch and that it was unnaturally supported by a torrential flow of money coming from fiscal policy (huge government spending and deficits) and easy money policy from the Federal Reserve (zero interest rates and Quantitative Easing). We did not think it would be sustainable.

We also mentioned there were serious divergences developing inside the stock market. To be sure, the market continued to power higher.  But internally, fewer and fewer stocks were participating. The S&P 500 was becoming the S&P 5, as just a handful of behemoth tech stocks that are overweighted in the index, were painting a false picture of market health.

Finally, we mentioned that while investors had little choice to participate in markets because the Federal Reserve has destroyed safe investments that pay interest (like insured bank deposits), the dilemma was we are playing with a late-stage, overvalued bull market that was now confronting serious inflation. But those same investors would have to face the consequences, which are almost impossible to time, for market excesses and the likelihood that the FED at some point would have to fight incipient inflation and “take the punch bowl away.”

Inflation can come in two forms: asset inflation and consumer price inflation.

The FED has actively encouraged asset price inflation. The price of stocks, bonds, art, real estate, cryptocurrencies, SPACs, NFTs, have all been climbing steadily. This created the “wealth effect” the FED was seeking. It also makes wealthy the small number of well-heeled citizens that can afford to own and leverage assets. This also conveniently tends to be the donor class, that is the very people politicians need for big campaign donations.

Consumer price inflation is not harmful to the donor class because even with increased costs, there is no problem with a large budget paying for necessities like auto repair, food, rent, and gasoline. But it is very harmful to most of us. Consumer price inflation affects the vast bulk of people and hence can create swift and punishing political blowback.

It is clear that when Quantitative Easing was extended from being an emergency measure to deal with the Crash of 2008 by then-Fed Chairman Ben Bernanke to a policy used to accommodate a spendaholic Congress, it drove income inequality to extremes. That in turn, has much to do with the “populist” political revolt.

The Biden Administration and the Fed both also said inflation was “transitory”, and would go away soon. It didn’t.

As the traditional year-end rally approached, the markets surged into January even as the FED began to make noises that they were now concerned about inflation and would soon start to raise interest rates and reverse Quantitative Easing with Quantitative Tapering.

Now, The Prickly Pear is not an investment publication and the last thing we want to do is start to make market calls, which is an undertaking guaranteed to make one look foolish. But we are concerned that market busts spread economic pain, economic trauma creates political tensions and extremism, and frankly can harm the finances and liberty of our readers. Thus, while we make no claim to timing markets, it was clear last summer that investors and the country were headed for trouble. We just did not know when.

There is no way to cut back the torrential flow of money without changing the investment landscape, and perhaps the real underlying economy. That is especially so when the levels of speculation, the widespread use of leverage, and public mania that we described last summer have reached such fantastic levels.

The “when” seems to have been early January. Most markets had their typical “Santa Claus rally” that runs usually from Thanksgiving into the first few days of January. After a few days into January, markets became quite unsettled and started to decline.

Although the FED as yet has done nothing concrete yet, interest rates are already rising and the crunch is being felt.

The markets are off-balance, which is one of the problems when you have a central planning agency like the FED running things, rather than the natural supply and demand of the free market.  Now, every statement by the FED Chairman, or a voting member, or an arch of an eyebrow, can send the markets into a tizzy. 

Stocks, as measured by broad averages right now look like your typical “correction.” A correction usually is defined as a decline of less than 20%, that occurs within an ongoing bull market advance. So, if you looked at say the NASDAQ, you will see a nominal decline of 17%, and the big cap S&P is down a little more than 11%.

However, underneath the surface, there is considerably more pain. In the tech-laden NASDAQ, 42% of the stocks within the index have fallen 50% or more. Thus, a number of stocks are suffering more than a correction, they are in a bear market. Individual sectors have been hit hard. One of the hardest to be hit are the healthcare stocks, with 70% of them down 50% or more.

We have also seen some impressive and violent volatility, as markets try to figure out how serious is inflation, how serious is the FED, and how much economic growth is just a natural spring back from the economy being shut down and how much is sustainable. On January 24th, the S&P plunged 4% inter-day only to later close up on the day. That is a whiplash worthy of hiring an accident attorney! This kind of action will tend to grind up the speculator using heavy leverage and scare even the long-term holder.

Cryptocurrencies, which we also have warned about, have suffered enormous damage. According to data from CoinMarket.com, after reaching a market capitalization of $3 Trillion or so in October, they are now down to about half that amount. Bitcoin, the leader of the pack is down over 50% from its November high while Dogecoin is down over 70% from the high last spring. Such extreme volatility makes their claim to be a “currency” hardly defensible.

