The Fed has always been seen as Republican-leaning player in politics. After all, the Fed’s main job is to look after the best interests of regulate the banks. But it occurred to me that, right here and now, Powell has a lot of good reasons to favor a Democratic Presidential and (more crucially) Senate win.
(Near Term): The Fed Desperately Needs More/Continued Fiscal Stimulus.
The Fed’s only real tool is to flood the banking system with money. That is all for nought if the banks don’t lend it onwards. Instead banks are (very reasonably) tightening lending standards. So that money isn’t finding its way into the economy.
The main props for the economy over the last few months were the PPP business loans and the $600 unemployment benefit. Those aren’t being renewed. Why? It ain’t Trump. His objections are a sideshow to the real problem. 15-20 Republican senators that won’t vote for any new money for anyone – all with an eye towards their 2024/2022 elections.
That voting block isn’t going to budge. Leaving the Fed holding the bag and the blame if the pandemic knocks down a debt-fueled economy’s house of cards. Unless the house of cards falls before November. The election takes place in the midst of a crash. Blamed on Congressional inaction. Those 15-20 Republican Senators end up in the minority.
(Medium Term). The Fed Desperately Needs MORE Inflation.
The Fed is practically begging (in very polite Fed speak) for more fiscal stimulus. Partly to sustain the economy short-term. But also because they desperately need to kindle some inflation. Everyone at the Fed knows deflation is a killer for banks. They also know that inflation is a whole lot easier to fight at some future date. Deflation is a bitch to kill once it sets in (see “Japan”). The best route to inflation is through loosening the governmental spending taps. Particularly working from the bottom up.
The $600 unemployment benefit has demonstrated this unequivocally. That money has been spent fast and almost entirely into the “real” economy. By contrast, the Fed’s increasingly ineffectual money-printing since 2008 has ended up parked in various asset markets without ever circulating into the real economy (cue declining monetary velocity).
Side Note: The relative effectiveness of that $600 is exactly why Republicans hate it so much. It shreds 30 years of ideological flim flam economics. The most effective response to a major downturn is to hand money to the people most likely to spend it immediately? Who would have ever guessed such a thing!?!
The anti-inflation narrative has always been “don’t let those bolshie left-wing politicians get their hands on the spending taps! They’ll end up raising the long-dead monster of inflation!!!!” With the monster of deflation at least halfway out of the grave, maybe those left wing spendthrifts are exactly what we need. To extend the Japan metaphor, maybe we need an inflationary Godzilla to fight back a deflationary Mothra. The battle might wreck a few buildings in Tokyo, but it is better than just Mothra unchecked.
(Long Term). The Fed Desperately Needs Adults in Congress (and Wall Street).
Every Central Bank in the world is sick of pulling politicians out of ditches they keep driving into. Politicians have grown equally comfortable driving into ditches, knowing the Central Bank will always come do the heavy lifting to pull them out. Daddy will just dust me off, get me a new car, and I’m back on the road.
Investors have grown equally as comfortable. The Fed will always step in to stop a crash, but they never tighten rates if the market revolts. The current rally boils down to a simple continuation of that faith. “Don’t fight the Fed” is just another way of saying “The Fed will always save us, so pile on the risk….”
Everyone knows this. Central Bankers most of all. They have always stepped back from the ultimate solution. Let a crisis inflict real losses on politicians and investors alike. The timing has always been tough. Like St Augustine “Oh, Master, make me chaste and celibate – but not yet!”
The current crisis (created by failure to re-up the $600 payments and PPP) presents particularly fortunate timing for a crisis. It comes in front a major US election. A massive wipe-out for over-their-skis investors and posturing politicians would do wonders to drive home a lesson that Daddy isn’t always going to come save you. Engineer a serious crash where the most feckless drivers take a permanent, painful hit.
That sets up a few months of serious turmoil and pain, but it also sets up a new Administration and Senate in February. Precipitating that crisis is potentially a risk worth taking for the Fed. Especially as we now know just how rapidly and effectively a relatively tiny $600 weekly stimulus makes its way into the real economy when targeted at high-marginal-propensity-to-spend individuals (generally known as “poor people”). Even more so if that new Administration tees up other inflation-kindling measures that help the Fed steer its flock of banks away from a deflationary abyss.
Most importantly, the Fed would finally kill the “moral hazard” trade for politicians and investors alike. As someone once observed, air bags aren’t the “best” way to reduce auto accident injuries. Mandate instead that driver-facing, needle sharp spikes get mounted on every steering wheel. The prospect of being impaled would do wonders to ensure good driving behavior. An October crisis re-creates that awareness of risk and permanent loss, with a decent shot at a reasonable recovery effort starting 3-4 months later.
Would the Fed Actually Do This? Probably Not.
The above all seems a little far-fetched. Does the Fed have the means to precipitate a crisis? Almost certainly yes. Probably just by standing aside. Failing to ride to the rescue as cash flow starvation drags down the real economy. Is the Fed really that political? Maybe, but I hope not). Do they have the courage to pull the plug like that? Probably not.
However, Powell just might decide he has no choice. Look at his alternatives. If Biden wins, he faces the prospect of carrying the burden and the blame over 4 years after Mitch McConnell goes back to his Obama-era posturing against any of Biden’s spending plans “because we can’t possibly afford it (after all those tax cuts).” If Trump wins, he faces the the even-more-horrific prospect of him appointing more wackadoodle gold bugs like Judy Shelton to the Fed’s Board.
The fortuitous election timing also points towards taking (in)action. Eliminating the one-way risk trade would restore a lot of power to a Fed rapidly running out of real-world policy levers to pull (vs placebo effect PR moves). They know they are on thin ice, at the zero-lower-bound, and already at negative real rates. And they know how much its sucked to be the Central Bank of Japan the last few decades. Maybe this is the time to make a stand?
Heck, a “good crisis” now also might just save us from future deflation. I don’t want to get my hopes up, but that would be a price worth paying.
FYI I’m back at home in front of a real keyboard (hopefully meaning fewer typos). RV trip back across country was a lot of fun actually. Lots of adventure and surprisingly little drama. I need to do a “what did I get wrong?” piece one of these days. But the thought above struck me so figured I’d share. OK, baby’s crying so hitting “send.”
