Back in 2022 the Federal Reserve raised fed funds rates (the interest rate banks pay to borrow over night) an astounding 525 basis points (bps). Two very destructive things happened.
First, bank lending came to a standstill still. In other words, economic activity ceased and the economy went into a mini-recession. I submit economic activity has not improved overall. The improvement we see are limited, not general.
This decision by the FOMC created an atmosphere of massive uncertainty in the markets and damaged bank margins, further reducing lending activity. Rate hikes did little to reduce inflation because the Fed Reserve used the wrong tool to control the type of inflation our nation was undergoing. More on this latter.
The second surprise, when the Fed raised rates, is that the longer end of the yield curve did not go up in unison with fed funds. The one-year to 30-year bond rates are determined by the market, the smart money. The fact that this smart money did not require a risk premium, in higher rates, tells us they did not see long-term inflation harming their returns.
The Federal Reserve’s implementation of monetary policy led to two grievous errors for which the American people are paying. First the Fed created massive monetary liquidity, using an arcane gimmick called Quantitative Easing (QE).
Through QE the Fed created $8 Trillion US Dollars starting in 2008. The Federal Reserve’s balance sheet exploded from $850 Billion to $9 Trillion. This single action caused devaluation of the US Dollar. Dollar devaluation manifests as price inflation.
An immutable, and time-tested principle of monetary theory is that any currency created in excess of that required to maintain economic liquidity, devalues that currency. Inflation in the last decade is a result of dollar devaluation due to excess liquidity.
The Fed Reserve used the wrong monetary tools to prevent this type of inflation. Instead of raising interest rates, which works if this inflation were caused by supply imbalances, the Fed should reduce the supply of money. Which requires far less spending by the government.
Inflation (dollar devaluation) is an insidious destroyer of private enterprise. It destroys the purchasing power of our savings and strangles economic expansion. Inflation hurts the low wage earner the worst. It is the cruelest form of manipulation leading to dependency. It is far better when we allow an independent and free market to function without federal malfeasance. Instead we are shackled with Fed Reserve errors.
There is good reason for the Fed Reserve’s prime directive to maintain the value of the US Dollar. That simply means keep a lid on monetary liquidity, money in circulation, so the value of our dollars remains stable and price inflation in check.
It’s not that we have a choice in the matter. If we are to pass on the freedom granted us, to our children, then we must reduce the money supply, and including government spending, and with it, inflation.
Federal Reserve FOMC implementation of monetary policy has proven not only inadequate, but destructive.
Jay Davidson is founder and CEO of a commercial bank, a student of the Austrian School of Economics and a dedicated capitalist. There is a direct connection between individual right and responsibility, our Constitution, capitalism, and the intent of our Creator.