As Chairman Jerome Powell defends the Federal Reserve’s political independence and prepares to cut interest rates to keep the expansion going, he risks missing much bigger challenges—the growing irrelevance of Fed policies and the challenge posed by Facebook’s cryptocurrency Libra to the primacy of the dollar.
The Fed targets 2 percent inflation as a compromise between accomplishing full employment and stable prices, but this standard has become a false God for central banks around the globe.
Over the last decade, whether unemployment was 10 percent or less than 4, no matter how high or low the Fed set interest rates or engaged in quantitative easing, inflation has mostly fluctuated below 2 percent and has largely been determined by oil prices. The pace of growth has been impervious to inflation—it has fluctuated widely, mostly between 0 and 4 percent, without much correlation with inflation.
The Fed is chasing an irrelevant target with policy tools that don’t work.
Part of the problem is that money—traditionally defined as currency and checking account balances – is not what it used to be. Businesses’ and consumers’ ability to spend against next months’ sales and paychecks is really defined by the size of the lines of credit and credit card limits. Small movements in short-term interest rates have little impact on the availability of these forms of liquidity.
The Fed can’t control the traditional money supply anyway. It has put huge reserves in the hands of banks – those are sums only banks, hedge funds and money managers are allowed to keep in electronic checking accounts at the Fed. However, banks often prefer to take the interest the Fed pays on these reserves instead of lending those out to create new checking account money and spending power.
The size of the Fed’s balance sheet—the bonds it holds to create reserves for banks—and those of other central banks like the European Central Bank, are dictated by slow growth government policies – too much regulation, multilateralism and political correctness. That compels ambitious politicians to promise angry voters an increasing array of welfare benefits. Ten and 30-year Treasury and mortgage rates are so low now, not because of Fed or ECB aspirations, but because those institutions are compelled to hold ever larger sums of government bonds or the finances of their central governments will collapse..
As a young professor in the 1970s, I carried around my checkbook and paid the grocer and department stores with signed vouchers. When was the last time you saw the checkout line at Safeway held up by an old man fumbling with a check?
Now credit cards, banks and even the Fed are on the cusp of being subverted by Libra – Facebook’s proposed cryptocurrency—or a similar contraption if regulators won’t let Mark Zuckerberg have that much power.
Deficits of national governments will fly out of control over the next few decades to pay for underfunded social insurance pensions, the demands of displaced blue collar workers for lower taxes, free college and health care and guaranteed incomes for those who refuse to work, and mitigation to defend coastlines and farms from rising sea levels, temperatures and drought through sea walls, CO2 recapture and irrigation. The Fed and central banks throughout the world will be compelled to purchase huge sums of government bonds by issuing fiat money. Only fools will have confidence that anyone really controls the supply of fiat money and in the security of government bonds denominated in those currencies.
Enter the Libra. It will initially be backed on a dollar for dollar basis by a basket of high quality fiat money – dollars, euros, yen and the like. But fiat currency and checking account money were originally backed by the gold and silver coins and bullion that fiat money replaced. And in time, Libra’s independent commission in Switzerland could do something the Fed and ECB can no longer do—manage and expand its supply for the needs of commerce by creating its own Libra-based banking system.
Central banks everywhere have shied from issuing electronic money akin to Libra directly to consumers to by-pass banks and directly influence the private economy. The Fed and banks had better look out—Mr. Zuckerberg’s privately run monetary policy could make them as irrelevant as Facebook did telephones and texting for keeping large groups of people informed of their common endeavors.