The Fed and Inflation
The stories we tell.
Summary: Today, we’re talking about the stories we tell. Narratives that take root and stubbornly refuse to die. The economic version of urban legends. Today’s culprit is the Federal Reserve. I watched the two-hour testimony of Federal Reserve Chair Jerome Powell, so you don’t have to. And it was a masterclass in euphemisms intended to cover the Fed’s desire to put more people out of work. Two million of you, to be exact. So let’s talk about stories and legends.
Listen to the full episode here.
Chapter One: In God we trust. In the consumer, not so much.
There’s an X factor that drives market behavior and the economy: Human emotion. The way people feel about the health of the economy has a lot to do with how they behave. If people feel secure in their jobs, they’re more likely to spend on discretionary items. If they sense that interest rates are going to be low for a while, they might consider putting a home on the market to upgrade, or perhaps buy a home for the first time. Small business owners might consider hiring. Investors will consider riskier investment vehicles like equities.
These sentiments are fueled by a couple of factors. First, people tend to have a keen sense of their own financial stability. A few bucks in savings, comfortably managing one’s bills, going to dinner without the fear of a credit card declining. These are lived experiences that contribute to sentiment. Then there’s narrative trends. If the news channels are promoting recession fears, if your boss is tightening the belt and there’s chatter among friends about feeling insecure, that’s when assholes start to pucker.
I’m threading a couple of topics together here, so bear with me. The point is that narratives—feelings, stories, sentiments, even past experiences—all inform how events and circumstances evolve and take shape. The stories we tell are powerful and enduring. To set things up, here’s a connection I want to make that reflects this phenomenon and relates to another topic that we’ve covered in great detail: Student Debt. Recently, I revived this topic on YouTube to add some additional context to our episodes, since debt forgiveness is in front of the Supreme Court right now.
In case you missed it, this was the setup from Bill Maher interviewing Bernie Sanders about debt forgiveness.
Maher: “This is a survey of student loan forgiveness recipients. 73% of applicants say they are likely to spend their extra money on non-essentials including vacations, smartphones, drugs and alcohol. They admitted that to the pollster.”
Sanders: “Who is the pollster?”
Maher: “Uh, NBC News.”
The point Maher is trying to make is that Americans, especially young ones, aren’t responsible with money. They don’t deserve giveaways, as he calls them. Tax breaks for the wealthy, forgiveness of PPP loans, amnesty to onshore trillions of dollars hidden offshore. Those are responsible giveaways and handouts because they’re for job creators. But money in the hands of average Americans will just be spent on consumables and entertainment, food, drugs, appliances and general foolishness. First off, even if this was the case—which it’s not, and I’ll get to that in a moment—he’s literally prescribing things that reflect a healthy consumer economy. God forbid people buy weed, go to the movies, dine out and travel. The man literally hosts a show where he smokes weed and talks about movies, food and traveling. Fucking hypocrite.
More to the point, that’s not what the average American spends, or would spend, discretionary income on. Not even fucking close. So, obviously, I was as curious as you heard Bernie was in that clip. Where did Bill Maher even get this information? Now, he says at the end that it was from NBC. But that’s not the pollster, which was Bernie’s question.
Well, I tracked it down. It was a real poll conducted in October of 2022 by a private company.
A private polling company?
No. A private digital content company that creates contact aggregation websites and has about three employees as far as I can tell. And those three employees are technically employed by a parent company that matches companies with private equity.
And they also happen to specialize in polling?
Not at all. But they are transparent with their methodology. Here’s what it says at the end of the survey results. It was an online poll conducted on a survey platform called Pollfish. 1,250 Americans participated in the poll and, to qualify, respondents had to truthfully answer that they aren’t currently students but had applied or planned to apply to the loan forgiveness program.
So 1,250 people responded to a poll on Pollfish conducted by a company that doesn’t do polling, and these completely unscientific results made it into Bill Maher’s big plan to catch Bernie off guard, out of his mouth and into the right wing media echo chamber. Right wing pundit Dave Rubin repeated the talking point, as did the Black Conservative Perspective channel on YouTube. Between the two of them, they had 500K views and counting already.
