NOVEMBER 17, 2024
November 2024
Cause and Effect
“Nothing good can come from the Federal Reserve. It is the biggest taxer of them all. Diluting the value of the dollar by increasing its supply is a vicious, sinister tax on the poor and middle class.” Ron Paul
Among the many topics debated going into the November election, inflation stood out as a key issue. Price levels have increased 21% over the past four years, but wages haven’t kept up. Real wages—nominal wages adjusted for inflation—have actually declined over the past four years, meaning the average person’s standard of living is less today than it was in 2020.
It’s worth noting that the definition of the word, inflation, has changed drastically over the past century. An excerpt from the Federal Reserve Bulletin in 1919 described inflation as an increase in the money stock without a commensurate increase in the production of goods and services. In other words, when central banks inflate the money supply faster than the rate of output. Since price is simply the function of two variables; supply and demand, when the money stock increases faster than the production of goods and services, prices increase. But today inflation has become synonymous with increasing prices. What was once a verb has since become a noun. Funny that.
When questioned about the rapid and extreme post-COVID surge in general price levels, the two most prominent figures in the global economy, Jerome Powell and Janet Yellen, proved incapable of providing a clear and cogent explanation. During numerous testimonies, they cited obscure economic technobabble, such as demand-pull, cost-push, supply chain dislocations, labor disruptions, and similar jargon. However, these intelligent-sounding terms weren’t the cause, but the effect. The cause was simple; too much money chasing too few goods.
The chart below illustrates why price levels rose so rapidly; the Fed increased the money supply more than 40% between 2020 and 2022, during a time when output, due to COVID lockdowns, fell by nearly 17%. Why was this so difficult for the experts to understand?
The Fed’s myopic perspective—that monetary policy is the panacea for all economic woes—isn’t just wrong; it’s dangerous. Their misguided notion, that they are wiser than the collective wisdom of the markets, is absurd, and a fairy tale only an academic elite could believe.
Business cycles are a normal and healthy part of the economy; however, the Fed’s oft ill-advised and reckless actions exacerbate the extreme swings in growth and contraction. While any economist can cite data points and speculate about the current stage of the economic cycle, the reality is no one knows. Why? There are far too many variables at play—geopolitical events, legislative changes, monetary policy shifts, fluctuations in consumer confidence, weather events, and other factors—to know with certainty the future direction of the economy. Yet the voting members of the Federal Reserve boldly go where angels fear to tread. Their arrogant and misguided belief that they can both manage the economy and solve all economic woes with the right elixir of monetary stimulus/restraint is a fool’s errand, and the nation is far worse off because of it.
Sadly, the Fed hasn’t just been wrong in their views and policies; historically, it has been catastrophically wrong. Though stimulus schemes like quantitative easing (QE) and zero interest rate policies (ZIRPs) may provide short-term relief, the long-term costs of these bad ideas are immense. In 1981 the debt-to-GDP ratio was 30%. Today it has soared to 120%. Over the past four decades the Fed has enabled a profligate government (both parties) by masking and deferring the true cost of unsustainable fiscal and social policies.
Monetary stimulus such as manipulating interest rates below the market or natural rate, quantitative easing, printing money, and manipulating credit spreads make the economy feel better in the short run. This Keynesian approach—reducing the cost of financing, boosting asset prices, and reducing government debt service—is the monetary equivalent to pumping an accident victim full of morphine; it doesn’t heal the injuries but merely masks the pain.
True economic growth doesn’t come from monetary shenanigans, but, rather, from innovation, capital investment, entrepreneurship, risk-taking, and a government that promotes free market principles and protects property rights.
While (former) senator Paul’s calls to abolish the Fed are extreme, he’s not wrong in his criticism of the overreach of prevailing monetary policy. The incoming administration should refrain from politicizing or attempting to control the Fed, but should curtail its power and influence. A revision to its Congressional charter would be a meaningful first step. The Fed’s role should return to its original purpose: overseeing the banking system and serving as a lender of last resort, rather than allowing a select group of Ivy League academics to manipulate the economy.
Mark Lazar, MBA
CERTIFIED FINANCIAL PLANNER™
WasatchFinance.com
