The Fed Pivots To What?

Authored by Jeffrey Tucker via The Epoch Times,

Whether it is real or not, the messaging of the Federal Reserve over the last week has been gravely irresponsible. The word leaked with heavy encouragement from Jerome Powell that the Fed is done fighting inflation and could cut rates three times in the coming year.

This matters because it means pivoting from a three-year campaign to use higher rates as a tool to reduce inflation. Exactly what the mechanism here was supposed to be was unclear. Was the Fed deliberately reducing economic growth to cool down spending? Or, without admitting so, was it attempting to sop up some of the excess liquidity it had created during its crazed monetary expansion of the 2 previous years?

I suspect it was the latter. It worked to some extent. The money stock has fallen some 5 percent since November 2021, and that has caused a bit of a pullback from roaring inflation. The stated goal has always been to create a “soft landing.” That’s an odd metaphor since the economy never really got off the ground following the catastrophic lockdowns of 2020. From that time on, it’s required every manner of data manipulation and spin to keep recession from being officially declared.

No one anticipated a Christmas surprise from the Fed which amounted to announcing a dramatic reversal of the policy. The word on the front pages this week is that the Fed is considering rate cuts next year, strongly suggesting that the Fed considered its anti-inflation campaign to be over and won.

Remarkably, this news arrived the same week as terrible inflation data came out of the Bureau of Labor Statistics. Contrary to the spin, it was not good at all. Yes, the overall weighted rate was 3.1 percent—50 percent over the target—but this was dragged down mostly by declines in some energy prices. Some food and services were still approaching double-digit increases.

The timing was odd too because Americans from all walks of life are only now fully cognizant of what has happened to their purchasing power over 3 years. It’s been devastating to lose fully 20 percent of purchasing power (and likely far more depending on which good or service is in question) over such a short period of time.

In addition, it’s not as if the run of “tight money” has become an entrenched part of economic life. We’ve only barely met it. And this has happened at a time when average Americans have ever less cash on hand to take advantage of the new opportunity in savings.

Once you adjust the federal funds rate for inflation, you can see that we’ve only had positive rates for 6 months, and this follows nearly a quarter-century of consistent distortions from the Fed.

(Data: Federal Reserve Economic Data (FRED), St. Louis Fed; Chart: Jeffrey A. Tucker)

This kind of interest rate manipulation has many deleterious consequences. It punishes savers and rewards debtors. It subsidizes industrial projects with a long forecast of a rate of return or profit, at the expense of borrowers who need cash to serve more immediate needs. Of course by nudging the banking system to expand money and credit, it adds to the money stock in ways that risk price distortions from inflated financials to diminished purchasing power.

All of these things have happened thanks to the Fed.

It is infuriating and disingenuous for the Fed to pretend to come to the rescue now. They slammed us with the high tax called inflation (thanks to money printing that once equaled 26 percent year over year). Then they ginned up rates to the point that mortgages have become unaffordable for most and revolving credit cards are charging pillaging prices even as Americans carry more debt than ever before.

Now they dare to claim some kind of victory and throw markets into another frenzy of anticipation of more rate cuts! It’s gotten outrageous. But of course Wall Street loved it. It was the Fed’s version of doggie treats for Wall Street. And it had the right effect, even without delivering the treat itself. The Fed only needs to take the box from the cupboard and shake it to cause the dogs of finance to comply.

But is this actually wise? We have a real history to consult. President Nixon took the United States off the gold standard in 1971, with the promise of a wonderful new monetary system that would control inflation and allow the scientists to manage things better than ever before in history. (That’s a familiar incantation!) The result was the opposite. Inflation shot up and Nixon, of all people, imposed wage and price controls in response.

Those didn’t help, of course, but rather only created shortages. Once removed, inflation shot up again. From 1973 to 1974, Americans were pummeled with price increases in everything. The Fed got to work fighting inflation with rate increases starting in 1975. That seemed to work, bringing inflation down from 12.5 percent to 5.6 percent.

By early 1976, the Fed was convinced that its job was done. The inflation trend was headed in the right direction and now the Fed could cool it with the tightening and loosen up again. After all 1976 was an election year (like 2024!) and Gerald Ford was not the establishment’s choice. A more calm electorate was essential in anticipation of the election of the responsible establishment manager Jimmy Carter.

(Data: Federal Reserve Economic Data (FRED), St. Louis Fed; Chart: Jeffrey A. Tucker)

Carter was safely elected and all seemed well. Then what happened shortly after the Fed had settled into its low-rate regime? It turned out that the inflationary fires were still burning. Suddenly the drapes caught on fire and everything else in the house too. Inflation roared out of control for a solid 4 years, wrecking the whole Carter presidency. They peaked at an incredible 14.5 percent. All told, between the end of the gold standard and the election of Ronald Reagan, the dollar in terms of domestic goods and services lost more than half its value! This was the result of the great monetary experiment that began in 1971.

It was a catastrophic decade from an economic point of view.

The fix came after 1981 with a dramatic tightening of money, plus deregulation and tax cuts. That magic combination repaired much of the damage and at least established a new path for authentic economic growth that began in earnest in 1983.

What’s extremely weird about the Fed policy today is how much it looks almost identical to what happened in 1976. If history repeats itself (or at least rhymes) we could be looking at a massive resurgence of inflation from 2025 and onward.

The truly pessimistic scenario is that it could be far worse than the 1970s simply because Fed policy has been so irresponsible for much of this century so far.

And true to form, not one person associated with the Fed has taken any responsibility for the damage that institution has done.