One of the bigger conservative think tanks, Americans for Tax Reform, quoted the survey directly in an article with the headline, “Student Loan Bailout Applicants Will Spend More on Vacation, Drugs, and Gambling.”
And now it’s in the ether, all because Bill Maher has a shitty staff and is too lazy to think about this stuff for himself. Any self respecting pundit would have questioned the veracity of a poll that made such wild claims. It’s why Bernie looked at him like he had three heads. Of course, Maher isn’t a pundit or a journalist. He’s a comedian with an entertainment show. But we’ve lost the ability to discern between news and entertainment.
And this plays into the larger narrative that I want to focus on. And that’s the idea that Americans are not trusted by those in charge to responsibly manage disposable income; that in order to maintain balance in the economy, a few million need to be unemployed and the vast majority of us are to live paycheck to paycheck so that we don’t accumulate enough spending power and freedom to move about the job market in search of something better.
To wit, the economic pundit class, personified by Larry Summers, squarely laid inflation at the feet of workers who quit their jobs en masse during the pandemic, or opted to move about the country to work remotely. Blaming workers for killing the corporate real estate market because they refuse to return to the office. Instead of admitting that wages have been suppressed in this country for more than forty years, and commercial landlords hiked corporate rents to the stratosphere because of favorable refinancing and capital withdrawal conditions, workers have been blamed for everything from rent to the price of eggs.
We know it isn’t true. The data support the working class and not the pundits. And yet, the narrative persists.
Chapter Two: Enter the Federal Reserve.
Jerome Powell came down like Moses from on high to testify in front of the Senate Banking Committee, as he is required to do at least twice a year. Powell is an extremely savvy politician, in addition to being a well respected official. We’ve talked about Powell’s reputation before and his ability to bring warring factions together and calm a room. Nearly everyone on the committee in the two-plus hours of testimony was polite and deferential and thanked him for his steady hand. Strike that. All but one of the questioners.
“You cling to the idea there’s only one solution: lay off millions of workers. We need a Fed that will fight for families. And if you’re not going to lead that charge, we need someone at the Fed who will.” -Senator Elizabeth Warren
As is customary at these hearings, Senator Elizabeth Warren used her time to drive a stake through the idea that economic progress must always come at the expense of the working class. She pulled no punches during her allotted time, pressing Powell on this perspective. We’ll get into the other hot takes on the committee, which unsurprisingly fell along party lines, though shrouded in civility. But Warren’s remarks stood out for their pointed hostility toward Powell and the world view that guides the central banking system.
Now, before we get too far into the weeds on the hearing, I think it’s helpful to review what exactly the Federal Reserve does, because its very existence is mired in controversy. At any given time, the Fed can find itself in the crosshairs of groups all along the political spectrum. One of the most popular refrains from libertarians, for example, is “End the Fed.” Likewise, it was adopted by many on the Left, especially during the Occupy movement.
Most people don’t think about the Federal Reserve. Congress makes laws. The courts decide law. The Treasury prints the money. The Fed—I’m not pandering when I say that Unf*ckers probably know 1,000 times more than the average citizen. People just don’t have the time or brain space to actually describe the role of the Fed.
They probably have a vague notion of what it does and have likely heard of Alan Greenspan, who was treated like a celebrity until the housing crisis exposed his actions. For those who may not recall, Greenspan encouraged Americans to take out adjustable rate mortgages, signaling that rates were going to remain low for the foreseeable future; he then proceeded to increase the federal funds rate 17 times in a row, beginning in 2004. Many credit this as the pin that burst the housing bubble that led to the financial collapse in 2008. All a meek and feeble Greenspan could muster when reflecting on the Great Recession was that he didn’t anticipate the level of systemic corporate greed in the country.
I don’t fall into the end the Fed camp, by the way. Because the alternative is either what we had prior to its existence, which are economic catastrophes nearly every other year, or Bitcoin, which is what libertarians advocate for.
Here’s an overview, mostly courtesy of the St. Louis Fed, on what exactly the Fed is and does:
The Federal Reserve system is overseen by Congress, but operates with a great deal of autonomy.
There are three parts to the Fed. The Board of Governors, 12 regional Reserve Banks and the Federal Open Market Committee (FOMC).
The Board of Governors oversees state-chartered financial institutions and bank holding companies.
