Where will the Federal Reserve take us next?
First, I'd like to go on record that I've been studying the Federal Reserve's monetary policy, in particular the direction of future interest rates, for decades, and I can say with great certainty...I don't have a clue. Or as my friend Steve says, "I'm always wrong." And he is smart.
Two questions to ask: Will Powell raise rates? Should Powell raise rates?
The answer to the first is that, reflecting on Powell's track record, we see he is similarly unaware to how I am, which indicates that the Federal Reserve will raise rates. In essence, I'm suggesting that the Fed will continue to be clueless and make mistakes.
Powell and his Fed believe the Great Misdirection regarding inflation: that raising interest rates is the only way to curb inflation. It will work, eventually, but rates are a blunt tool. They work by undermining the private economy by driving borrowing costs too high, and they invert the yield curve, depressing banks, who rely on interest spread and are the source for lending.
By far the more elegant tool is reducing money supply.
Interest rates are not the cause of inflation. Excess liquidity is the source: Money Supply, M2, dollars in circulation. Excess money supply devalues all dollars in circulation, so consumers must trade more dollars to obtain the same commodity. That is inflation.
If excess supply of money causes inflation (dollar devaluation), and the Fed Reserve controls the money supply, then why doesn't the Fed reduce supply (liquidity) and reduce inflation? Why is Powell using interest rates to bludgeon private businesses?
That answer becomes obvious upon reflection. Start by asking why the Fed printed $8 trillion starting 2008, in an incestuous act called Quantitative Easing (Q.E.). They are guilty of causing inflation starting fifteen years ago. The irony is that we are asking the very entity that is the cause of our economic problems, the Federal Reserve, to solve the problems it created. Not too smart of us.
As to why the Fed won't solve inflation: It doesn't want to.
In order to reduce the money supply (the number of dollars in circulation), the Fed has to rely on Congress to spend less, and Congress will not reduce spending unless the voters pressure their congressmen to do it. We are all afraid of losing our phony-baloney jobs.
A little history on today's inflation: Early in Obama's term, the economy was heading into the Great Recession. In typical leftist fashion, Obama and minions figured more government spending would solve all our problems, instead of relying on the private economy to self-solve, as it would have.
So the economists of the left came up with Q.E. or printing dollars that would be transferred to the Treasury Department in exchange for Treasury Bonds. The Department of the Treasury spent those dollars on government "stimulation" programs like welfare, entitlements, and green energy, as directed by the administration and Congress. Every dollar printed put every citizen into debt and caused inflation. They nailed us twice.
Should we go deeper in our thinking, we may see the fundamental difference between these two schools of thought. One idea is to solve a problem with more federal intervention — like printing dollars, or raising interest rates faster than any time in the past. This mindset is illustrative of a government-centric solution. Examples of this mindset are fascism, communism, and corporatism. It depresses the market economy and hurts private business and individual citizens.
Continuing our plunge into the depths, the other way of thinking is to allow the owners of capital to solve their issues through a free market. In this case, the free-market solution is to reduce the supply of money to reduce inflation. Reducing the money supply necessitates reducing spending and government intervention in private enterprise. This is the way the great Milton Friedman sought — a strong, independent private economy guided by the rule of law. His mentor F.A. Hayek wrote extensively on the issue in The Road to Serfdom.
So the surface issues are rates, or money supply. The deeper issue is which economic philosophy works better: central control or individual rights. There is no middle ground, no compromise between these two ideals.
The last question: Should Powell raise rates? Nope. He should reduce the supply of money and beat the drums to convince voters to demand that Congress reduce spending in order to tame inflation. It's not confusing if we remember that no government program is funded by government. Every dollar of government spending and debt comes from one source: you.
Jay Davidson is founder and CEO of a commercial bank. He is a student of the Austrian School of Economics and a rabid capitalist. He believes there is a direct connection connecting individual right and responsibility, our Constitution, capitalism, and the intent of our Creator.