The Fed’s ‘cure’ for inflation is worse: Recession
Amazon founder Jeff Bezos and Tesla and SpaceX CEO Elon Musk blame the government and the Fed for inflation. In Musk’s words, “The obvious reason for inflation is that the government printed a zillion more dollars than it has. This is not super complicated.”
They and other luminaries subscribe to the inflation sophism: “too much money chasing too few goods.”
Yes, we’ve had “too few goods,” due to a pandemic perfect storm — depressed U.S. oil production and manufacturing output, severe supply chain disruptions and war-like labor shortages — but that won’t endure. It was exacerbated by Russia’s invasion of Ukraine, which has radically reduced global purchases of Russian oil, grain and fertilizer and drastically diminished Ukrainian grain exports.
Meanwhile, our economy rebounded much faster than expected (due largely to the dollars pumped-in by the government and Fed), reviving demand that couldn’t be readily met.
It’s true that when our economy was blindsided by COVID, the government borrowed trillions to send stimulus money to most Americans, and — as it had after the financial crash — the Fed electronically “printed money” to buy nearly $5 trillion of government debt and mortgage securities.
But according to a Washington Post analysis, most of those dollars can’t possibly have stoked inflation — because the financial institutions the Fed paid parked over $2 trillion in their accounts at the Fed, and American households saved a big chunk of their stimulus, banking about $3 trillion. The Post quotes a former Treasury Department official: “The money supply went up, but… they’re not spending it.” In fact, money is moving through our economy more slowly than at almost any time in 65 years.
Clearly, what impelled inflation was the unprecedented confluence of supply and demand incongruities as a result of the pandemic and war in Ukraine, not “too much money.”
So it’s understandable Fed Chairman Jerome Powell recently said, “Now, we think more of just the imbalances between supply and demand in the real economy rather than monetary aggregates” (our total money stock, referred to as M2, is the paramount monetary aggregate). A refrigerator and pantry stuffed with food won’t make you fat unless you overeat; likewise, even an economy awash with dollars doesn’t inevitably induce lending and spending.
President Biden — despite stellar growth and employment stats — is unfairly maligned for stoking inflation.
Historic money metrics further undermine the Bezos/Musk fallacy. Since 2020, M2 has expanded about 50 percent; total inflation, as measured by the Consumer Price Index (CPI), has been less than 15 percent. From 2010-2020, with the Fed still ladling lucre onto our economy to resuscitate it from the Great Recession, M2 almost doubled — but CPI increased only 19 percent. Annual inflation lingered below the Fed’s 2-percent target.
There’s been a similar non-proportionality between M2 and CPI and between annual M2 growth and CPI increases for 52 years. M2 is over 22-times larger than in 1970, but the CPI is only seven-times higher — a 3:1 ratio of M2 growth to inflation.
This disconnect — and the fact that additional money in the economy isn’t automatically lent and spent — is related to another rarely-mentioned reality: Added dollars fuel not only consumption but investment — which stimulates increased productive capacity, business formation and expansion, R&D that spurs innovation and which can draw more people into the workforce. These counteract inflation by adding to output, lowering prices and curbing compensation hikes.
Amazon and Tesla epitomize how this works. Bezos and Musk built their behemoths when Fed policy was accommodative; investors slung cash at startups. Now Amazon restrains inflation more than any company in history. Tesla collapsed electric vehicle costs, making EVs affordable to a large swath of Americans. SpaceX has astoundingly lowered the cost of space travel.
Yet the Fed and a lot of smart people cling to the canard that Fed tightening is necessary to tame inflation — even if it results in a recession.
Indeed, with one exception, the Fed has brought on recessions with every tightening cycle that continued for over a year — the more prolonged and pronounced the Fed funds rate increases, the longer and deeper the recession. The lone exception was in the middle of the raging 1990s tech boom, which the Fed eventually did kill by more than doubling the Fed funds rate from its 1994 trough.
Many liken today’s inflation to the late 1970s — but that was brought on by the sudden ascendence of OPEC as U.S. oil production was imploding and President Nixon’s wage price controls, a cynical ploy to forestall Fed tightening and unemployment during his 1972 campaign. Nixon’s scheme fomented horrific distortions across our economy that ended up supercharging the inflation spiral. Unemployment eventually soared alongside inflation, a cataclysmic combination that never occurred before or since.
Most economists erroneously extol Paul Volcker, the imperious Carter-appointed Fed chairman, for ending that inflation. The horrendous 1982 Volcker recession inflicted untold misery. Unemployment peaked at almost 11 percent — nearly a full point higher than during the Great Recession. In truth, that inflation was conquered by Reagan’s lower tax rates and big investment tax incentives, which substantially boosted productive capacity, as well as his deregulation of energy prices, which promoted domestic production, and his indexing income tax rates to the CPI.
How do we know it wasn’t the Fed that “saved” us from this inflation? Because it almost evaporated after Volcker, amid one of our greatest peacetime booms, with declining Fed rates, Reagan’s massive military buildup and a ballooning budget deficit — all traditionally thought to be inflationary. Over the next 37 years, the CPI increased little more than it had over just the preceding 12 years. During the 1990s tech boom, our longest peacetime expansion, inflation actually dropped to its lowest level since the mid-1960s.
The Fed and haughty experts ignore that while higher prices are certainly painful, they’re far preferable to the trauma of losing a job — and at least somewhat neutralized by compensation increases. Social Security is indexed to the CPI, significantly insulating nearly 50 million retired seniors.
Fed tightening also swells the value of our already overvalued dollar, making U.S. exports more expensive and imports cheaper, another blow to our middle-class workers — and abjectly antithetical to the crucial goal of Americanizing our supply chain.
The “conventional wisdom” that the Fed must choke the economy to contain inflation is an orthodoxy that should go the way of the ancient medical practice of bloodletting.
What’s more, these momentous money tightening decisions are made by an unelected seven-member board of governors, often bulldozed by the Fed chairman. That a group smaller than a jury arrogates the power to dictate the availability of dollars for our entire $24 trillion economy would be considered un-American had it not been normalized by the elites. It’s akin to the government empowering a tiny, unelected council to constrict the food supply for our whole population to overcome obesity.
While the Fed is ineffectual at achieving “soft landings,” it’s proven quite adroit at ameliorating financial crises and severe slumps. The Fed headed-off catastrophes following the 2008 financial crash and at the pandemic’s onset. So, the Fed’s freedom to combat contractions should be unfettered.
But the Fed’s unchecked power to tighten the money supply must be rescinded.
The Fed funds rate should be permanently set at half GDP growth — or much lower, as it is now, during and after pandemic-level emergencies. And the Fed’s authority to take other contractionary actions should be strictly limited. The current Fed tightening spree should be stopped.
Oddly, many free-market champions are terrified at the prospect of monetary prerogatives being devolved from the Fed star chamber to private lenders (under a regime of sound practices). Obviously, even if they had a zero cost of funds, lenders would want their loans repaid. They’ll maintain ample lending discipline based on borrower creditworthiness and business conditions, which, being closer to the ground, they’re far more qualified to assess than the Fed.
Many who laud the Fed’s current tightening crusade — which, based on history, may well lead to a recession — are in cushy financial situations. Perhaps if they were subject to being laid-off, having their hours cut or losing tip income, they wouldn’t so blithely endorse such a destructive policy.
Lee Spieckerman is a political strategy and policy consultant and frequent network television and radio commentator. He was an advisor to Newt Gingrich during his 2012 presidential campaign and to Texas Land Commissioner George P. Bush during his successful 2018 re-election campaign. Previously, he was a longtime media industry executive and consultant. Follow him on Twitter @spieckerman