The Fed Is Dangerously Wrong

More voices are starting to join ours in criticizing the Fed.

More and more prominent people from the world of finance and politics are beginning to realize that the Fed’s actions have benefitted the few at the expense of the many.

The 0.01% has gained enormously, while the bottom 80% have lost ground. This deeply unfair outcome is increasingly becoming politicized, meaning that the Fed’s era of free reign to shovel ever more money to their Too Big To Fail bank owners and the ultra-wealthy is coming to a close.

And not a decade too soon!

Given that the Fed has persisted for many years longer than it should have, it now finds itself cornered.  Should a new recession arrive soon, as we think is likely, then the Fed will be caught ‘out of ammo.’

This means it won’t have much room to lower interest rates. And even if it does, the effect is likely to be muted.

Why? Because in its aborted meager efforts to raising interest rates last year, the Fed didn’t remove a single dollar from circulation to accomplish that task.  All it did was dial up the Interest on Excess Reserves (IOER) that it pays to the big banks and they, in turn, dialed up the amount they charge each other for overnight money.

Because of this feature, when it comes time to lower interest rates again, the reverse of that process will happen.  IOER will be lowered, and so the banks will charge each other less.

What WON’T happen is a withdrawal of the huge flood of money that was poured into the financial system through all the Fed’s QE efforts.

Historically, such movement of liquidity is a huge part of creating or limiting loan growth, which is the ultimate effect the Fed is actually targeting.

When the economy is cooling off, not enough new loans are being made and so economic activity tails off.  When the economy is running too hot, the Fed wants to cool off loan growth and so removes money from the system.

At the margin, some economic activity is driven by different decisions based on the interest rate.  But, honestly, not a huge amount of extra activity can be traced back to a car loan being offered at 7.75% vs 8.00%.