The One-Note Fed

Jerome Powell, Chairman Federal Reserve

One of the most ludicrous aspects of our modern American society is the elementary solutions that our leaders present for our highly complex problems. Using the same old “answers” to contemporary issues.

A case in point is the contemporary debate over inflation. Higher prices are the issue. The energy prices for heating our house and running our car, food, and shelter continue to escalate. Every day, everybody sees these higher prices in all that we consume.

“Raise interest rates,” cries the Federal Reserve, “that will solve inflation.” Wall Street then goes into fits of ecstasy or depression, depending upon whether the latest Fed utterance meets the Street’s desire. For example, on Wednesday, Federal Reserve Chairman Jerome Powell delivered an address before the Brookings Institute. When asked what rate of interest rate increase Powell was looking at, he answered:

“My colleagues and I do not want to overtighten because cutting rates is not something we want to do soon. That’s why we’re slowing down, and I’m going to try to find our way to what that right level is.”

And that was the sum and substance of Powell’s remarks, that the Fed would be “slowing down” in their interest rate hikes. What makes this comment so astounding is that Powell began his speech by noting that the higher interest rate policy is not working, or at least it is working so slowly that we mere mortals cannot see any change.

Powell began his comments by noting (quote):

“Twelve-month core PCE inflation (DR. the Fed’s preferred measure of inflation) stands at 5.0 percent in our October estimate, approximately where it stood last December when policy tightening was in its early stages.”

So after all of these rate hikes that took interest rates from nearly zero to over 3 3/4%, the result has been nada. A big goose egg, no change in inflation.

The Fed began its interest rate tightening, incidentally, in mid-March. And since that time, according to the Chairman, there has been no noticeable change in inflation.

How can that be? Let’s think about that question for a moment. Now interest rates affect monetary conditions. People tend to spend less as interest rates rise because higher interest rates make everything more costly. So many of our daily transactions are paid for on credit. Raise rates, and the cost of credit goes up. The cost of financing inventory, store leases, and marketing also ratchet higher for the vendor, which means both sides of a commercial transaction, like purchasing food or gasoline, rise. The consumer costs rise, and the vendor’s prices rise.

So the basic assumption behind raising interest rates is to curb excess demand in the financial system. Cool down demand by raising interest rates, and you solve the inflation problem.

Higher rates and lower demand worked like a charm when the economy was steaming ahead in the 1970s and 80s. For over ten years, the US Economy grew at nearly 10% per year. And demand-driven inflation got out of hand. In stepped the Fed Chairman Paul Volcker, who drove up interest rates to dizzying heights, and that was enough to stop demand-driven inflation back then.

So today, a new Fed Chairman, Jerome Powell, uses the same strategy as Volcker, but with no result. Powell also raises interest rates, by many estimates, at a more severe rate than Volcker, and yet, by his admission, there is no effect.

Powell today, no less than Volcker back then, is lowering overall demand in the economy. But inflation is unmoved.

Well, a couple of things distinguish today’s economy from Volcker’s back in the 70s and 80s.

First, today’s economy is much weaker than a generation ago. Since the 2008 Great Financial Recession, this economy has been lucky to grow at 3% annually. With only one quarter’s exception, today’s economy is not hot; it’s barely tepid. Economic growth is missing.

Many factors have contributed to our poor economic growth over the last decade, not the least of which has been a major demographic shift. As a larger and larger portion of the population (the Baby Boomers) have retired, productivity/growth in the economy has naturally slowed. Retired people don’t spend as much as working people; aggregate demand has fallen.

But please don’t tell that to Powell’s Fed, who would like to drive demand even lower.

Another principal difference between today’s economy and a generation ago was that we had a reliable, consistent supply of energy back then. Energy back then was plentiful and low-cost. We indeed imported much of our oil and gas back then. And it’s also true that we had lived through the OPEC Oil Embargo, which had created a massive disruption, but once we solved that problem, it was smooth economic sailing. There was no issue with energy supplies until this year.

That all changed when President Biden used our energy purchases as a geo-political weapon. Reacting to Russia’s Special Military Operation in Ukraine, Biden cut off all Russian oil imports to the US. This boycott immediately eliminated 8% to 10% of our oil supply. The result was predictable. The price of all energy, but especially gasoline, skyrocketed. And this has been the principal source of higher consumer prices, in other words, inflation, ever since.

So here’s what we’re saying. We’re living in a low-demand economy ever since the massive Baby Boom Generation began to retire. Demographically, today’s economy is the opposite of the high-demand economy of the 70s and 80s, when last we tried to cure inflation with higher interest rates.

Today’s bout of inflation came not from the demand side but from the supply side. President Biden began cutting energy supplies with an anti-oil policy, followed by his boycott of Russian oil and gas.

If you’re with me, it follows that Powell’s higher interest rates will drive our economy’s already tepid demand even lower. The ultimate result will be to slow the economy further. Even the economy’s neutral 3% growth rate will likely be a thing of the past.

Slowing the economy is never in our best interest, especially when the real answer to our economic problems is more supply, namely energy supplies.

Econ Briefs

Welcome to OZ. The Wizard has been busy again.

The monthly Payrolls Number is a closely watched indicator of how many jobs are being added to the economy. The more jobs added, the stronger the labor sector.

So, if you read today’s headlines: “US Economy Adds More Jobs Than Expected,” you naturally assumed that the Job Market is looking pretty good right now.

Let’s correct that misimpression. New Jobs added to the economy fell by 10%, the lowest number in well over a year. In short, this Jobs report was an absolute disaster.

However, Wall Street had so lowered their “estimate” on new Jobs added that this report was better than that bogus estimate.

The bottom line, we should ignore these silly Wall Street Estimates. Forget what Wall Street “thinks” will happen and focus instead on what’s going on in the economy. The reality today: the worst Jobs Report in a year, new jobs down 10% from the month before. Stop playing games.

Later this afternoon, Baker Hughes will report on the number of active oil wells in the country. And finally, after two years of this Administration’s anti-oil policies, we’re finally getting some additional oil exploration, which will eventually lead to more supply. Something that is desperately needed.

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David Reavill

David Reavill writer + finance +iconoclast + hiker + Pennsylvania #valueside daily podcast + medium + meditate valueside.com/links