This week I’m traveling and unable to write a full letter, so I’m instead going to revisit a theme I have written about in the past and is still very appropriate today. The most recent was last year in Time to Rethink the Fed. In hindsight, my opinions have not changed much but I do have a few additional insights.
I believe Fed officials are largely responsible for the cycles of bubbles, booms, and busts over the last 30 years. Furthermore, they share some of the blame (clearly not all) for the growing divisions and tribalism in our society. Much of it springs from the wealth disparity they aided and abetted.
What we have today isn’t working and the time has come to amend the Federal Reserve Act and change its purposes and authorities.
I realize these are bold words. I fully acknowledge the gravity of what I’m proposing here.
It also will take time. I do not expect anything to happen of any substance until we get to The Great Reset, where we will be forced to think and do many things now unthinkable in the current environment.
In the 1870s the Bank of England pioneered the “lender of last resort” concept. British writer Walter Bagehot (a co-founder of The Economist magazine) famously summarized the central banks’ job as averting panic by “lending freely, to solvent firms, against good collateral, and at high rates.”
As former Morgan Stanley Asia Chairman Stephen Roach explained in this early 2022 Project Syndicate piece. Quoting (emphasis mine):
“Consider the math: The inflation rate as measured by the Consumer Price Index reached 7% in December 2021. With the nominal federal funds rate effectively at zero, that translates into a real funds rate (the preferred metric for assessing the efficacy of monetary policy) of -7%.
“But only to a point. The forward-looking Fed still faces a critical tactical question: What federal funds rate should it target to address the most likely inflation rate 12–18 months from now?
“No one has a clue, including the Fed and the financial markets.”
Walter Bagehot, 19th-century British economist and journalist. His father-in-law, James Wilson, founded The Economist magazine that still exists today. Bagehot was its editor from 1860–1877. (Incidentally, if you want to sound very British and sophisticated, mention Bagehot and pronounce it as they do, “badge-it.” I don’t know where they get that from the spelling of his name. That’s an even more unlikely pronunciation than the one they apply to Worcestershire.)
Bagehot wrote an influential 1873 book called Lombard Street: A Description of the Money Market.
How did the Fed act in 2008? In exact opposition to Bagehot’s rule. They sprayed money in all directions, charged practically nothing for it, and accepted almost anything as collateral. Not surprisingly, the banks took to this largesse like bees to honey. Taking it away from them has proved very difficult. We now find ourselves in an era of speculation about what will happen when interest rates are raised.
I assume and the markets agree with me that the Fed will raise rates another 25 basis points in May. That will take fed fund rates up to 5¼%. And while inflation is coming down, real rates are still below zero.
The Fed has taken on a third unwritten mandate, that of “financial stability,” which really means stock market stability. The low rates that keep the stock market happy also financialized the entire economy.
John Mauldin April 21, 2023
Time to Rethink the Fed
John Mauldin February 4, 2022