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Weekly eLetter 9/30/2022 — Fed Overreach?

As you peruse our notes below in today’s Market Minute, you will see how we feel about Fed Chair Powell’s commitment to a very aggressive strategy. Our comments there are based on the logic of taking Powell at his word – at full face value. It’s always a good idea to put the strongest consideration towards what people have declared. However, there is a growing feeling in some circles that there may also exist a ‘plan B’. So, let’s take a look at that.

For those who recall the days of ‘The Great Inflation’ of the late 70’s (thank you, Jimmy Carter) and also recall the tactics of Paul Volker to ‘WIN’ (‘Whip Inflation Now’) you will recall that much of the conversation centered on the money supply, specifically the version known as M2.

M2 is a basket of ‘money’ that includes cash, checking deposits and other assets that are ‘near cash’. M2 has an important, some say ‘direct’, relationship to inflation because “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. ~ Milt Friedman. In other words, ‘too much money chasing too few goods’.

Oddly, M2 is not getting much press these days. Instead, we hear a lot about supply chain issues and foreign wars, not to mention ‘price gouging corporations’. Some of that is undoubtedly true and does help to account for the ‘too few goods’ part of the equation. But, in our humble opinion, more attention should also be paid to the ‘too much money’ part.

Powell accurately explains that the Fed controls the rate of inflation through three “blunt tools”:  1) raising and lowering the interest rates it charges other banks for money, 2) buying and selling assets on the open market, and 3) signaling its future intentions to the market.

So, what have they been actually doing?

First, the Fed lowered interest rates by 1½% in March 2020, from about 1½% to just above 0%. That cut nearly all of the banks in the country’s cost of borrowing to nothing. Then they went on a buying spree. Starting around the beginning of March 2020 the Fed bought nearly $6 trillion in assets (mostly bonds and other long-term securities) with money they created (and which added to the money supply). This includes $3 trillion in just the four months beginning March 2020. These purchases by the Fed were intended to put more money into the economy. Economist Roger Cryan notes: ‘The Fed’s actions drove a $6.4 trillion increase in the M2 money supply between March 2020 and the end of 2021. This was an unprecedented 42% increase in only 22 months, far more than could be absorbed by economic growth, even with the strong recovery we have had.’

It seems clear that if Powell and the Fed gang will back up the tough talk with action, they will, at some point have to become more vocal with regard to the administration’s money expanding efforts. Things like the Inflation Reduction Act and Student Debt Relief work against contracting the money supply. Instead, those things aggravate inflation, so why does the Fed ignore their effects?

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