Why won’t the Fed act?
Inflation is soaring, but the ruling class are caught in a trap of their own making
“The time has come to reverse the flow of power and resources, from Washington to the states and communities, and more importantly, to the people all across America.”–Richard Nixon, 1971
The great Potomac of power and resources continues flowing – towards Washington. Joe Biden has just proposed the biggest tax increase in history, a rise of $2.5trn, the largest ever increase in dollar terms, as part of a $5.8trn budget for federal spending. The deficit will top $1.15trn.
Who will cover that deficit? The Fed, who else? But the Fed already has its back to the wall. Former treasury secretary Larry Summers warns that the Fed’s current policies are likely to lead to stagflation and that its babysteps approach to inflation will lead to low growth and higher prices. He may be right, but he’s wrong in thinking that the Fed can reverse course. We doubt it is possible. Birds gotta fly. Fish gotta swim. And – given the circumstances – the feds gotta inflate.
“How can they be so stupid” is a question usually posed only rhetorically. But we have an answer: because it pays. At least, that is our hypothesis. Summers is offering policy advice. It is good advice – as far as it goes. But here on the back page, we offer no advice. We merely observe. And what we see is a ruling class grown fat and sassy on bad advice; it is unlikely to give it up.
The middle 80% of the population depends on the Main Street economy for its daily bread. But the top 10% and the bottom 10% depend heavily on the public sector. At the top, the Fed’s negative interest rates boost stock gains… and federal spending provides contracts, jobs and sinecures. At the bottom, handouts and freebies keep people from having to get up in the morning.
What would the Fed have to do to bring inflation under control? Summers reckons rates of 5% or more – something markets currently regard as “almost unimaginable”, says Summers. He may be right. But the “Volcker rate” – the rate really required to bring inflation under control – may be much higher. If the current inflation rate were 8%, and you need a real interest rate of 2% or 3% to slow inflation, that would mean the key Fed rate would have to go to at least 10%. Unimaginable? Maybe. It would crash the stockmarket; the deciders would probably lose at least $25trn. And it would curtail the feds’ big spending plans – considerably reducing career prospects for the policy elites.
The Fed is caught in an “inflate or die” trap. Summers believes it will eventually see the error of its ways and, when it has exhausted its bag of mistakes, it will do the right thing to bring inflation under control. Not likely. Instead, it will threaten to control inflation, the stockmarket will crash, the entire elite establishment will howl in horror, and the Fed will rush in with a whole new sack of errors.
“How can the Fed be so stupid? Because it pays