Author: Mr. X
There are no good options.
The signals from the Federal Reserve have not been complicated. The Fed has constantly signaled that it is prioritizing stopping inflation, even if that means hurting economic growth and the stock market. The seeming refusal to believe the Fed means what it says explains what is likely a short-lived bull market.
The Fed is in this situation because it because it acted too slowly at the beginning of this crisis. At the risk of saying, “I told you so,” we wrote quite a bit here about how inflation was not transitory. It’s too late to do anything about that now. Chairman Jerome Powell is correct. Stopping inflation must be the highest priority, even if it gets in the way of economic growth.
What’s frustrating is the refusal to acknowledge that there will be a cost. This has two elements.
First is the willingness to believe that the Fed is not going to raise rates. For example, last week Federal Reserve of Atlanta President Raphael Bostic said that quarter-point increases may be sufficient and that the Fed should be cautious about raising rates even higher. The market spiked in response. Yet even Bostic’s comments were cloaked in caution. “We must determine when inflation is irrevocably moving lower,” he said. “We’re not there yet. That’s why I think we need to raise the federal funds rate to between 5-5.25% and leave it there well into 2024. This will allow tighter policy to filter through the economy and ultimately bring aggregate supply and aggregate demand into better balance and thus lower inflation.”
Other officials at the Fed have an even more hardline policy. The almost cartoonishly hawkish Neel Kashkari said that he would be “open minded” about another half-point increase. “Given the data in the last month – higher inflation than we expected and a strong jobs report – these are concerning data points suggesting we’re not making progress as quickly as we’d like,” he said.
On Friday, the Federal Reserve issued its semiannual Monetary Policy Report, which restated the goal of bringing inflation down to 2%. Chairman Powell will testify before Congress today, and is unlikely to back away from that goal.
In October, he was clear about the cost that needs to be paid. “We have got to get inflation behind us,” he said. “I wish there were a painless way to do that. There isn’t.”
Yet he is likely to get political pressure from at least some in Congress. This brings us to the second issue – those in Congress are unlikely to simply accept the Fed’s policy as economic growth suffers. Senator Elizabeth Warren (D-MA) has already called him a “dangerous man.” “Jerome Powell’s rhetoric is dangerous, and a Fed-manufactured recession is not inevitable – it’s a policy choice,” she said in September. “Some might find this controversial, but higher unemployment should not be the economic policy of the United States, particularly when the Fed’s aggressive interest rate hikes are ill-suited to address inflated food and energy prices from Putin’s war in Ukraine, supply chain bottlenecks, and corporate price gouging.”
Senator Sherrod Brown (D-OH) ripped Jerome Powell in July 2021, saying that the Fed isn’t doing enough to fight big banks. “The Fed should be fighting this trend, protecting our progress from Wall Street greed and recklessness – not making it worse,” he said. In October 2022, the senator warned against taking such a hard line on inflation that it will cause job losses. “For working Americans who already feel the crush of inflation, job losses will make it much worse,” he said. “We can’t risk the livelihoods of millions of Americans who can’t afford it.”
The problem is that the Fed is only going to lighten up if we see weakness in the jobs market. We will get multiple reports this week on jobs. So far, jobs reports have continued to indicate a strong jobs market and limited unemployment. One of the factors that may not be considered fully are the number of people who have simply dropped out of the market since the COVID-19 pandemic. “A large number of American men of prime working age – between 25 and 54 years old – are not working or even looking for work,” reported CBS in January, “resulting in a major hold in the American economy.” It estimated that 7.2 million men had essentially “dropped out of the workforce.”
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There’s also a hidden time bomb in the American economy. That’s the level of debt plaguing both consumers and the government. Total household debt hit $16.9 trillion in the fourth quarter of 2022, a new record. Mortgage balances are up, even as originations for new loans and refinancing declined. Mortgage loans in “serious delinquency” also increased, as did those for auto loans and credit card debt.
The current federal debt is at $31.46 trillion – and rising. There is still a building conflict about whether the Republican Party will raise the debt limit to enable more borrowing. The outcome is not in doubt – the GOP is going to have to raise the debt limit or risk a default that it will take the blame for. Yet the current situation can’t just continue indefinitely. Interest payments on the debt will ultimately consume an ever greater part of yearly expenditures, but our system may not be capable of limiting spending to the degree that is necessary.
All of these problems – inflation, government and consumer debt, and the failures of the American workforce – are combining to create a very uncertain long-term dynamic. Jerome Powell is probably right to identify inflation as the most important threat. However, his war against it is going to have casualties, especially among Americans who are likely to suffer through a recession. The temptation will be for politicians to attack the Fed and demand for more easy money policies. That might spare us some pain in the short-term, but will make things worse in the long run. Unfortunately, the kind of government we have isn’t designed for long term thinking.
Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com to bring you news on what those with power are debating, planning, and doing.