The regional Reserve Banks distribute currency to banks, lend them money and process electronic payments. They also conduct research and report on regional economic issues and trends to help keep a finger on the pulse of different parts of the country.
The FOMC is the main body that determines monetary policy. It’s made of the Board of Governors, four Reserve Bank presidents and the president of the New York Reserve Bank, because New York is the center of the universe and all you other states can go scratch.
Now, here’s the most important thing to know, because you’ll hear this a lot when you watch or read anything related to the Federal Reserve. The Fed has what is called a dual mandate from Congress. This is a statutory mandate that requires the Fed to make decisions through a specific prism. The first is called price stability. Basically, to manage inflation. The second is maximum employment. As the St. Louis Fed describes it, “the concept of maximum employment can be thought of as the highest level of employment that the economy can sustain over time.”
A few quick technical items before we get into the hearing. When reading about inflation, you often hear two different terms to describe it. We’ve covered this before, but it bears repeating. The first is called consumer price index (CPI). It’s compiled by the Bureau of Labor Statistics. The second is the personal consumption expenditures price index (PCE), from the Bureau of Economic Analysis. CPI tends to be used interchangeably with the term “headline inflation.” PCE is typically referred to as “core inflation,” and it excludes food and energy prices. Personally, I don’t think there’s much use for core for that very reason, but it does help to isolate certain trends that reflect housing data and services, so it’s helpful if you want to dig into the numbers. But, for real impact on the consumer, headline inflation is what you most often hear about for obvious reasons.
A few other technical items and regulations bear covering as well.
When financial people talk about “tailoring,” they’re basically talking about the Fed’s ability to tailor regulations and policies to match certain circumstances. For example, liquidity and capital requirements on banks. Capital requirements are a way to constrict lending and ensure that banks have enough money to cover catastrophic defaults. Much of the language that relates to these provisions came on the heels of the financial crisis, and can be found in the Dodd-Frank Consumer Protection Act and subsequent updates.
Similarly, there is something called Basel requirements that apply to multinational banks. Same liquidity principle, but based on international standards.
In terms of the Fed’s powers and the dual mandate, here’s what the Fed does and is capable of. First off, it sets the baseline interest rate for the nation. The Federal Funds Rate. This is the rate at which commercial banks lend to one another. This is important. Money is constantly moving. Balance sheets change by the minute. Technically, the Federal Funds rate applies to overnight lending because we’re in a 24 hour banking world. So these are moves that settle outside of so-called banking hours. This is the rate all others are based on.
For example, Prime Rate usually runs about 3 points higher than the Federal Funds rate. So, as of this recording, the Federal Funds rate is around 4.5% and prime is 7.5%. Mortgage rates today are in the 6% to 7% range as well, because the Fed has pushed the Federal Funds rate so aggressively. So, you can see how directly this impacts consumers on a significant portion of household expenditures. It’s why fixed rate mortgage holders aren’t keen to sell right now. Any upside from a sale is likely to go out the window when acquiring a new mortgage for your next place. Likewise, new home buyers are struggling to justify the sudden increase in rates as well. And that’s why housing is cooling.
The Fed also has the ability to purchase investments. This is usually referred to as adding to the Fed balance sheet. This was one of the primary levers they had during the financial crisis, as an example. The Fed bought everything from treasuries to toxic assets to flood the market with liquidity and prevent financial institutions from going belly up. This was referred to rather elegantly as quantitative easing, and it’s something Jerome Powell has been slowly reversing in order to restrict money supply. The other way it can augment or restrict money supply is through tailoring. The Fed has the ability to raise or lower capital requirements at lending institutions.
So that’s it. Even the Fed characterizes itself as a blunt instrument because of the limited amount of tools in its toolkit. But there’s no question that they have some of the most powerful tools in the world.
Chapter Three: Crossing the river.
Let’s start with a senator I despise. Because, in his own subtle southern way, he corners Powell to admit what the Fed is trying to do. Kennedy brings Powell through a Socratic exchange designed to extract a confession of sorts out of Powell that the Fed believes that people have to lose their jobs in order for inflation to come back in line. It’s a worthy exchange, if you have the head space to watch it. In so many words, Powell ultimately capitulates to the line of questioning, though the conversation is obviously more nuanced.
