In his upcoming book Aftermath: Seven Secrets of Wealth Preservation in the Coming Chaos, James Rickards talks about how the Fed went from deflating bubbles (or “taking away the punch bowl”) prior to Alan Greenspan’s chairmanship, to trying to maintain bubbles prior to 2008. Then, under Ben Bernanke and Janet Yellen, everything changed: the Fed began overtly using monetary policy to stoke asset inflation and huge financial bubbles to keep deflation at bay.
The current Fed chairman, Jerome Powell, seems to disagree with Yellen-era policies, but as author James Grant observes presciently, Powell is “a prisoner of history.” Many observers like to talk about keeping the Fed “independent.” But since the early 2000s, the central bank has been the scene of an intense political battle between proponents of hard money (the hawks) and those with a pro-inflation tendency (the doves). The latter faction has gradually moved the central bank’s intellectual center further and further to the left, both politically and in financial terms.
Rickards notes in his new book: “It’s one thing when loose monetary policy results in private credit extremes. The Fed can rein that in. But what happens when public credit from the Fed is the source of the problem?”
What Rickards refers to is the trillions of dollars in additional liquidity that the FOMC has added to the U.S. economy via “quantitative easing,” which involved the Fed buying Treasury bonds and mortgage paper between 2009 and 2015. These purchases created vast new bank deposits in the financial system, liquidity that’s now running off as the Fed’s balance sheet shrinks.
The pro-inflation side, led by the likes of Bernanke and Yellen, wants to leave the Fed’s swollen balance sheet as is—essentially making permanent the increase in stock, bond, and home prices engineered by the FOMC over the past eight years. Conservatives inside and outside the Federal Reserve recoil at such a suggestion. Yet the reality is that once Bernanke made the decision to hyper-inflate the Fed’s balance sheet by an order of magnitude, the addition of cash to the U.S. financial system was essentially irreversible.
Despite the reassurances provided by Fed officials, this policy has come at a cost. The near-collapse of the U.S. financial markets in December reflected the systemic stress introduced as the FOMC has sought to recover at least some modicum of credibility with respect to inflation by shrinking its balance sheet. The enormous size of the injection of liquidity by the Fed under Bernanke and Yellen, however, seemingly rules out any potential for redemption.
Realizing its political exposure, the Fed has put out a steady stream of “research” to justify its actions. “In line with a growing economy, the amount of currency in circulation has increased so much that it is not possible to shrink the balance sheet to its earlier size,” notes the Federal Reserve Bank of San Francisco in a report titled “Why is the Fed’s Balance Sheet Still So Big?” The answer, of course, is that the FOMC decided to roll the proverbial dice with the American economy, blowing financial bubbles today despite the risk of market crises and economic recession in the future. And that may be exactly what’s about to happen.
Since December of this year, interest rates have been falling in the U.S. Around the world, more than $11 trillion in public debt now has negative yields. Negative government interest rates are viewed almost universally as an indicator of a looming recession or depression. Despite all the Fed’s actions and all the assets purchased by the Bank of Japan and the European Central Bank, the world economy seems to teeter on the verge of financial deflation. This raises the question as to whether current monetary policy is helping or hurting the situation.
In a review of an important new book, Inflation Targeting and Financial Stability by Michael Heise, Claire Jones of the Frankfurt Bureau of the Financial Times notes that “the U.S. Federal Reserve, the Bank of England and the Bank of Japan all share with the European Central Bank a belief that their goal should be to consistently produce inflation of around 2 per cent.” Heise argues that this doctrine of targeting low but stable inflation is “a fool’s game.”
The only problem with this from the Fed’s perspective is that the Federal Reserve Act requires it to pursue price stability—this after achieving full employment. Having an explicit policy of 2 percent inflation is a violation of U.S. law, but the FOMC under Bernanke and Yellen didn’t seem to mind. Even when other members raised concerns about the Fed’s “extraordinary” policies a decade ago, both chairs ignored these protests.
From a market perspective, a viewpoint too often absent from Fed deliberations, the low or negative interest rate regime imposed by these unelected central bank governors is in fact the cause of the very deflationary malady that economists pretend to fight by encouraging inflation. Instead of truthfully telling their respective national governments that excessive public debt is problematic and must be reduced, the world’s central bankers have instead functioned as drug dealers, peddling the heroin of easy money as a short-term solution to the reality of long-term insolvency.
The victims of the intellectual fraud perpetrated by Bernanke and Yellen are savers and investors—that is to say, all of us. Yet the Fed continues to talk about targeting higher inflation even as the Treasury yield curve has inverted, with short-term interest rates significantly above longer-term bond yields.
Looking at the history of the Fed’s quantitative easing, the growth of debt, and especially highly risky leveraged loans, tracks the Fed’s intentions to take risk-free assets out of the system and force investors into riskier products. During congressional testimony, both Yellen and Bernanke conceded that financial instability is a risk, but said in effect that they’d rather deal with deflation now and financial stability problems later.
Today, the Fed is a seriously conflicted organization that is committed to a policy of promoting inflation rather than price stability as commanded by Congress. Obviously the half-century-old “dual mandate” of seeking price stability and full employment is a practical impossibility. Yet rather than address this conflict of visions honestly and in public, the FOMC has instead tried to manage an increasingly unmanageable situation as annual deficits soar to $1 trillion annually.
This summer, the Fed may again put the markets at risk of financial contagion as it pretends that it can manage interest rates, inflation markets, and the global economy.
In an interview with the Financial Times, Dr. Judy Shelton, who has been suggested as the next member of the FOMC, calls on the Fed to “think about whether they are doing more harm than good.” She adds: “How can a dozen, slightly less than a dozen, people meeting eight times a year, decide what the cost of capital should be versus some kind of organically, market supply determined rate? The Fed is not omniscient. They don’t know what the right rate should be. How could anyone?”
She is dead right.
Christopher Whalen is an investment banker and chairman of Whalen Global Advisors LLC. He is the author of three books, including Ford Men: From Inspiration to Enterprise (2017) and Inflated: How Money and Debt Built the American Dream (2010). He edits The Institutional Risk Analyst, and appears regularly on such media outlets as CNBC, Bloomberg, Fox News, and Business News Network. Follow him on Twitter @rcwhalen.