Speaking at the Jackson Hole meeting on August 27, 2021, Federal Reserve (Fed) chairman Jerome J. Powell showed that he supported “tapering” toward the end of this year and quickened to include that rates of interest walkings are still a long method off. The term “tapering” means that the central bank reduces its monthly purchases of bonds and decreases the regular monthly boost in the quantity of cash accordingly. Simply put, even with tapering, the Fed will still produce recently printed US dollar balances, but to a lower level than before; that is, it will still trigger monetary inflation, however less than before.
Financial markets were not alarmed by the Fed’s statement that it might take its foot off the accelerator pedal a little: ten-year United States Treasury yields are still trading at a fairly low level of 1.3 percent, the S&P 500 stock index hovers around record highs. Could it be that investors do not think in the Fed’s suggestion that tapering will start soon? Or is tapering of much lower significance for monetary market asset costs and economic activity moving forward than we believe? Well, I think the second question nails it. To comprehend this, we require to explain that the Fed has put a “safeguard” under financial markets.
As a result of the politically determined lockdown crisis in early 2020, financiers feared a collapse of the economic and financial system. Credit markets, in particular, went wild. Borrowing costs increased as risk premiums rose dramatically. Market liquidity dried up, putting terrific pressure on debtors in requirement of financing. It wasn’t long prior to the Fed said it would finance the credit market, that it would open the financial spigots and release all the cash needed to fund federal government companies, banks, hedge funds, and companies. The Fed’s statement did what it was expected to do: credit markets cooled down. Credit started flowing once again; system failure was prevented.
In truth, the Fed’s production of a safeguard is absolutely nothing brand-new. It is perhaps better called the “Greenspan put.” Throughout the 1987 stock exchange crash, then Fed chairman Alan Greenspan lowered rates of interest significantly to help stock rates recover– and thus set a precedent that the Fed would come to rescue in monetary crises. (The term “put” describes an option which provides its holder the right, however not the obligation, to offer the underlying property at a predetermined cost within a specified amount of time. Nevertheless, the term “safety net” may be better suited than “put” in this context, as investors do not have to pay for the Fed’s assistance and fear an expiration date.)
The fact is that the United States dollar fiat cash system now depends more than ever on the Fed to provide commercial banks with sufficient base cash. Given the exceedingly high level of debt in the system, the Fed needs to also do its best to keep market interest rates artificially low. To attain this, the Fed can reduce its short-term financing rate, which determines banks’ funding expenses and therefore bank loan interest rates (although the latter connection may be loose). Or it can purchase bonds: by influencing bond prices, the central bank affects bond yields, and offered its monopoly status, the Fed can print up the dollars it needs at any point in time.
Or the Fed can make it clear to financiers that it is prepared to fight any type of crisis, that it will bail out the system “no matter the cost,” so to speak. Suppose such a pledge is considered reliable from the financial market community’s point of view. Because case, rates of interest and risk premiums will astonishingly remain low without any bond purchases on the part of the Fed. And it is by no indicates an exaggeration to state that putting a safeguard under the system has ended up being possibly the most effective policy tool in the Fed’s bag of tricks. Mostly concealed from the public eye, it enables the Fed to keep the fiat money system afloat.
The critical factor in all this is the rate of interest. As the Austrian financial company cycle theory explains, synthetically reducing the rates of interest sets a boom in motion, which relies on bust if the rates of interest rises. And the longer the central bank is successful in lowering the interest rate, the longer it can sustain the boom. This describes why the Fed is so eager to resolve the idea of hiking interest rates whenever quickly. Tapering would not necessarily lead to an instant upward pressure on rates of interest– if financiers voluntarily purchase the bonds the Fed is no longer ready to purchase, and/or if the bond supply declines.
But is it most likely that financiers will remain on the buy side? On the one hand, they have a great reason to keep purchasing bonds: they can be sure that in times of crisis, they will have the chance to offer them to the Fed at an appealing rate; which any bond cost decline will be short lived, as the Fed will correct it quickly. On the other hand, however, financiers require a favorable real rate of interest on their investment. Smart money will rush to the exit if small interest rates are constantly too low and expected inflation constantly too high. The ensuing sell-off in the bond market would force the Fed to intervene to prevent rate of interest from increasing.
Otherwise, as noted earlier, rising rates of interest would collapse the financial obligation pyramid and result in a collapse in output and employment. It is, therefore, no wonder that the Fed is doing whatever it can to conceal the inflationary repercussions of its policy from the general public: the steep rise in durable goods cost inflation is being dismissed as just “temporary”; property rate inflation is stated to be outside the policy required, and the impression is considered that increases in stock, housing, and realty rates do not represent inflation. On the other hand, the boost in the cash supply– which is the origin of items rate inflation– is barely discussed.
Nevertheless, once people begin to lose confidence in the Fed’s desire and ability to keep items rate inflation low, the “safeguard hoax” reaches a crossroads. If the Fed then chooses to keep interest rates artificially low, it will have to monetize growing quantities of debt and problem ever-larger amounts of money, which, in turn, will increase goods rate inflation and intensify the bond sell-off: a down spiral begins, causing a perhaps serious decline of the currency. If the Fed focuses on decreasing inflation, it should raise rates of interest and reign in cash supply growth. This will more than likely trigger a rather unpleasant recession-depression, possibly the most significant of its kind in history.
Versus this background, it is difficult to see how we could escape the debasement of the United States dollar and the economic downturn. It is most likely that high, perhaps really high, inflation will precede, followed by a deep downturn. For inflation is usually viewed as the lower of two evils: rulers and the ruled would rather new cash be released to prevent a crisis over permitting services to fail and unemployment to surge drastically– a minimum of in an environment where individuals still think about inflation to be reasonably low. There is a limit to the central bank’s machinations, however. It is reached when people start wondering about the central bank’s currency and discarding it because they anticipate goods rate inflation to draw out of control.
However up until this limitation is reached, the reserve bank still has rather some freedom to continue its inflationary policy and increase the damage: debasing the buying power of money, increasing overconsumption and malinvestment, and making big government even larger, successfully creating a socialist tyranny if not stopped eventually. So, better stop it. If we want to do so, Ludwig von Mises (1881– 1973) informs us how: “The belief that a sound monetary system can when again be achieved without making considerable changes in financial policy is a severe error. What is required firstly is to renounce all inflationist misconceptions. This renunciation can not last, nevertheless, if it is not firmly grounded on a full and complete divorce of ideology from all imperialist, militarist, protectionist, statist, and socialist concepts.”