There is a vocal group that likes to talk about the Fed in very negative terms. I have withheld any permanent sort of judgement because I believe there is good and bad in any institution. For example, during the 2008-09 financial crisis it is clear that the Fed did the right thing lowering interest rates to zero and embarking on the first round of quantitative easing. Without that action and the bailouts, the banks would not have survived. Sure, other banks would have taken their place in time, however, the social cost to that multi-year transition would have been monumental and likely violent.
The “good” financial crisis response actions by the Fed of course followed a period where their oversight of the banking industry was woefully deficient and monetary policy the prior eight years was questionable at best. Since the financial crisis ended, which I think can reasonably be put at 2011-12 when real estate bottomed, the Fed has probably been deficient in normalizing monetary policy on the misguided assumption that more easy money is better for stimulating growth. I firmly believe that is not true for two reasons. First, as I have discussed in three articles the past year, “slow growth forever” is due to global aging demographics and an overwhelming debt load, those things cannot be cured with easy money. Second, continued extra easy money clearly leads to the idea that something is wrong, which lowers consumer and business confidence and results in a drag on further economic development.
The chart above demonstrates that Fed easy money is losing effectiveness. If you compare the M2 Money Supply to GDP prior to the financial crisis, you see that GDP is nearly double M2 Money Supply consistently. Since the financial crisis there is not as large a multiple. If you recreate this chart on the St. Louis Fed website you’ll see that there has been a significant decrease in the growth rate of GDP despite massive monetary inputs.
The blue line represents the increase in the Fed balance sheet. Since the financial crisis, the Fed has added well over $3 trillion to their balance sheet. The primary benefit of this expansion went to the banks, which should be able to withstand another financial crisis. However, because so much money remains in reserves, it is not moving through the economy terribly well. Unfortunately, there is no way to move this money through the economy as it would weaken balance sheets. In addition, aggregate demand – due to demographics and debt – is not increasing in meaningful way because even as the millennials moving into household formation years the boomers move into retirement offsetting the otherwise stimulative millennials. The net effect of the millennials spending and boomers reducing spending is a sort of GDP draw.
Ultimately, the only solution to the draw between millennials and boomers is to embark on a different policy approach. So far the Fed has briefly mentioned negative interest rates. What i can say unequivocally and without reservation is that negative interest rates would be a disaster. Banks would suffer and we would still see no improvement in aggregate demand because as I’ve said, easy money can’t change the demographics and merely encourages more debt which we don’t need.
“Helicopter money” has been the another recent rumor gaining some traction. I have long said, going back to 2009, is that this approach that would work best if done right. Helicopter money is Fed money that bypasses the banks and goes to specific purposes. For example, if the Fed prints a trillion dollars, rather than give it to the banks, they five it to an infrastructure fund or to forgive student loans, the money gets directly into the hands of the public in the form of income and debt relief. These are in fact the two things I think that the Fed and government should target. It would stimulate from the middle out. Given that the middle class has been attacked from both the top and bottom, it seems like time to focus on us to me.
On Monday I’ll discuss the Fed’s potential motivations with the market, politics and preservation of the dollar as reserve currency.
Happy Easter.
Kirk
