A Monetary Revolution is on the Horizon
Updated: Jan 15
As 2021 comes to a close, the Federal Reserve is on the verge of shifting towards a relatively tighter monetary policy. After the unprecedented interventions in 2020, the Fed must uncover a way to unwind some of those interventions to stem off the rising threat of inflation. While the Fed tries to fight inflation, it must also be mindful to avoid crashing the cheap money addicted economy. This will be a truly Sisyphean task as the Fed tries to solve one problem while simultaneously exacerbating another.
The music is starting to wind down and no chairs remain. The false precision of monetary policy and the physics envy of mainstream economics will be put to the ultimate test. No individual or small group of individuals can comprehend the complexities and unintended consequences that come from fixing the price of credit, i.e. monetary policy. Reserve ratios have been abolished and we are living in a new "Ample Reserves" regime. Through repo and reverse-repo facilities, the Fed can pump in or out as much liquidity as necessary to fix short-term interest rates between a narrow band. With QE, the Fed can manipulate long-term interest rates and artificially lower the borrowing cost for the Federal government. Suppressing the price of credit and ensuring demand doesn't drop is the recipe for an inflationary disaster. The problem is worsened when those policies are enacted during an economic environment with many significant supply constraints. Pumping liquidity into an economy doesn't create more resources; it just creates more dollars to chase an unchanged resource pool. Input costs and asset prices are rising quickly. Valuations are stretched thin and there are a multitude of scam assets attracting billions of dollars. From shell companies with no revenues and barely an idea, to scam coins, to meme stocks, to free internet pictures (NFTs) trading for tens of thousands of dollars, there is so much money slushing around in the economy that we are living through an everything bubble. Extravagant risk-taking is occurring and the Fed is about to take away the punch bowl. The Fed needs a monetary magical bullet, but the magazine is empty and the gun never existed.
A monetary revolution is on the horizon. Barring unforeseen events, the Fed must choose between high inflation or a devastating recession. Neither will be popular and both may occur regardless of the Fed's actions. Both sides of the political aisle will have participated in getting the economy to this point and very few will have clean hands. The Federal Reserve will be in the crosshairs as its fingerprints are all over the current economy and they will be an easy target for all politicians. Those on the left will argue that the Fed helped the wealthy and big business at the expense of the average citizen. The right will argue that Fed policy was too loose and caused excessive risk-taking. Both will be right. It is likely the Fed won't survive in its current state. I would like to offer an outcome where the Fed is abolished and sound monetary policy, i.e. none, reigns supreme. Unfortunately, I believe Congress will push for more direct control over monetary policy and begin to implement a form of Modern Monetary Theory (MMT). MMT provides the spiritual foundation to print and spend as much money as necessary. Pursuing this economic sophistry will only pour more gasoline on the fire.
The economic environment over the next few years could be the turning point towards significant change in the United States. The 2022 Midterm Elections and the 2024 Presidential Election will probably be the most divisive yet. This will only be exacerbated by an unending pandemic, inflation, and recession. The prices for everyday items could surge or they might not be on the shelves at all. State secession could be just around the corner and all it would take is one state to light the fuse. Like a stack of dominoes - once the first one falls, many will follow. A one-size-fits-all policy doesn't work in a country this large with this many divergent views.
Decentralizing political and economic power is a prudent and necessary outcome.