Fed Shock And Awe?

Yesterday we cited the latest CPI report – up 7.5% from a year ago – which is prompting an uproar over accelerating inflation.  Analysts are widely calling for aggressive rate hikes from the Fed, some including officials of the Fed itself.  Markets are in turmoil over the prospect.  The Fed faces a dilemma, because such aggressive action would validate market fears, yet if it fails to act, that itself could upset markets on fear the Fed is falling even further behind the curve.

This is all tragically unnecessary.  This inflation did not just materialize.  It’s not even accelerating.  As we pointed out weeks ago, It’s Been Inflation All Along.  This was hardly the first time Financology has raised the alert … we identified an inflation problem back in 2020, for example in Inflation Is Here.  We’ve been calling for the Fed to allow rates up off the floor since mid-2020.  The Fed has gravely erred in waiting too long to act.

We discussed a core fallacy underlying this error in our last post – the unjustified assumption that inflation can only be defined by and detected in US domestic consumer prices. By excluding consideration of asset prices, such as those we cited way back in 2020 in Inflation Is Here, the Fed deliberately blinded itself to the problem.  It merely compounded that error by engaging in persistent denial when, even after it was showing up in consumer prices, it dismissed it as “transitory”.  As we pointed out at the time, the inflation would be just as transitory as the policies causing it.

We have even traced this wave of inflation back further, to the beginning of 2019, when the Fed abandoned its campaign to normalize interest rates.  Not merely content to arrest a decline in asset prices, it continued to cut rates, inflating them to new heights.

Yet Financology called for aggressive Fed Treasury purchasing in the wake of the deflationary crash triggered by the corona crisis in early 2020; in particular, in Calling All Helicopters, on March 18, 2020.  The Fed responded on March 23.  Alas, the Fed did not stop there, but also bought mortgages, corporate bonds, and foolishly committed to literally years of zero rate policy.  It’s as if you went to the doctor for an emergency appendectomy, and he removed your appendix every week for two years.  

Sheer economic malpractice.

4 thoughts on “Fed Shock And Awe?

  1. cb says:

    I followed you link to “Calling all Helicopters” Sorry I missed it. It is now closed for comments. I think your position taken would have been an interesting discussion. I disagree with your checks to every one view. It seems unnecessary and an inflation inducing waste. I would have preferred unemployment benefits and welfare distributions for hardship cases.

    Oh, and we have had continuous inflation for decades, aside from minor blips barely worth mentioning. Malpractice within the FED has been the order of the day. It’s hard to stop continuous inflation if you never allow deflation.

    The grave error regarding the FED was made in 1913. Not for the FED or its constituency, but for the common American.

    1. Bill Terrell says:

      Fair enough, CB. Reasonable people could disagree. My reasoning is that the corona crisis induced a massive demand for dollars, causing them to surge in value. If the Fed has a legitimate role in stabilizing the value of the currency, it was right to increase supply to meet demand. Of course the Fed had no business buying mortgages, corporate bonds, promising years of ZIRP, etcetera. It should have withdrawn the policy as soon as the crisis had passed, but failed.

      The “checks to everyone” part has to be put into context. The government in fact did issue checks to almost everyone. But that wound up being only a fraction of the funds disbursed. The majority went to special interests. A little for individuals and families, a lot to corporations, states, and other groups. I would simply rather have seen all the aid go to individuals and families, and let them direct their spending to those corporations, states and other groups as they chose … “trickle up” if you will. If you’re going to get cash into the economy, I’d just prefer to do it democratically … everybody gets the same.

      Far as creating inflation goes, it’s context again … the idea was to counter an intense wave of deflation. Once that’s done, there need be no inflation left over; just declare victory and withdraw the policy. Instead it kept going. Hence my remark that it was as if you went to the doctor for an emergency appendectomy, and the surgeon removed your appendix every week for two years.

      Far as deflation goes, the Fed doesn’t prevent it anyway. We had hair-raising, white knuckle deflation in 2008. We had a smaller episode in 2020. The problem isn’t that the Fed prevents it … it causes it. The Fed causes inflation, pushes it too far, and deflation is the natural reaction. For something to deflate, it must first be inflated.

      Then once the deflation is making a mess of things, the Fed not only steps in to stop it, but keeps inflating, sowing the seeds for the next crisis. Rinse and repeat. Stupid, stupid Fed.

  2. cb says:

    You recently posted an excellent list of commonly stated economic fallacies There are many fallacies, mis-directions and unproven assertions bandied about by economists and financial practitioners and observers. It is maddening because support is rarely demanded of many of these incorrect platitudes. One such common unproven assertion concerning our current economic structure with the dollars place within it is:

    “The system will keep working as long USD remains the reserve currency.”

    The implication is that the dollar, being the world’s reserve currency has been a net benefit for America. A devil’s advocate might contend the opposite; that the dollar’s status as world reserve currency has been detrimental to the USA, hence the position we have found ourselves in over the last couple of decades with continuous inflation and a manipulated, bastardized financial system with a pathetic and corrupt FED in the middle of it.

    Could it be that the system is dying because the USD(dollar) is the reserve currency?

    1. Bill Terrell says:

      This is an excellent example of sloppy media discourse. A “reserve currency” is simply a currency held as reserves by a government or central bank. The problem comes in when people use phrases like “the US dollar is the world reserve currency”. As if there were no others. In reality, central banks hold a number of assets as reserves, including gold and a number of other currencies. So the phrase overlooks the fact that there simply isn’t any such thing as “the” reserve currency … it’s a plurality.

      The US dollar has made up more of these reserves than any one other currency for some decades, leading to media oversimplifications like it’s “the world reserve currency”. The amount of these reserves has been declining. Whether the dollar loses its status as the reserve currency is therefore not a binary on or off proposition, but one of how much.

      I personally don’t pay much attention to the “reserve currency” issue. If the US responsibly manages its currency, it won’t be a problem. If it doesn’t, it won’t matter.