As the Federal Reserve considers lowering interest rates, it risks falling victim to its own dominance. For too long, the Fed has been a monastery where 2% inflation, 2% trend growth and the primacy of conventional banking are accepted without sound foundation.
President Donald Trump, perhaps awkwardly, gives voice to increasingly public impatience with the theology we call macroeconomics.
The Fed targets 2% inflation as a compromise between accomplishing strong growth and stable prices. Since the financial crisis, whether unemployment was 10% 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% with the variance largely determined by international oil prices.
The pace of economic growth has fluctuated widely, mostly between 0% and 4%, but stayed depressed without much correlation with inflation.
The Fed is chasing an irrelevant target with ineffective policy tools — that simply doesn’t work.
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 the federal funds 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.
Since 2008, the Fed effectively has paid banks its target federal funds rate, and banks appear to prefer taking that rate on their reserves over lending those funds to businesses to create new checking account money and spending power.
The size of the Fed’s balance sheet—which includes government bonds in addition to bank reserves and some other securities — and those of the European Central Bank are dictated by slow growth government policies.
Those include too much regulation, multilateralism and political correctness and a blind, polemical acceptance that despite automation, artificial intelligence, more women seeking work and immigration long-term economic growth must stay depressed at no more than 2%.
Those impel politicians to promise angry voters an increasing array of welfare benefits. Ten- and 30-year Treasury and mortgage rates are currently so low, 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 unravel.
Soon the Fed, banks, fiat money and credit cards will be challenged by Facebook’s Libra. Its basic architecture is remarkably elegant and something like it will happen even if federal regulators won’t let Mark Zuckerberg have that much power.
In the coming decades, government’s deficits will soar to pay for underfunded social insurance and employee pensions, health care, guaranteed incomes, and efforts to combat and mitigate the consequences of climate change.
The Fed and other central banks 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.
Libra will initially be backed on a dollar-for-dollar basis by a basket of high-quality fiat money —dollars DXY, +0.02%, euros EURUSD, -0.1703%, yen USDJPY, -0.06% and the like. But fiat currency and checking-account money were originally backed by the gold and silver coins and bullion that those replaced.
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 as a Libra-based banking system emerges through private initiative.
Nothing Washington can reasonably do can prevent Switzerland from letting Libra or something similar establish within its jurisdiction or stop existing banks and new institutions around the world from take taking deposits and making loans in Libra.
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 cryptocurrency could make them as irrelevant as Facebook did telephones and texting for keeping large groups of people informed of their common endeavors.