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“I don’t do that. That’s really not my job. We hope and expect that other policy makers will respect our independence on monetary policy. And we don’t see ourselves as, you know, the judges of appropriate fiscal policy.”
FOMC Press Conference
June 14, 2023
March 28, 2024 | Last night Standard & Poor's reaffirmed the credit rating of the United States at AA+ with a stable outlook. This is more than a little amusing since the fiscal status of the US has deteriorated dramatically since 2011. The fact that investors and policy makers can even talk about “fighting inflation” when the US federal debt is spiraling out of control says a lot about the national frame of mind in 2024
This past week, we asked on X.com whether the Federal Open Market Committee has a specific ratio in mind for the size of the Fed’s balance sheet in relation to the federal debt. We are reminded that the Fed thinks about the balance sheet in terms of liabilities – that is, reserves – but the purchase of federal debt for the System Open Market Account creates an asset and a related reserve liability.
While there has been a lot of talk about the Federal Reserve Board tapering the runoff of the Fed’s balance sheet, in fact reserve balances have been growing for more than a year. This may be why deposit balances at banks actually rose in Q4 2023 for the first time in two years. Measured by reserves at the Fed, the FOMC stopped fighting inflation more than a year ago.
Source: FDIC
If the Fed actually starts reinvesting maturing Treasury debt, the reserve balances and related assets will rise and more than likely inflation will follow higher. Federal deficits are inflationary, but as we see with busted CRE assets, not all asset prices rise even when the consumer price index of the month is moving higher. Will Chairman Powell tell Congress that fighting inflation w/o deficit reduction is futile? But if we cut the federal deficit, deflation ensues.
Economist Robert Brusca put it succinctly in his latest comment:
“There has been a Fed obsession with achieving a soft landing that I think has been a really bad idea. I have and continue to argue ‘soft-landing’ is the wrong pitch for US policy at this point. ‘Soft landing’ is a policy that emphasizes controlling the rise in unemployment and accepting whatever happens with inflation as a result. That is not where the US and monetary policy should be after three years of persistent inflation overshooting.”
Since the Fed is entirely unwilling to put the US economy into a recession in the name of really fighting inflation, the best that seems possible is for the US to keep the effective inflation rate in mid-single digits. Were Federal Reserve Chairman Jerome Powell really concerned about taming inflation, then he’d tell members of Congress that any rate cuts are conditional first on deficit reduction. Merely stating that deficits are "unsustainable" is not good enough.
The question no one wants to ask is whether the US can tame inflation when the Treasury is running an estimated $1.6 trillion deficit in 2024. The COVID-era spending spree from March 2020 to December 2022 led to the worst inflationary wave since the 1970s, which led to a labor shortage, badly skewed financial markets and broken supply chains globally. Yet nobody in Congress accepts blame for this policy error.
Chairman Powell will be making remarks at 11:30 ET on Good Friday. In the salons of Washington and Wall Street in the 1980s and 1990s, Fed Chairman Paul Volcker used to joke to people about how during the Fed’s battle with inflation, he received a large piece of wood from an aggrieved citizen who compared the Fed’s high interest rate policies to the crucifixion of Jesus Christ.
Volcker’s decisive action on inflation became a model for public servants for decades to come, but sadly, the willingness of America's leaders to sacrifice themselves and their careers to defend consumers from inflation has waned since that time. Will Powell stand up to the forces of mediocrity in Washington and speak truth to power? Odds are pretty good that regardless of the election outcome, Powell will be out as Fed Chairman after November.
“Inflation has eased substantially while the labor market has remained strong, and that is very good news,” Powell stated at the FOMC press conference. “But inflation is still too high, ongoing progress in bringing it down is not assured, and the path forward is uncertain. We are fully committed to returning inflation to our 2 percent goal. Restoring price stability is essential to achieve a sustainably strong labor market that benefits all.”
Sadly, low inflation and full employment is not really possible when the libertines in both major political parties in Washington are running trillion dollar deficits. The problem with a soft landing is that it does not really address inflation nor does it provide a sufficient pretext for sharp interest rate cuts to allow for a true economic recovery. When Governor Chris Waller says we should wait for interest rate cuts, maybe he gets the joke. Fed Chairman Paul Volcker testified before Congress in 1981:
"What can be done—and done consistent with our short and longer-run objectives—is to provide assurance that the federal fiscal position is indeed clearly on track to balance.”
Whether we speak of residential mortgages or moribund commercial real estate, interest rates will need to drop 200-300bp in the next twelve months in order to clean up the approaching tsunami of busted real estate, hidden consumer defaults and related bad debt. If you figure that the buyer of the assets of a dead bank or REIT needs at least a 50% discount from par to make the restructured asset work financially, then Powell’s roadmap to the end of his term is quite clear.
Fighting inflation means a hard landing and lower stock prices. This is the only way out for Powell and the FOMC -- if they really intend to fight inflation. In the spirit of sacrifice that is central to the Easter season, perhaps Chairman Powell will be kind enough to fall on his sword on way out the door to make things easier for a future Chairman Waller.
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