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Has the Fed “Stabilized” the Economy?

By Walter Donway

September 11, 2022

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In 1913, the U.S. Congress enacted legislation creating a national banking system, the Federal Reserve. Congress was responding to the panic of 1907, often called the only true financial panic (as contrasted with stock-market crashes) before the 2008 panic.

Keynes’s work permanently institutionalized the role of the Fed in both theory and practice.

The 1907 panic incited bank runs that shook the U.S. banking system. Congress gave the new Fed a narrow mission of addressing bank panics, but that is only one implication away from “stabilizing” the U.S. economy. By that time, the (relatively) unregulated economy of capitalism had been indicted repeatedly for having an inherent boom-and-bust cycle. Joseph Schumpeter deemed the cycle intrinsic to Capitalism. Building on Schumpeter’s Marxist concept, John Maynard Keynes published The General Theory of Employment, Interest and Money in 1936. Keynes’s work permanently institutionalized the role of the Fed in both theory and practice.

The Federal Reserve (“Fed”) would stabilize the economy, tame the business cycle. In time, that came to be stated as stabilizing prices and employment. No more roller coaster ride.

This is not a history of the Fed. Nor a systematic critique of the Fed. Those are found easily on this site. No, this is a temperature-taking of the “stability” achieved by the Fed now, summer 2022.

Between March 2020, the pandemic lockdown and stock panic, and mid-April 2022, the Fed expanded its balance sheet 115.6 % or by $4.8 trillion.

Between March 2020, the pandemic lockdown and stock panic, and mid-April 2022, the Fed expanded its balance sheet 115.6 % or by $4.8 trillion. This was unprecedented in Fed history—radical “quantitative easing” (in Fed jargon) or “money printing” that more than doubled the U.S. monetary base.  In other words, the Fed more than doubled the country’s circulating money in less than two years.

Stability?

The Consumer Price Index (CPI) is reported as gaining 8.0%-plus annually. The method of calculating the CPI, however, has been altered repeatedly to low-ball the actual rise in prices.

By now, of course, the monetary inflation (money-supply creation) is resulting in a soaring general price level. The Consumer Price Index (CPI) is reported as gaining 8.0%-plus annually. The method of calculating the CPI, however, has been altered repeatedly to low-ball the actual rise in prices.

Stability?

Earlier in 2022, Fed officials signaled repeatedly that the price instability had become intolerable. The Fed at subsequent meetings would begin to rein-in the money supply it had created and raise interest rates to slow bank lending, another contributor to the money supply.

By about the end of the first quarter of 2022, this expectation of Fed “quantitative tightening” (more Fed jargon) of the money supply, and forcing up interest rates, caused the international exchange rate of the U.S. dollar to soar: parabolic. Buying of the dollar (mostly weighted against the Euro) blasted it to an astounding 1.09x its 200-day moving average by mid-May. The exact move is less important than that this is the most extreme dollar overbuying on record—ever.

Stability?

What drove this record dollar surge? From years of no increase in the key Federal funds rate, the Fed was talking about (and then implemented) three-quarter point and half-point increases for the first time in decades. At its next meeting on July 27, 2022, it repeated the performance.

Meanwhile, of course, from the beginning of 2022 until mid-year, the U.S stock markets crashed into, or near to, official bear-market territory (a 20 percent drop). The first half of 2022 in U.S. securities markets was the worst in more than half-a-century as investors responded to the most extreme pivot in Fed history from “quantitative easing” and low interest rates to “tightening.”  This also motivated “safe haven” buying of U.S. dollars.

Stability?

The Fed even managed to disrupt the historic relationship between monetary inflation and general price increases, on the one hand, and the price of gold on the other. When expansion of the money supply drives up prices, gold’s price increases to account for a devalued dollar. And soon, gold rises even faster to account for anticipated inflation.

The Fed managed to destabilize that historic relationship. A bull market in gold into the end of 2021 reversed in 2022. The first half of 2022 saw the most extreme plunge in the price of gold in any gold bull-market in two decades—from about $2050/oz. to $1700/oz. in just months.

How could the price of gold plunge when the U.S. CPI was soaring 8.0%-plus?

How could the price of gold plunge when the U.S. CPI was soaring 8.0%-plus? The chief driver of short-term moves in the gold price are speculators in the futures market who are permitted to buy gold using 24X leverage (borrowing on margin) of their own funds (for perspective: the legal limit of margin in the stock market is 2X).

Thus, futures speculators “punch above their weight” and dominate the gold price in the short term. Their sole concern today is the U.S. dollar price of gold. As the greenback has rocketed to unprecedented levels, making gold worth less in U.S. dollars, the futures speculators have sold tons of gold.

Government interventions inevitably evoke private responses that further distort the economy (For example, a decline in new housing units in response to controls on rents). Some of these responses are criminal. The historic money supply instability caused by the Fed provided the perfect atmosphere for private price manipulation:

“Just a month ago, the former head of JPMorgan Chase’s precious-metals business and his top gold trader were convicted of manipulating gold prices from 2008 to 2016!  ….They did this through leveraged gold-futures trading, including spoofing….unleashing huge bogus gold-futures sell orders to hammer gold, which are then quickly cancelled before execution.

“…That brings the US Justice Department’s secured convictions to ten former Wall Street traders at JPMorgan, Merrill Lynch, Deutsche Bank, Bank of Nova Scotia, and Morgan Stanley.”

Stability?

Incidentally, as the Fed has jacked up interest rates, other markets have been shaken, as well. A boom in sales of new and existing homes has deflated abruptly in a couple of months. The huge and burgeoning market in cryptocurrencies such as Bitcoin and Ethereum has crashed—are these “collateral damage” of the Fed’s efforts at “stability?”

Now, chaos in the money supply and financial markets is translating into economic problems, with early indicators suggesting slowing employment, lower earnings, and problems with mortgages. On July 28, GDP was reported to have contracted for the second quarter in a row, one official definition of a recession.

Stability?

The Fed today is setting records for destabilizing the American economy.

Greater efforts by the Fed to achieve economic “stability” result, instead, in unprecedented instability. The Fed today is setting records for destabilizing the American economy. Money supply, price “inflation,” the dollar, the securities markets, crypto, real-estate, employment: The instability is a pandemic.

The virus is legally enforced government control of the money supply. And manipulation of perhaps the single most important key to our economy: interest rates. A free market is inherently stable. The Fed’s interventionist policies destabilize it. It’s high time the Fed’s true aftereffects are revealed.

 

 

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