Fed's Fatal Flaw

Psychologist Gabor Matay describes addiction as a response to trauma, and an attempt to escape suffering, at least temporarily. People partake in addictive substances or behaviors in order to feel momentary relief from the background of trauma and suffering that they have been exposed to. The problem of course is that this behavior does nothing to address the root cause of the suffering, but creates a downward spiral from which it's increasingly difficult to extricate oneself. The brain needs higher doses each time, and the crashes from those highs get increasingly debilitating. The final outcome, quite often, is complete destruction.

Given this context, one must wonder about the nature of pain and suffering that haunts the American economic landscape, and requires ever increasing amounts of drugs in the system. For no analogy fits better what the Federal Reserve has been doing to the American economy over the last two decades. As the ultimate drug peddler, the Fed has been forced to increase it's dosage....sorry, stimulus....with every new crisis. Interest rates, the beating heart of capitalism, for that's how capital risk is assessed, keeps getting pushed down to stimulate economic activity for longer and longer periods of time. Higher rates are now blips on the time series. Money printing, or what's popularly called debt monetization, has now become a permanent part of monetary policy. The economy at large is now addicted to artificially low rates and waves of easy liquidity sloshing around the system.

So what happens when these economic drugs are taken away, even briefly? What do the withdrawal symptoms look like? Well, given how deep the addiction now is, the face of economic withdrawal is quite ugly. Corporations that were until recently flushed with easy money and didn't have to show profit for years, are suddenly finding it hard to refinance their debt at higher interest rates. Layoffs have ensued, and will continue to pick up pace for the foreseeable future. Regional banks are suddenly realizing that their 'safe' bond assets have actually gone down significantly in real terms. I'm guessing many state pension plans have a similar issue. Residential real estate sales have fallen off a cliff. The devastating combination of high rates and high home prices have created an affordability crisis in the housing market. Commercial real estate is facing even worse headwinds. Office vacancies have skyrocketed due to the post-pandemic work preferences. And debt restructuring at higher rates has become much harder, especially with the current crisis in regional banking which constitutes most of the lending. Used car sales have also plunged, and prices have now begun to follow. The M1 money supply has seen it's sharpest rate of change contraction in many decades, which will show up in economic activity sooner than later. Speaking of long and variable lags, we have just begun to see the effects of last year's rate hikes manifest in the economy. At this point, no matter which way the Federal Reserve pivots, an economic recession is baked in.

Why not just cut rates and go back to the printing presses, you may ask? Well....one word.....the Fed's Achilles heel.....the Fatal Flaw in it's central planning agenda.......INFLATION! For over a decade, pundits have lambasted anyone that criticized Fed's loose monetary policy. "What's the problem"....they would ask...."money printing was supposed to create inflation......but it hasn't.....so why not keep doing it?" An entirely new economic philosophy called Modern Monetary Theory or MMT came into being around this premise. They completely ignored that money printing in fact DID create inflation. It was just in financial assets. The trillions of dollars that the Fed manufactured out of thin year never made it out of the canyons of Wall Street. Stocks and housing boomed, yet consumer inflation at large remained under control. There was no incentive for Wall Street to lend money out......their arrangement with the Fed gave them the profits they needed. ....Until Covid happened......, and the Fed, perhaps for the first time, was forced to share a piece of the pie with the public. Suddenly it wasn't just Wall Street getting bailed out, but Main Street as well. The drugs were now available at the local pharmacy, no prescription required. And general inflation raised it's ugly head across the American economy.......as had always been predicted. And now we're all on the same page.....after the initial high of seeing money magically appear in your bank account..... everyone  now understands the pain inflation can wrought, especially on those who can least afford it. It's the bitter invisible tax that nobody wants to admit.....a monster hiding in your finances, chewing away at your ability to proper and leave a legacy for your children.

That's the Fed's Fatal Flaw. It presumed that it could cover up the general suffering of the American way of life by drugging them up with extremely loose monetary policy. With no ill side effects. And now the chickens have come home to roost. The drugs are being withdrawn, and the patient is beginning to convulse, begging for more as time goes by. But the Fed's hands are tied, because it cannot risk the Inflation monster, created by it's own misshapen policies, to run loose. We are about to find out just how much trauma and suffering was being covered up by the Fed. The real rot in the system is soon going to reveal itself. ............... It will be on us to not shy away from it, and maybe in a very long time.......look our trauma right in the eyes.