Senator John Kennedy is a real shitgibbon from Louisiana who has perfected the art of bless your heart southern charm while he’s sticking a knife in your spleen. His questioning was really interesting because it started off along party lines when he tried to honey pot Powell into a fiscal conversation around government spending. But Powell didn’t take the bait. Basically, Kennedy, along with the other Republicans, tried to score highlight reel points by criticizing the Biden administration and government spending, but Powell handily manages each of them.
So, Kennedy switches gears and goes right at the blunt tools in the Fed arsenal to get Powell to admit he’s trying to put people out of work. Every questioner from the Democratic side pretty much drove the same lane, which is why I found it interesting to watch a Republican hammering at this point.
Throughout the hearing, Powell returns over and over to the idea that it’s all about price stability. The price of goods and services must match what we’re able to pay, or the economy is out of balance. Totally fair. But, remember that he only has a couple of ways to impact this equation, one of them being interest rates, because it squeezes the economy.
We talked about this in the Jimmy Carter series when cigar chomping giant Paul Volcker took over the Fed and squeezed the life out of the economy. Powell is doing an ever so gentle, but consistent, version of that right now, and it’s hard to see where it will end because the labor market is so strong. The reason interest rate hikes have the ability to tame inflation is because it throws an economy into a recession at a certain point. It makes everything more difficult.
Mortgages are more expensive, so home buying slows down.
People stop spending money and start saving it because they can get a better rate in the bank. This takes money out of circulation and slows spending in the economy.
It makes borrowing of all kinds more expensive, especially in the corporate sector. So, all the deals that are done with debt begin to look less attractive, so mergers and acquisitions slow down as well.
That’s the solution Powell is driving at here. But that doesn’t address why we have inflation.
Senate Banking committee chair Sherrod Brown opened the proceedings by talking about the root causes of inflation in an attempt to set the table for the hearing, citing corporate greed, supply chain disruptions and the war in Ukraine.
Now, interestingly, Powell never capitulates to this concept. Meaning, he never reveals one way or another anything about what he believes to be the root cause of inflation. For all we know, he believes and understands that inflation is due to these factors, as pretty much everyone in politics, economics and the thinking world knows at this point. All he falls back on is the dual mandate. He knows he can tame inflation. If he gets the interest equation just right, the country will go into a mild recession and about 2 million people will lose their jobs. And the process is to raise rates, reduce the Fed balance sheet, which takes some money out of the system, and increase capital requirements so banks have less money to lend and invest.
You know the old tale about the scorpion that asks a frog for a ride across the river?
Powell’s probably not a bad dude. He’s just a fucking robot. Watching the hearing, it became evident that he doesn’t relish this position. He’s resigned to it. It’s his job. He knows it will be hard, but it must be done. But does it really?
This is about the stories we tell. The myths and legends that persist over time. Like the idea that students are too irresponsible to have money in their pocket because they’ll buy drugs. The direct child tax payments, instead of credits, was the perfect example. We know now that people paid down debt, bought food and caught up on rent with that money. And it lifted millions of children out of poverty in a matter of a few months. So, what did corporate America do? Raised prices on literally everything across the board, and they took that money out of the pockets of everyday citizens and moved it to their own. And who got the blame? Citizens.
And so now the Fed is set to punish citizens again because, well, because it’s a scorpion.
Bring it home, Max.
There’s a terrific book I’ve referenced before called Narrative Economics, by Robert Schiller. In it, he describes the ways stories and legends take hold and impact the real economy. “Narratives that occur together in a constellation may have different origins,” says Schiller, “but in our imaginations they seem grouped together in terms of some basic idea, and they reinforce one another’s contagion.”
Schiller describes the power of what’s known as the wage-price spiral, one of the central principles that has been used to beat back union power in this country. Essentially, it says that high wages put too much money in the hands of workers who, in turn, purchase more items, spurring demand, which causes corporations to increase prices. The central flaw here is that price increases are a necessary response and not an opportunistic response. Here’s Schiller:
“The end of the wage-price spiral narrative was marked by changes in monetary policy and the advent of newly popular ideas: the independent central bank and inflation targeting by central banks. The independent central bank was designed to be free from political pressures, which organized labor tries to exploit. Inflation targeting was designed to place controlling inflation on a higher moral ground than appeasing political forces.”
