By dropping rates dramatically only a month and a half before a presidential election, the Federal Reserve is playing with fire. It’s a move that seems deeply political, since the election, by all visuals, would seem to pit the establishment against an insurgent populist movement. Regardless of the motives, the Fed is inviting resentment and retribution.
Let’s examine the case for the rate cut. Rates are not tremendously high in real terms. The inflation fight of the past two years seems to have drawn down the rate of price increases, though the battle is far from over. But now the Fed believes it has another problem with which to deal, namely weakness in the labor market.
The desire to get ahead of a possible impending recession compels the Fed to engage in another round of easing. That’s the thinking, in any case. But there is the problem of facts. The recessionary conditions are evident everywhere except on official paper. Bankruptcies are quite high already. Inflation is underestimated and growth overestimated. At this point, everyone in the know is aware.
There is another factor of which many people are unaware. The money stock is already on the increase, either due to relaxed lending standards, more debt purchases by the Fed, or both. This has combined with an inevitable increase in money velocity after the risk aversion of the lockdown years. That could show up in the retail sector or it could show up in financials. In either case, this is not economic growth but rather the illusion of it, in the form of monetary depreciation.
The uptrend in money stock has been going on for nearly a year, following the previous year of decline.
We need to reacquaint ourselves with the concept of a lag. What the Fed does today does not show up in its real effects until 12 to 18 months after the fact, depending on a range of other factors. We know this from the best research of 100 years of monetary policy and its impact.
Very likely, the reduced price pressure we are experiencing right now is due to declining money stock from two years ago. That also means that the shift to greater easing now and in the future will hit us sometime next year.
If, after the election, the Republicans control Congress, the presidency, or both, there will be hot fury in the land. Though people today are unwilling to blame the Fed for the 25 percent decline in purchasing power, this will likely change after the election. At that point, the Republicans will be screaming, “This is enough.” The Fed created the last range of problems, and it has created this one as well.
Scour the Constitution and you will find nothing about this beast called the Fed that was created in 1913. Its purpose was to deploy science in defense of economic stability and low inflation. Almost immediately, it produced the opposite: more business cycles, more inflation, and more government profligacy. This is all because the central bank works as a kind of blank check for the government.
Moreover, the Fed created a cartel-like arrangement among banks, which were once products of free enterprise but quickly became a privileged monopoly serving its member banks and the government. The most immediate result of the Fed’s creation was World War I, which otherwise could not have been funded.
The problem grew worse over the decades. Consider the following. No state government has a central bank. They have to pay for what they buy with tax dollars or float debt that is subject to a default premium. That doesn’t prevent financial profligacy, but at least it introduces a check.
The federal government has no such limit. Its bonds are considered as good as cash for only one reason: the Fed’s ability to print our way out of crisis.
There is nothing necessary about such an institution. To be sure, eliminating it would be a severe shock to the system. Wall Street would scream. Central banks around the world would panic. Big media would denounce the move, and all establishment economists would be in freak-out mode.
All that aside, there is no getting around two crucial facts: Such a powerful institution is nowhere in the Constitution, and none of its grand promises have worked out.
The possibility of abolition aside, there are many ways in which Congress could assert more control over the Fed. It has no control now. As Sen. Rand Paul (R-Ky.) has long urged, Congress could demand an independent audit to discover where the money is coming and going without trusting the Fed’s reports alone. Every major corporation and medium-sized company does this. Why is the Fed exempt?
Congress could make other changes to the Fed’s discretion over the discount window and bank monitoring. It could even take back a portion of monetary control itself, perhaps tasking the Treasury with new monetary functions. This would compromise the Fed’s much-celebrated independence. But many have started to doubt how many compromises the Fed has to make in order to preserve itself. These days, it seems like a highly political institution, as every central bank necessarily must be.
In the ideal world, the dollar would be restored to its gold-backed status and the Fed would be deleted entirely, thus restoring the pre-1913 days of high growth, rising purchasing power, and decentralized banking. The goal would be to normalize the industry so that it worked like every other in a free enterprise system, with the possibility of bank failure and normal competitive pressure.This would unplug the printing press and thereby get the debt under control.
Getting from here to there would be technically difficult, but that is not the real problem. The real obstacle to restoring the gold standard has long been a lack of political will. That could be changing now, as more lawmakers than ever are livid at what is taking place right under our noses.
In other words, the Fed could be preparing the way for its own demise. This time next year, as inflation surges again and the dollar resumes its purchasing decline, more people will join the ranks of the critics, doubters, and even abolitionists.
We do seem to have crossed some invisible line. The Fed is now considered both more culpable and responsible than it was in the past. The next round of inflationary pressure should and will be directly blamed on the Fed.