Real estate is not “marked to the market” every day like stocks, so price data is slower to accumulate. The Federal Reserve Bank of St. Louis reports the median price of new houses sold in the U.S declined to $377,700 in December, the second consecutive month of decline. Inventories appear to be increasing. While that is not enough data to constitute a “trend”, it seems more than coincidental with weakness in other parts of the “everything bubble.”

Even gold, which tends to be a safe haven when markets plunge, dropped from the $1840 level back below $1800. This was a bit surprising since gold actually declined last year and did not seem to participate in the generalized surge in asset prices.

Many of the “technical” people we read suggest the stock market has fallen too far, too fast, and is now “oversold.” Such conditions normally create a rally. If this rally can return the market back above moving average and linear trend, perhaps the worst has been seen for a while. Failure to do so may signal more correction to follow, maybe even pulling the markets into official bear territory.

All of these gyrations could prove to be temporary. The mantra of the last decade has been “buy the dip.” Without question, that has been a strategy that has worked.

It is when “buy the dip” no longer works that we know we are in big trouble.

The FED is starting the tightening process behind the curve. It is also starting the process with the lowest sustained period of interest rates in history intersecting with the highest inflation in four decades. Debt at all levels; government, corporate, and household, are all greater than they were in the early 1980s. Public participation in markets has been huge. Monetary flows into Wall Street last year equaled the previous 12 combined. We don’t have Paul Volker and Ronald Reagan at the helm either. In fact, national leadership appears quite weak and confused.

The optimists on Wall Street seem to feel that Jay Powell, the current Chairman of the FED can “thread the needle”, that is successfully cool off inflation without wrecking either the markets, the economy, or both.  

There is one problem with the needle threading metaphor. You really don’t want needles anywhere close to financial bubbles.

America’s Most Dangerous Unknown Man

Estimated Reading Time: 2 minutes

The US Senate will soon vote on Federal Reserve Chairman Jerome Powell’s nomination to a second term. One of the senators opposing Powell is Elizabeth Warren. I don’t often agree with Senator Warren, but I do agree with her assessment that Powell is “dangerous.” However, Warren actually doesn’t understand what makes Powell, or any Fed chairman, intrinsically dangerous to liberty and prosperity.

Warren thinks Powell is dangerous because she thinks he will not be supportive enough of imposing her desired new regulations on banks and other financial institutions. Senator Warren, like most progressives, clings to a fantastical notion that regulations benefit workers, consumers, and small businesses. The truth is most regulations benefit large corporations by imposing costs that big businesses can easily absorb, but that their smaller competitors cannot.

Powell is a threat to the American people. Under his tenure, the Fed has kept interest rates at or near zero. The Fed’s balance sheet has grown to over eight trillion dollars. This has caused prices to climb at a rate America has not seen in several decades.

At his nomination hearing before the Senate Banking Committee, Powell reiterated the Fed’s intention to fight inflation by reducing its monthly 120-billion-dollar purchase of Treasury and mortgage-backed securities. Powell also stated that the Fed is planning to increase interest rates this year. However, even if the Fed follows through on this, interest rates will remain at historically low levels.

Powell, like Elizabeth Warren and other progressives, dangerously believes that the Fed should go “woke.” However, Powell is still not “woke” enough for progressives who lobbied President Joe Biden to replace Powell with Fed board member Lael Brainard, the biggest supporter of Elizabeth Warren–style regulations on the Fed board. Brainard is more committed than Powell to using monetary and regulatory policies to advance the “woke” agenda. President Biden did end up nominating Brainard to become vice chairman at the Fed.

A Powell-Brainard Fed would likely use “social and climate justice” as a justification for expanding the Fed’s easy money policies. President Biden has recently nominated Sarah Bloom Raskin to the Fed board, who also has advocated for the Fed to use its power to fight climate change.

A central bank committed to the social justice and climate change agendas will inevitably increase the Fed’s “inflation tax.” Contrary to the claims of some progressives, lower-income Americans are primary victims of this hidden and regressive tax.

Powell prefers to push his rather zealous and extremist philosophies behind the scenes. Thus, not surprisingly, he is a leading opponent of Audit the Fed. Powell claims that bringing transparency to the Fed’s conduct of monetary policy would somehow jeopardize the Fed’s independence. Powell’s claim is truly fake news. There is nothing in the Audit the Fed bill giving Congress or the executive branch any new power over monetary policy.

Any group of individuals given the power to manipulate the money supply, and manipulate the interest rates that are the price of money, poses a threat to our liberty and prosperity. The solution is not to replace Powell with a “better” Fed chairman or to force the Fed to follow a “rule” that still allows it to erode the dollar’s value. The only way to protect the people from dangerous individuals like Jerome Powell, Lael Brainard, and the rest of the Fed board is to audit and then end the Fed.

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This article was published by Mises Institute and is reproduced with permission.