The-Ave.US

I’m leaving the first two slots on the Public Enemy list blank, for you to fill in as you please. (I have my own nominees.)

Biden has just nominated Jerome Powell, the Federal Reserve chair, for another 4-year term, and the Senate will soon vote whether to confirm him. This article is about what that means, and whether it’s a good or bad thing.

Monetary policy is a hard subject to wrap your brain around, not least because how it works and affects the economy is so complex. Also, there’s a lot of disagreement, frequently of a partisan and ideological nature, about whether the Federal Reserve’s policies are helpful or harmful, and even whether the “Fed” is good or evil. Some people on the right want to abolish it altogether, although that’s not currently on the table.

A recession, by definition, is when the economy shrinks. This can happen on the supply side, i.e. because businesses are producing less, or on the demand side, i.e. consumers are buying less. Or a combination of both.

Inflation, by definition, is when the buying power of a unit of currency shrinks. The late conservative economist Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon.” I disagree. He has a Nobel Prize in Economics, and I don’t, so what do I know? All I can do is explain why I disagree.

When the entity that controls money supply, i.e. the amount of money in circulation — which in America is the Federal Reserve — expands money supply faster than the economy is expanding, you get monetary inflation. But I believe there’s also a thing you can call “real” inflation, i.e. higher prices not caused by monetary policies, but by higher production costs. An obvious example is when the easy-to-get oil runs out and you have to expend more resources to extract oil. Another example is when the nearby forests are logged and you have to ship logs farther, from more distant forests, to get material for lumber.

This digresses from where I’m going with this article, so let’s get back on track.

In the bad old days, when the U.S. was on the gold standard — a stupid and dangerous idea still supported by ignorant conservatives — money either was “backed” by gold stored in vaults, or consisted of gold itself (e.g., in the form of gold coins), and government “pegged” currency to gold’s value by decreeing a gold price. Back in the 1930s, this was $35 per ounce.

This limits the money supply to the gold supply, which is the whole idea, the argument being that if government can’t “print” money it can’t create inflation. The problem is that arbitrarily limiting money supply has the knock-on effect of arbitrarily limiting the size of the economy, too. Now visualize a population growing faster than the gold supply, and you’ll see why that’s a problem (even if it wasn’t otherwise).

An impressive number of very smart people with a superior understanding of economics, including economists and bankers, credibly argue that the gold standard was a major cause of the Great Depression. (See, for example, this book.) It’s popularly believed that the 1929 stock market crash “caused” the depression, and there’s some truth to that, but stupid and destructive monetary and fiscal policies (i.e., Republican policies) were very instrumental in turning an ordinary recession into the worst depression our economy ever experienced.

But we’re getting sidetracked again.

Let me cut to the chase: Stupid Republican laissez-faire financial regulation led to the housing crash and financial crisis of 2007-2008, which would have turned into another terrible depression if the Federal Reserve hadn’t intervened by pumping money into the economy. The great sucking sound in 2008 was scared people stashing cash under mattresses (or in insured bank accounts) in case the economy collapsed, and the money supply was shrinking rapidly.

The Fed pumped something like $3 trillion into circulation by “printing” money through its “quantitative easing” (“QE”) program and by slashing interest rates. Stupid conservatives complained this would cause hyperinflation; it didn’t because it didn’t expand the money supply, it only kept it from shrinking, which prevented a massive deflation that would’ve led to an even more serious contraction of the economy.

So, the Fed did the right thing in response to the financial crisis and Great Recession.

When, 10 years later, the arrival of Covid-19 closed businesses, put millions out of work, and threatened to crash the economy again, the Fed reinstated QE and kept suppressing interest rates (which were never raised much after the Great Recession). On the fiscal side, which is another way to stimulate the economy (or save it from contraction), Congress handed out money to businesses and households, which not only helped tide them over during the crisis, but also kept the money supply from shrinking as income dried up.

But there’s no free lunch in economics, and while these policies kept the economy from shrinking further (there were recessions in 2009 and 2020, but the monetary and fiscal policy stimulus kept them in check), they had knock-on effects.

