Humphrey Hawkins: Inflation & Inequality
New York | “On Friday, October 23, 2020, Almena State Bank was closed by the Kansas Office of the State Bank Commissioner,” the Federal Deposit Insurance Corporation announced. “The FDIC was named Receiver. No advance notice is given to the public when a financial institution is closed. Equity Bank, Andover, KS acquired all deposit accounts and substantially all the assets. All shares of stock were owned by the holding company, which was not involved in this transaction.”
When Congress made FDIC the Receiver of failed federally insured banks in 1933 it was a landmark event, an evolution of the role of the federal government in resolving matters of equity and bankruptcy nationally. The FDIC is best known as the protector of bank deposits that is backed by the US Treasury. In fact, FDIC is a public-private mutual insurance scheme supported first and foremost by the assets and income of the entire US banking industry.
Contrary to the narrative of progressives like Senator Kamala Harris (D-CA) (“Kamala Harris: Queen Of The Crony Capitalists”) and Senator Elizabeth Warren (D-MA), the US banking industry via the FDIC cleaned up its own mess after 2008. With the notable exception of Citigroup (NYSE:C), which was arguably a political question, the US banking industry did not require or want a federal bailout. The bank bailout was the bright idea of President Barack Obama and Treasury Secretary Tim Geithner. But US banks cleaned up the mess, not the taxpayer.
The FDIC shows how government can act with purpose and competence to ensure the safety of government insured bank deposits, the payments system and the wider economy. Indeed, the FDIC is a rare example of a public-private partnership that actually works for the benefit of society. Other federal agencies tasked with delivering different types of consumer benefits have yielded uneven results.
Most economists would say that government support for housing, for example, is a net benefit to society. Federal housing agencies subsidize home ownership by low- and middle-income households to the tune of several points in annual interest payments. Without the subsidy of federally guaranteed mortgage backed securities (MBS), US consumers would see annual mortgage rates in the 5s and 6s instead of mortgage loan coupons today below three percent.
But perhaps the most powerful agency in Washington, namely the Federal Reserve Board, has mixed results in terms of supporting its legal mandate to ensure full employment. We talked about how the Fed became the guarantor of full employment in a 2019 article for The American Conservative (“When The Fed Became A Socialist Job Creator”).
Simply stated, the 1978 Humphrey-Hawkins law and the actions taken by the FOMC to pursue the dual mandate of full employment and price stability seem instead to cause disparity in terms of real incomes and wealth in society. The excessive decline in interest rates over the past 40 years represents a vast transfer from savers and investors to debtors, particularly the US Treasury. How does thus fulfill the dual mandate?
The FOMC chose to expropriate a heretofore private market price called the federal funds rate, this in order to achieve the employment imperative of the Humphrey-Hawkins law. This decision by the Fed locked the US into a bizarre policy path. Debtors are explicitly advantaged, but consumers and investors are hurt. People who work hard and save conservatively are the losers in the Fed's brave new world where inflation, not stable prices are the real object.
A successful free enterprise system requires inequality, winners and losers to fuel economic growth. But a free society can only tolerate a large surfeit of losers for so long before people take to the streets in frustration and anger. The Washington fixation with using lower interest rates to stimulate short-term economic growth is as much a political expedient as a deliberate economic policy choice. And this is not a new discussion about inequality.
In the decades after WWII, there was considerable pressure in Washington to guarantee a job and other benefits to every returning soldier. This demand for universal employment evolved through the Vietnam War and the social unrest of the 1960s and 1970s. Ultimately, a Democratic Congress refused to embrace universal employment. Instead, in 1978, a majority led by Rep. Augustus Hawkins (D-CA) and Senator Hubert Humphrey (D-MN) tasked the FOMC with ensuring the desired economic outcome of “full employment.”
Such was the level of entitlement and hubris in Washington during the late 1970s that Americans thought they could simply legislate future economic outcomes with laws like Humphrey Hawkins. And for half a century, the FOMC delivered the goods to Washington’s political class, but even this was not enough. Both political parties have since embraced fiscal deficits that in the wake of COVID have grown to monstrous size.
The Treasury is now the single largest factor affecting US monetary policy. The Fed, as alter ego, creates discontinuities and injects volatility into the markets as it seeks to fulfill the dual mandate. Since April of this year, the FOMC has imposed negative real returns on owners of Treasury securities and agency MBS worldwide. The de facto regime of negative returns imposed by the FOMC threatens to undermine and ultimately destroy the role of the dollar as the global reserve currency.