In casting inflation as a moral issue, it targets workers rather than the primary corporate drivers behind rising prices. This is where fiscal intervention should also be considered. That’s why Bernie Sanders and others were calling for taxation on profiteering and windfall profits. What’s fair is fair. You can’t simply blame workers for working and demanding their worth, and then blame them further when they do these things and spend money, as is their right.
Not to mention, the blunt focus on beating back worker gains and low unemployment ignores some hardcore realities about the labor market. And we’ve talked about this. In fact, it came up and was even acknowledged in the hearings. After the devastating loss of life during the pandemic and influx of newly retired Boomers, the number of available workers declined. Add tight immigration policy to the mix, and it only exacerbates the situation.
Powell himself pointed to a natural cooling of certain aspects of headline inflation, like rents cooling off and supply chain issues easing. And yet, he persists with the narrative of the dual mandate and the blunt tools at his disposal.
There were other points made during the hearing, some of which fell along party lines, and others that are seriously problematic. The most transparently corrupt part of the day was during Kyrsten Sinema and Cynthia Lummis’ periods, when they spent their time asking about the future of crypto. Both have been linked to crypto lobbying funds, in particular disgraced Sam Bankman Fried and FTX, and yet they did their solemn duty to keep crypto in the conversation. Another senator spoke about the looming commercial real estate crisis, with more than $6 trillion in commercial loans coming due for refinancing. A troubling thought, considering commercial real estate is already struggling with the fact that workers simply aren’t returning at the levels they once were. It’s a crisis in the making for sure, because the refi rates are going to be significantly higher than the original rates. That’s a crisis of their own design, and fuck them, but it’s still going to be an issue.
In proof of our America first mentality, the one issue that wasn’t raised was the impact higher rates have already had on emerging market debt. If Powell continues to increase rates at this pace, it’s going to have a devastating impact on foreign debt and potentially lead to crises around the world. Remember, we are money. We are the global economy. There’s no mincing words about this.
So here we are. For all the collegiality and respect on display at the hearing, the subtext is troublesome. For all the talk of independence, and I can’t believe I’m going to say this, I actually wish Biden would channel a bit of Trump here and start rattling some cages over at the Fed. Remember that Trump browbeat the Fed into holding rates because of his precious stock market, the only thing he really cared about.
Powell positions inflation and wage growth as a ‘Sophie’s Choice,’ saying:
“Strong wage growth is good for workers, but only if it is not eroded by inflation.”
And, technically, he’s right. But by correlating the two in every way, he’s taking blame away from the real inflation culprits and hanging it around the neck of the working class in this country. That’s why, for all the so-called independence of the Fed, it doesn’t mean the Fed can operate in a silo. Fiscal intervention by the government to crack down on profiteering will have a far greater and more positive impact on inflation than creeping rates that squeeze the poor and middle class. Powell isn’t wrong about the Fed’s mandate and ability to quell inflation, but it doesn’t make him right in using the blunt tools at his disposal to do so.
Here endeth the lesson.
St. Louis Fed: The Fed and the Dual Mandate
Politico: The Senate’s crypto queen has a sweeping new Bitcoin bill
The New York Times: Fed Chair Opens Door to Faster Rate Moves and a Higher Peak
Americans for Tax Reform: Student Loan Bailout Applicants Will Spend More on Vacation, Drugs, and Gambling
Intelligent: Nearly half of student loan forgiveness recipients will use relief to go on vacation
St. Louis Fed: CPI Vs. PCE Inflation: Choosing a Standard Measure
Podcast: Student Debt: Hey Boomer, STFU.
Podcast: Biden’s Big Student Debt Announcement: PITOTWIU for the Indebted Masses.
YouTube: Student Debt. The Supreme Court and GOP team up against the working class.
Robert J. Shiller: Narrative Economics: How Stories Go Viral and Drive Major Economic Events
Looking at the possible responses on that poll, it seems like it may have been crafted and administered in such a way as to produce a desired result. An “online poll” - a notoriously ineffective method- and where was it posted? In r/richwhitemillennial?