Chairman Powell: Man of La Mancha or man of the moment?

Is Chairman Powell truly serious about stopping inflation?  Or is he merely a modern-day version of the Man of La Mancha, tilting at windmills?

Something clearly seems strange.  Chairman Jerome Powell is a veteran of the economics profession and the Federal Reserve.  As chair, his primary responsibility is to limit inflation to 2% per annum.  It is currently running around 8%.  Did he misread its strength, when he referenced it as temporary and transitory?  Remember, this was his position when he was trying to be reappointed to the position by the Biden administration.  Did his want or need for reappointment influence this assessment?

Does Mr. Powell truly believe he is the reincarnation of Paul Volcker?  If he truly understood what needed to be done and the current administration's propensity to spend what it doesn't have, he may be delusional.

There is another possibility, likely too juicy to be true.  Suppose Powell knows what is necessary and is willing to destroy the Federal Reserve and the economy to accomplish this goal?

Regardless, history will not treat him fairly.  The last person seen at the scene of a disaster is history's first choice for blame.

Economists not controlled by the political class are quite aware of what is coming.  Here is Lance Roberts's take:

The Fed has a tough challenge ahead of it, with very few options. While increasing interest rates may not "initially" affect asset prices or the economy, it is a far different story to suggest that they won't. There have been absolutely zero times in history the Federal Reserve began an interest rate-hiking campaign that did not eventually lead to a negative outcome.

The Fed is now beginning to reduce accommodation at precisely the wrong time. To the point:

  • There are growing economic ambiguities in the United States and abroad: peak autos, peak housing, peak GDP.
  • Excessive valuations exceed earnings growth expectations.
  • There is a failure of fiscal policy to "trickle down."
  • Geopolitical risks abound.
  • Yield curves are declining amid slowing economic growth.
  • There are record levels of private and public debt.
  • Junk bond yields are exceptionally low.

Such are the essential ingredients required for the next "financial event."

When will that be? We don't know.

Economics is complex, involving millions of potential variables and their interactions.  It is impossible to determine which variable will trigger the reaction.  In a sense, it is similar to determining which particle of sand started the landslide.  This is impossible even after the fact.

Has Powell Done Enough Already?

History suggests he is nowhere near where he need be to stop inflation.  The following chart shows the divergence in terms of prior inflations:

Bianco Research argues that an approximate real rate of +3% is necessary to halt inflation.  That is apparent from prior inflationary episodes.  (Note the two reactions in this new century when the Fed showed less aggressive actions toward inflation.)  If Bianco's "rule" is correct, Powell will have to raise interest rates into double digits in order to tame inflation.  Paul Volcker did that, but he had an administration that demanded it and supported him.  Volcker was also not plagued by an administration hell-bent on spending money for frivolous things.

Markets are not expecting such a response from the Fed.  According to Charles Schwab, futures markets are pricing a peak of 3.4% in the Fed Funds rate.

Regardless of whether this expectation is true or not, markets seem unready for appears to be a big surprise!  What happens to financial markets and the economy if interest rates exceed this expectation?  Conversely, what happens to inflation rates if they don't?

Powell seems to have sadly miscalculated his decision to seek reappointment.  Did he believe he could defeat these windmills?  In the end, economics always rules politics.  Ludwig von Mises said it best:

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

To get a simple explanation of why this is true, refer to this article by Frank Shostak.

The Man of La Mancha is about to fall victim to windmills!  Get ready for seriously bad times — hyperinflation, recession, or depression.  Combinations of these are possible and perhaps likely depending upon economic policies!

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