These are: (1) inflating asset values (i.e., pushing up prices of stocks, homes, etc.); (2) expanding wealth inequality (only some people got richer from higher stock and home prices); and (3) low interest rates encouraged massive borrowing and punished savers by drastically reducing the interest income from savings (this especially hurt retirees). (For an article in The Hill about Powell’s and the Fed’s role in wealth inequality, go here.)

So, while QE and suppressed interest rates helped save the economy twice in the last dozen years, they’ve had some sucky effects, too. And the sucky effects are unevenly distributed across the population, resulting in growing wealth inequality, although nothing like the wealth inequality that Republican economic policies produce (billionaire tax cuts, corporate subsidies, etc.).

Now back to Biden’s decision to keep Powell as Fed chair. Powell doesn’t single-handedly control the Fed’s monetary policy, a committee does, but he’s the public face of the Fed and has a lot of influence over its policy decisions. He’s a Republican first appointed by Trump, but a pragmatic Wall Street banker not an ideologue, and is a proponent of “easy” or “loose” monetary policies, i.e. lots of QE and keeping interest rates low.

This is a problem, because those policies are partly to blame for the inflation happening now. And you’ll find a goodly number of very smart Wall Street people and bankers who think the Fed overshot with stimulus and went too far in letting inflation runner hotter in order to get employment back to normal. More about that in a moment. Apparently there was only one other serious contender for the Fed chair job, and that was Lael Brainard, a Democratic who’s even “easier” or “looser” than Powell (in Fed-speak, more “dovish”). So, if you think Fed policy is too loose — and I’ve thought that way for a long time — given a choice between Powell and Brainard, Powell is the better (i.e., less dovish) choice. (Biden nominated Brainard for vice-chair, the No. 2 job at the Fed.)

There’s more to these nominations than monetary policy; the Fed is also responsible for regulation banks, and Sen. Elizabeth Warren (D-MA) doesn’t like Powell because he’s relatively easy-going on the banks. However, the banks are in pretty good shape right now, so I’m not worried about that. There also are differences in temperaments and personalities, but I think that’s less important than what the Fed’s monetary policy will be going forward. And I’m digressing again. (It’s hard not to in this business.)

I don’t like this inflation any more than anyone else, and the Fed is partly responsible for it, but I’m not worried about it, and that doesn’t make the Fed the third-worst bad influence in our country right now. The current inflation rate of around 6.8% (it hit almost 10% in October) is nasty, but it’s also temporary; a lot of it is caused by pandemic-related supply shortages and bottlenecks, plus consumers who hoarded cash during the pandemic are trying to spend it all at once, and businesses can’t keep up with consumer demand.

That will pass, as the goods pipeline returns to something closer to normal, and consumers burn through their savings and pull back on spending. Many of those very smart Wall Street people and bankers believe inflation will drop to 2.8% by December 2022, and if they’re not worried about long-term inflation, I’m not either. They’re closer to the nation’s financial arteries than I am, and know more about this than I do.

That’s still higher than the sub-2.0% inflation rate of recent pre-pandemic years. This is deliberate. During those years, the Fed struggled to push inflation up to 2% to get more economic growth. Powell, and Bernanke before him (who engineered the Fed’s response to the financial crisis), were fighting deflationary forces in the economy that are still there (an aging population, slower productivity growth, etc.), and will continue to be a problem after the pandemic abates (if it ever does). Now, Powell wants inflation to run “hotter” than 2% for a while in order to “catch up,” and also to pull America out of the unemployment hold the pandemic pushed it into.

These guys (Powell and Bernanke) have been mostly right about what monetary policy was needed and appropriate. Through both of those crises, the Fed had to do most of the heavy lifting because Congress didn’t do enough fiscal stimulus, restrained back by stupid Republicans who think government should cut spending to prevent inflation when the problem is not inflation but deflation. (Nearly all mainstream economists agree that Obama’s fiscal package of $900 billion was too small, but that’s all he could get out of congressional Republicans.)

But Powell probably is wrong about there still being a lot of unemployed people, and a need to stimulate employment. Last weekend, Barrons magazine published an article explaining why America doesn’t have unemployed workers. (You can read it here, at least right now you can.) The reason, they said, is because roughly 4.6 million Americans are suffering from “long Civid,” of whom about 2 million are workers who lost their jobs in the pandemic. “Long Covid” is characterized by, among other things, severe fatigue; and these people can’t work, even though many of them want to.