Investors in global equities, however, continue to benefit from the FOMC’s financial largesse even as millions of Americans have lost their livelihoods due to COVID. “In the fourth quarter of 2000, the top 1% of wealth holders had a household net worth (assets minus liabilities) of $11.82 trillion, while the top 10% had $14.62 trillion, according to Federal Reserve data,” writes Howard Gold in MarketWatch. “By the fourth quarter of 2019, before the coronavirus hit, wealth for the top 1% had more than tripled, to $36.3 trillion, and nearly tripled for the top 10%, to $41.18 trillion.”
Over that same period, the total assets of the US banking system went from barely $7 trillion in 2000 to over $21 trillion two decades later, an indication of the vast asset inflation caused by the inflationary policies of the FOMC such as quantitative easing. Even as the size of US banks has grown, of note, their asset returns have fallen dramatically.
Source: WGA LLC
And even as bond investors take principal losses on their government guaranteed securities, low- and middle- income households have seen their access to credit reduced as prices for residential homes have soared over the past decade. While the good people on the FOMC pretend that inflation is low and thus justify further action to juice employment, Americans face soaring real prices for tangible goods ranging from homes to automobiles.
Think about the vehicle that $20,000 could buy two decades ago vs the entry level car of today. An entry level Ford (NYSE:F) F-150 pickup retailed for $16,000 in 2000, but the entry level model F-150 is almost $30,000 today. Inflation manifests itself both in price and in terms of the quality of the product or service. The steady erosion in the purchasing power of the dollar, this even as global central banks try to stave off a long-delayed debt deflation, is crushing savers and consumers. But we pretend that inflation is low.
The FOMC cannot publicly endorse a debt deflation as in the 1930s, thus there is no economic reset, no “bounce” in production and employment in response to lower interest rates. There is no opportunity for young families to buy a house or a business cheap and thereby start to build wealth. More, the benefits of the periods of lower interest rates and asset price inflation seem to flow overwhelmingly to the investment sector rather than to areas of the economy that promote employment and household income.
See the chart below from the St Louis Fed below showing the consumer purchasing power of the dollar over the past century. The index was over 1,000 in 1913 but today is below 40. During the period of the Fed’s existence, the real value of the dollar for consumers has been decimated. Notice that half of the decrease in the dollar's purchasing power occurred in the 1920s after WWI and before the Great Depression. Looking at this chart, the Fed's focus on price stability has been a failure.
Congress needs to reconsider the dual-mandate contained in the 1978 Humphrey-Hawkins legislation. The Fed’s fixation on manipulating short-term interest rates as the core tool of policy may now be doing more harm than good. The growing gap in terms of nominal wealth, for example, is less about fairness and more about pretending that inflation is not a problem. If the Fed refuses to allow asset prices to fall for prolonged periods, then American consumers are doomed to see lower and lower real purchasing power.
When we hear our friends in the consumer policy community bemoan the lack of affordable housing, our answer is simple: We need to raise consumer income. Cut fiscal deficits and the FOMC can stop targeting inflation as a policy tool. Affordable housing required subsidies in the 1960s, but today the inflated cost of construction makes it a bad joke -- even with low interest rates.
A number of economists have argued in favor of targeting nominal GDP rather than interest rates, an important change that should get greater attention. George Selgin, Director, Center for Monetary and Financial Alternatives at The Cato Institute, argues that a new regime might actually result in lower prices and higher real growth, particularly employment growth. In “The Case for a Falling Price Level in a Growing Economy” (2018), Dr. Selgin writes:
“Not long ago, many economists were convinced that monetary policy should aim at achieving ‘full employment.’ Those who looked upon monetary expansion as a way to eradicate almost all unemployment failed to appreciate failed to appreciate that unemployment is a non-monetary ‘natural’ economic condition, which no amount of monetary medicine can cure.”
Congressional Democrats introduced new legislation in August that would make reducing "racial inequality" in the U.S. economy an official part of the Federal Reserve’s mission. How this would be measured is hard to predict. As the political pressure for change builds, the critical focus on the FOMC’s policy tools will only grow apace.
Fed Chairman Jerome Powell would do well to make changes to the Fed’s policy mix now, before radical elements in Congress impose changes that will make the Fed’s public policy mission entirely problematic. More than anything else, ending the FOMC’s use of the federal funds rate as a policy tool is the beginning of restoring equity and fairness in US monetary policy for all Americans.