Didn't you always hate those Supply/Demand graphs?

I've just  finished reading a pretty good book on the Fed called The Lords of Easy Money by John Leonard which describes the role of the Fed especially as it relates to that recent invention called Quantitative Easing (for those of you not schooled in this arcane idea the Australian comedy-news team of Clark and Dawe did a very short explanation of the policy which is right on point. - click on it - Clark and Dawe were a brilliant team of satirists whose weekly political spoofs on a variety of topics were cut short when John Clarke died in 2017).

The numbers around QE were astounding.  At one point the total QE injected into the system was larger than the total monetary expansions in 300 years!   All of that seems pretty arcane until you begin to realize that, at least according to the author there were several other consequences of QE.  To understand those, one needs to be reminded of two types of inflation - PRICE inflation and ASSET inflation.  The easiest way to understand price inflation is to go to any gas station in the US, or make a trip to the grocery store.  The cost of all sorts of things have increased rapidly over the last year.   Chair Powell commented that he expects if all the things they talked about yesterday are successful that at the end of the year price inflation will be down to just under 5% or two and a half times the Fed policy rate.  

Asset inflation is harder to detect and often its effects make us want to proclaim how smart we are.  When you buy a house that increases quickly in price - many people simply judge that they were good "students of the market."   Asset inflation can also be a bit harder to assess because one is not always to establish an accurate price for an asset easily. Many assets are intangible.    When I worked in a securities firm for two summers in college there was an obligatory read called Extraordinary Delusions and the Madness of Crowds by Charles MacKay written in 1841 which described a series of market bubbles where assets were absurdly valued because of the "madness of crowds". (Note it was a good yarn although several of his tales were not quite accurate).  Don't blame a 19th Century Scottish poet for not getting the facts right on financial blunders - economists have done their best to build fallible models since then.  When I started investing in securities about a decade later the founder of Fidelity Magellan offered some very sound advice to avoid bubbles - Peter Lynch commented that if you cannot define a financial transaction on a single sheet of paper with a crayon - you probably should avoid it.

Price inflation makes all of us poorer (we pay more for less) but the effects are harder on those who spend most of their resources on things. (The poor really do get whacked when we have 7% inflation!). Asset inflation affects only those who own assets (except for some indirect effects - like possible increases in rent for dwellings which might go up as the perceived price of the asset increases).  And an increasingly smaller percentage of society owns real assets.

While I am not a fan of the nonsensical wails of "social justice" advocates who decry income and wealth inequality and attribute the changes to conspiratorial effects, it is worth considering that as QE grew, the American economy slowed the opportunity for making moves between income quintiles.

Leonard argues that as all that fluffle money was pumped into the system it produced tons of asset inflation causing a couple of stock and housing bubbles - with the inevitable crash. That is because as you add money to the system it reduces the price of money (in essence it keeps rates low) so investors are forced to search for yield.   But here is where his analysis is most interesting.  First, as QE money sloshed the rich got richer, exacerbating the wealth inequality in society.  The most prominent discussions of income  and wealth inequality seem to ignore that major factor.  It is easier to point to some sinister force like the "1%. "  Second, federal policy makers decided that when asset markets crashed that the losers (owners of those inflated assets) should be bailed out.  SO the richest in society were given a chance to make odd economic decisions and still get bailed out.  Sounds like a pretty sweet deal.

The Fed announced on the 16th (the day I finished Leonard's book) that they would begin doing rate hikes in the federal funds rate - the first in about 4 years.  Powell said there would be seven before the end of the year (with the possibility that they might do another four soon after).   That sounds like pretty stiff stuff until you realize as the WSJ pointed out - all of those jumps would still leave negative interest rates (inflation would be higher than the borrowing rate).   He also said there would be an indeterminate reduction in the $9 trillion in QE still floating in the markets.

So with all these increases in rate - how will life change?  If you maintain either a variable rate mortgage (which was a lousy bet during this low rate environment) or any credit card debt - you are going to see rates increase.  Ditto for car loans and student loans.   You might get a slight jump in the rates you receive for money market and savings accounts.  But if you don't have any of those types of debts or plan to add some you might not feel anything.  The real question for everyone is whether all these rate hikes will tame inflation.  For me the Fed's actions are a step in the right direction but I remain to be convinced that price and asset inflation will moderate (assets are more likely to be slowed than prices).   Obviously, if the Fed moves too quickly we could be moved into a recession.

Leonard argues that the Fed stepped into a breach created by our other dysfunctional government institutions.  It is ill equipped to make policies which the Congress and the Administration and the interplay of interests would be better able to deal with.  I will admit that during the Greenspan era I was bothered by the rock star treatment that he was accorded by members of Congress.  When you compare Greenspan to Volker - the latter comes out as much more of a hero.   I think the same can be said of Bernanke and Powell.  (With a nod to Powell and not Bernanke)  But I must admit that I have always been a fan of the approach that Stanford professor John Taylor suggested where monetary levers are set and forgotten - fine tuning seems to be a contradiction in terms.