(CNN Business thinks a lot of older workers are opting for early retirement. See their article here. But while this helps explain the low labor participation rate (the percentage of working-age Americans either working, or looking for work), it doesn’t explain why people nominally in the workforce aren’t taking available jobs; the Barrons thesis does.)

Republicans were very wrong about more people weren’t going back to work. Last spring, they blamed unemployment benefits, and fought strenuously to end the distribution of federal pandemic unemployment benefits in states they control, arguing this would get people back to work. It had no effect. Last summer, they pushed to reopen schools (prematurely, it turned out in some cases), in the belief that getting kids back in classrooms would free parents to return to work. This had no effect either; the expected wave of job applicants in September never materialized.

Understand that Republicans only care about business profits and employers’ struggles to find enough workers; they don’t care whether whether workers or kids get infected, any more than they cared about workers dying on production lines last year, which is another reason not to vote for them. But I’m digressing again.

If Barrons is right, and I think they are, kicking people off unemployment benefits and shoveling kids back into classrooms before it was safe didn’t produce more job applicants because there isn’t a pool of job-ready workers out there. What we do have is roughly 2 million disabled workers who need about a year to recover and then may return to the workforce, according to some health experts.

This means Powell’s policy emphasize on employment, at the expense of inflation, is misguided and the Fed should be tightening faster to bring down inflation. However, the inflation problem isn’t so severe as to make the Fed a public enemy, at least not comparatively. And while it doesn’t appear that Powell realizes yet the U.S. economy is already at full employment, at least in terms of workers presently able to work, it does appear to be gradually dawning on him that monetary tightening needs to happen faster. The rest of the committee gets this, too, in fact several of them have been months ahead of him in coming to this realization.

Powell had planned to end QE by next June, and begin gradually raising interest rates by early 2023. The Fed now seems poised to end QE by March, and begin raising interest rates by fall of 2022 (see story here). With Powell now likely to remain Fed chair, that policy likely will remain in place. That’s not fast enough, and some Wall Streeters want the Fed to start raising rates no later than June and preferably sooner, but this is better than nothing. We’re talking about incremental shadings of policy, not the wrong policy direction of a crazy policy. I’m of opinion (and who am I? nobody) the Fed is making policy mistakes, and has been for a while, but not ones that rise to the level of making the Fed a public enemy.

The pandemic inflation effects will recede as supply lines improve and consumers burn through their hoarded cash. Fed tightening should bring inflation under 3% by 2023 and possibly sooner. I still don’t like that level of inflation, and voters probably won’t either. Employers are raising wages, but not as much as inflation, so most of America’s workers are taking pay cuts right now. That’s why you’re seeing labor strikes. I want a more aggressive Fed, and you should too, but we’re probably not going to get that under Powell, who probably will be confirmed by the Senate.

Bottom line, I think he’s too “easy” and too sluggish at tightening, but it is what it is, and at least he’s not some anti-Fed ideological whack job. And you can reason with him; the fact he’s speeding up QE withdrawal (albeit pushed by other committee members, Wall Street, bankers, and other outside influences) proves that. We could do worse.

Meanwhile, deflationary forces are still in the economy, and after this bout of inflation blows over, deflation will become a problem again. Are we in danger of living through something like the awful “stagflation” of the 1970s again (for those of you who remember)? Not a chance. This isn’t that kind of inflation. And the underlying economic forces then were inflationary, not deflationary like we have today.

No, America’s chief economic problem now is a long-term structural labor shortage, due in no small part to falling native birth rates and a shrinking U.S.-born population. (The U.S. birth rate fell below the so-called “replacement rate,” i.e. the number of births needed to offset deaths, years before the pandemic.) The solution to that is more immigration. Republicans are stupid about that, too.

Bottom line, I wouldn’t call the Fed public enemy #3, not even close. Despite dissing on them in this article, I wouldn’t call Republicans public enemy #3, either. That’s because I’ve already assigned them to the #2 slot. I’ll leave it to you to figure out who’s in the #1 slot.

Photo below: Lael Brainard (left) and Jerome Powell (right)

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