How the Ideology of Others is Impacting You – Part 1: The Fed
The policy decisions made by the various parts of our government have a huge impact on our lives and our finances. Good decisions have good outcomes and bad ones, well, you know. Every engineer knows that in order to make good decisions the decisions have to be based on facts, data, and science-based logic. Unfortunately, our government runs primarily on ideology. And we, The citizens are paying the price.
The Federal Reserve is one of those parts. It deals with economics which is one of those sciences, if you want to call it that, where when an issue comes up half of the experts will typically recommend doing one thing and the other half will recommend doing just the opposite. Whenever you have a science such as this, ideology will typically rear its ugly head and determine which path is taken.
Right now, we have a situation in the U.S. where inflation has taken off after years of low interest rates and excessive liquidity. The U.S. has one of the highest inflation rates in the world. The central banks in other countries are hiking interest rates to bring it under control. But not so much here.
Current Fed QE holdings are 40% of GDP or about $8.8 trillion, way more than the typical 5% or less, and the Fed is still buying. This seems to be kind of like throwing gasoline on the fire. This QE has been going on since 2008 and the Fed so far has proven incapable of undoing it even as the economy was booming before 2019. Since then, QE has gone through the roof, much more than seems necessary.
On top of this, interest rates are at zero with real interest rates at about minus 7% taking inflation into account. The Fed won’t change rates for about another two months before increasing them slowly. What the Fed has done, in effect, is created an economy on crack. While crack highs are addictive and easy to accomplish, withdrawal is very difficult and has severe to potentially life-threatening consequences. A growing number of economists think the Fed has been too slow in starting this painful withdrawal process.
But we have other issues that have been caused by excessive liquidity and low interest rates. We have massive bubbles in the stock market and the housing market. According to the Shiller PE Ratio, the stock market is way over that leading up to the 1929 and 2008 crashes and just shy of the 2000 Dot-Com bubble peak, but barely. The Wilshire 5000 divided by GDP, which is Warren Buffett’s favorite indicator is even worse showing that we are now two and a half times higher than we were during both the 2000 and 2008 peaks.
But the stock market is more or less a casino for the rich with little correlation to reality. About 25% of the stock market is owned by foreigners and about 85% of the remainder is owned by the wealthiest 10% of Americans. Since about 50% of Americans own no stock at all it is probable that a stock market crash will not have the same impact that it had in 1929.
It was reported that the Cleveland Fed President said on January 12 that the central bank should shrink its balance sheet quickly as long as the pace doesn’t have a negative impact on financial markets. This comes at a time when the Fed inspector general is investigating trading activity by top Fed officials.
High inflation, on the other hand, impacts everyone but has the biggest impact on the middle class and those on a fixed income. Based on this you would think the Fed would be much more concerned about inflation then a crash in the stock market.
Meanwhile, others outside of the Fed are warning of possible stagflation and recession. Former Kansas City Fed president Thomas Hoenig has warned about what is in store based on what happening in the 1970’s (see https://www.politico.com/news/magazine/2021/12/28/inflation-interest-rates-thomas-hoenig-federal-reserve-526177 for a very interesting article). Warnings have also come from former Treasury Secretary Larry Summers and many economists.
All of this disagreement is scary but it shows that there does not appear to be much ideological diversity inside of the Fed itself. The one thing that everyone understands is that the wealthy will come out on top again, the poor will continue to receive money from the government, and the middle class will end up as the big losers.
The Fed mirrors what is going on in our entire political system. Things will not change until those in the moderate middle and the middle class wake up and demand a political party of their own. Maybe the coming of an economic calamity will cause that to happen.