FWIW #38 - The Real Culprit

In the Wall Street Journal last week, I read an article about monetarism that’s important, even if the author’s perspective is less than right.

As the author, James Mackintosh, correctly points out, Fed Chair Alan Greenspan changed Fed policies in the mid-1990s from managing the money supply to managing interest rates. He nails down the year to 1993 and says the change was appropriate because “there was essentially no link between any of the various measures of money supply and inflation through the 1990s, 2000s, and 2010s.” While the statistics may show no link, was that because of the relationship between money and inflation? Or was it because the velocity of money declined as the Fed’s excess money flowed into the hands of political donors, who used it to expand their globalization and enrich elites in business and finance and their political enablers in Washington? When the business cycle began exerting itself during this 30-year period, the Fed suppressed interest rates to “stimulate” the economy and prop up investment markets. Speculators benefited from this “Fed put.” The poor and middle class, who saved what they could from their earnings, paid the cost of the Fed meddling. The Fed confiscated savers’ rightful earnings on their money so that speculators/donors to the political class wouldn’t have to pay the market-set price for their reckless, leveraged speculations. In simple terms, the Fed took money from the poor to enrich the rich speculators.

That wasn’t the only travesty. The US spent over 7 trillion borrowed money to fight the prolonged wars in Iraq and Afghanistan from 2001 to 2021. Would these wars have been fought or allowed to fester if the cost of that $7 trillion had been set by the markets instead of being suppressed by the politically controlled Fed? Further, if interest rates had been set at market rates, would the era of private equity firms borrowing substantial sums at suppressed interest rates have happened, resulting in a new billionaire class and causing many workers to lose their jobs? Even while these workers were losing their livelihoods through offshoring or business failure by over-leveraging, the Fed was suppressing the interest rates that the unemployed or retired citizens could have earned on their savings.

America is beset with a multitude of existential problems today: crime and inflation are top of the list. Crime is blamed on income inequality. This is a dubious excuse; however, it has some validity. If the poor and middle class, who had their jobs either shipped overseas or terminated by companies failing under poor financial management, were not experiencing their savings being destroyed by inflation and their interest on those savings confiscated by Fed policy deliberately suppressing interest rates, income inequality would be less substantial. Crime and looting cannot be excused or tolerated, but income inequality is real. Think of the billions of dollars in interest that the Fed took from savers in America over the last 30 years. If a average citizen had done it at the point of a gun, he would be in jail for centuries. Whether the resulting fraying of the lower and middle classes was intentional or unintentional does not matter, the results are the same.

Since 2021, the Fed’s irresponsible expansion of the money supply has reversed. Mr. Mackintosh points out that some economists are “concerned about an unprecedented fall in the money supply year over year.” Why weren’t they concerned about the irresponsible increase in the money supply during the period 2020–2021 and 1993-2020? Much of the blame for inflation is now laid at the feet of the pandemic and the fiscal response to the pandemic. There could not have been excessive inflationary fiscal spending by the federal government if the Fed had not turned on the digital printing press. Interest rates would have soared as the politicians bent to the will of their donors and lobbyists. If interest rates had been set by the markets for the last 30 years, would the wasteful and irresponsible spending and huge deficits by the federal government have taken place? The one governmental body that was designed and mandated to be the fiscal disciplinarian turned itself into the fiscal codependent to the spendthrift government.

Finally, because of Fed interest rate policies, ordinary savers were driven from the banking system into riskier investments, while smaller borrowers had to turn to high-interest-rate, non-bank lenders. The ramifications of these unregulated activities are yet to be seen.

Enough of the mismanagement and irresponsibility of the past. It must be understood that the Fed will always serve their political masters rather than the American public. It is interesting that Mr. Mackintosh says in his article that the lag effect of the changes in the money supply is felt 18 months later (as with any cause and effect, that’s a soft number, which could be shorter or longer). Isn’t it interesting that 18 months from now, the Fed chairmanship comes up for appointment by the newly elected president? Chair Powell, even if he is not reappointed, can serve out his regular Fed appointment until 2028. The Fed has said interest rates will stay higher for longer than the markets expect. Does that mean they still intend to control interest rates in the future? It certainly may since central banks around the world operate by controlling interest rates and their policies are as coordinated as ever. If that’s the case, it’s likely (a) inflation will stay elevated as a means of eroding the national debt’s value to bond holders, and (b) along with inflation will be interest rate repression by the Fed. Taken together, these actions will further exacerbate income inequality. Owning economic assets will be a must to offset as much of the dollar destruction as possible.

Perhaps the Fed’s mantra of higher for longer is a signal that it’s returning to managing the money supply rather than managing interest rates. With the financial state the world is in, market-set interest rates will punish the irresponsible and reward the responsible. Since the federal government and others have been irresponsible in their financial affairs, a painful adjustment for the government could be in order. President George H. W. Bush’s 1991 agreement with the Democrats in Congress capped spending and raised taxes, which worked for the period the agreement was in place (the Clinton years). It could be done again if Congress and the president agreed and the Fed allowed the investment markets to set the cost of money, thus bringing some discipline to the undisciplined federal government. The Trump era tax cuts will expire at the end of 2025. If the Congress can put in place an appropriate spending cap so that the tax increases will go to budget deficits, there may be hope if the Fed has money supply discipline.

Experts and analysts vie with each other in the business media as they attempt to be the guru of the moment by predicting the financial future without knowing the future. They make investing complicated. Finances are not complicated and don’t require a guess about the future. Truths for accumulating wealth and keeping it are few and critical. First, the federal government will always systematically debase the currency, no matter what Fed officials and politicians say. Second, accumulating wealth and keeping it requires taking risks by owning economic assets that are priced to reflect what they are worth in the present, not what someone who can’t predict the future says they will be worth in the future. Third, it is necessary to always have liquidity so that when an opportunity presents itself, it can be added to the portfolio, compounding the total return.

The Fed knows management of the money supply will return the economy to a sustained and stable growth rate with controlled inflation. If nothing else, the inflation rate decline over the last year, a reflection of the significant reversal of the money supply, should point the way. We’ll see what happens.