A couple of weeks ago a friend asked me to comment on an article in Time titled “How Jay Powell’s Coronavirus Response Is Changing the Fed Forever”. It is a discussion of the expansion of the Fed activities as they relate to our current economic crisis. You can read the original article at the following link:
Following is some of what I wrote about the Fed’s actions to my friend as well as a more expanded opinion about the dangers of the Fed’s current track:
I think the Time article is an outstanding presentation of the current reality of Fed behavior as well as the issues that are troubling about it. I don’t pretend to be a competent authority on monetary policy or the Fed. Therefore, I hesitate to weigh in too strongly on exactly what the Fed should have done differently in the 2008 worldwide financial crisis or what it is doing in today’s historic shutdown of economic activity, also pretty much worldwide. I know that both crises have created unprecedented challenges and the Fed has stepped outside its original charter and traditional role to deal with it. That is the part that scares me in today’s political and economic climate. But it is also possible that if the Fed had been more aggressive during the Great Depression as it is being now we may have recovered from that earlier than we did.
Having said all that though, my single biggest fear remains that the Fed is giving up its political independence. Coordination with Treasury is a good thing, especially in financial crises. It seems however that both in 2008 and now that arrangement is becoming more of a partnership than I am comfortable with. That invariably means politics will become more influential in Fed behavior the more intimate and longer that relationship lasts. That is almost a death spiral for rational monetary policy.
Within the Fed’s expanding authority I especially fear the broad exercise of quantitative easing as is being exercised now. Letting the Fed accumulate and hold trillions of dollars in assets on its balance sheet just begs for ever increasing deficit spending and economic instability over the longer term. If it were my choice I would allow very little purchase of debt by the Fed, essentially only federal government debt instruments, and serious limits on the volume and circumstances of that as well. That debt purchase exclusion would probably include Fanny Mae and Freddy Mac as well.
I think that even now in this pandemic, buying private corporate and business debt is a serious mistake. That makes companies feel a sense of security to be financially irresponsible. In a financial crisis like now I might be willing for the Fed to advance corporate loans but only in exchange for the surrender to the Treasury of the equivalent value in stock; that would add a measure of stability to the economy in times of severe stress. But it would also make CEOs, corporate boards, and stockholders more conscious of and careful about managing their own businesses to avoid having the government sitting at the table directly influencing their operations.
I also think that in general wildly imaginative financial instruments have become much too prolific and complex these days. No one, including banks themselves, the Treasury, and the Fed, seems to know what the economic risks are. I believe that we need to restructure the entire regulatory regime as it relates to overseeing the financial industry; we need to outlaw some transaction types altogether, as well as limit the volume and shift all the risk out of the public domain and to individual banks for some of the more complex instruments that are allowed. That includes more narrowly defining the Fed role and tools for stable monetary policy and forcing the Treasury and Congress to assume more responsibility for the nation’s economic health through sound fiscal management. That would cause the industry to be more responsible and Congress to exercise more rational control over fiscal deficits.
I like the Jay Powell of 2012 and 2013 more than the one we have now. I think he was exactly right in his concern about Fed actions impacting financial markets back then. I am convinced that is still true; the stock market is seriously inflated and running on emotion with little regard for the fundamentals. When unemployment has exploded and the economy is virtually shut down there is nothing that justifies the exuberance in the markets we are seeing these days. Investors seem to think, with some justification, that the Fed will bail them out even if things continue going south. That’s not healthy and won’t continue. Eventually reality will set in and then there will be a major correction.
At this point we seem to have reached the stage where the Fed is trying to manage to smooth out every minor irrational fluctuation in stock prices. The Fed should never manage monetary policy to the whims of the stock market. We need to allow some amount of volatility and danger of speculation in markets so stock prices will begin again to realistically reflect the economic value of companies. I know there will be some initial pain if the Fed stops propping up the stock market but in the long run the economy will be much more stable.
Sadly, I predict the coming decade or more is going to be very painful for Americans who are not already wealthy. I expect we will be in an extended recessive economic condition for most of the ‘20s; unemployment will probably be high (likely 6% to 8%) throughout the decade. And that is regardless of who is elected to the Presidency, controls the Senate and House, or what regulatory reform we implement. Debt to GDP ration is officially expected to reach at least 120% by the end of 2020. I personally expect it to be more like 140%. Either number is absolutely unsustainable. We must deal with that in the current decade and there are just no easy options available to get our financial and fiscal houses in order. It will all be painful regardless of how we choose to address our national debt, ongoing deficits, and grow our economy all at the same time. I will deal with my own thinking on those issues in a subsequent post.