Fed makes things worse


Jerome Powell came to power at the Fed with a determination to reverse the stunning mistakes of his predecessors, especially Ben Bernanke, who received the Nobel Prize for the dumbest central bank policy since the Weimar Republic. Back in 2008, Bernanke pushed banks’ borrowing costs to zero and kept them there for years.

The politics were always absurd. Why can’t the interest rate be zero? Because there is such a thing as the passage of time. Consuming in the present with resources stored by others must always come at a price. This applies regardless of whether there is money or not.

A super simple example: Let’s say your bushel of blueberries costs me an egg today, but I don’t want an egg until next week. The blueberries cost two eggs next week. Why? Because consuming now and paying in the future always has a cost to the borrower and benefits the lender. The lender may give me charity, but it does not take the price of time.

The entire yield curve as we know it today is nothing more than an elaboration of the simple example. In normal times and normal assumptions, the longer the term, the higher the rate. But even on the shortest maturity, the exchange rate on a normally functioning market is always positive.

So for Bernanke to force a situation where the passage of time costs nothing and is even negative is tantamount to making heaven on earth. It is an illusion that cannot last. It also introduced terrible distortions in the production structure. Money and capital seeking returns left the present and chased the future, which is why Big Tech and Big Media spiraled out of control and siphoned enormous resources away from ordinary savings, small businesses, retail and other such normal things.

Powell always knew this policy was dangerous, so he set out to reverse it in 2019. He made some progress in hopes of normalizing market signals and getting the production structure back on a rational track. But then came the pandemic, and Congress went on a spending spree. He stepped up and provided liquidity to the tune of $6.2 trillion in newly printed money.

Realizing the mistake and trying to contend with the inevitable price inflation, Powell reversed course. His only choice was to love it. He embarked on the highest and fastest rate hikes on historical record. These rates bled very quickly through the yield curve and all US Treasuries were repriced.

Such a move always poses a problem for holders of old fixed rate bonds. They necessarily trade at a discount. All holders of them will definitely have a problem that the value of the bond portfolio will be devalued.

And who held them? Many large banks. And why? There are two reasons. First, the tsunami of money that flooded the world from 2020 to 2021 will eventually land in the banks. Normally the banks would turn it into loans, but it wasn’t viable on this scale. Second, post-2008 government regulations required banks to put extra cash not in securities or other instruments with some risk, but rather in “safe” government bonds.

The banks complied. In the last six months, with the new Fed policies, smart risk managers started offloading the devalued bonds at a discount. But not everyone did. Silicon Valley Bank was apparently so caught up in ESG, DEI and LGBTQ stuff that they completely neglected the basics of banking, if they even knew them. After all, holding underwater bonds is one of the leading causes of bank failures.

The right policy, the obvious answer, and the path any rational central banker should take at this point is: let the failure happen. The liquidation would have occurred, the assets sold, depositors would have been paid 50 to 70 cents on the dollar for all uninsured deposits. There is absolutely no reason in the world why that shouldn’t have happened. As of yesterday, everyone thought it would happen.

But here the Biden administration intervened in ways that are likely to displease Jerome Powell. The Ministry of Finance promised another heaven on earth without justification. It would save every last depositor completely. With that one action, the US has now embarked on an even more dangerous course. It has provided full reserves for every single bank deposit no matter what.

Bank failures are usually deflationary in their effect. But with unimaginably large de facto bailouts of banks, we have here a recipe for the opposite. Treasury Secretary Janet Yellen says that taxpayers are not on the hook, but that there are other ways to pay taxes than through public revenue. You can also pay with more devaluation of the currency.

If the US continues with this policy, we will have the worst of both worlds. Interest rates will continue to rise while the central bank will continue to pour money into the system to keep it afloat with ever more quantitative easing. One force cancels out the other in a series of catastrophes until we reach the final endgame of a hyperinflationary explosion boom.

As Craig Pirrong points out, we’re not going to see anything like an Occupy Silicon Valley movement like we should. That’s because the bank being bailed out is the main lender to the Woke crowd, who are right behind the Democrats. They are in charge and are completely prepared to loot the entire gross domestic product to save their ideology and their friends.

This wicked little move might buy the Biden administration more time and put a damper on the possibility of contagion for now. But in the long term, this policy threatens to cause even more damage than the zero rates of 2008 and the monetary stimulus of 2020-21. It is an offer of perpetual paper money welfare for the entire awake ruling class. And here we come to the Federal Reserve’s core problem. Ultimately, its main task is to fix the problems it caused in order to save the banking system. It will always be forced to do so over the preservation of the underlying soundness of money.

The tragedy here runs deep and wide. The powers that be are involved in so many errors that it is getting beyond the point of repair. Not even the best president for a perfect four years will be able to reverse all this wreckage. The 2020 shutdowns were certainly the tipping point, but even then it might have righted the ship in time if the system could liquidate itself without intervention. But on the current course there is nothing but wreckage ahead.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of the Epoch Times.

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