Warsh on inflation

FOMC – From HogWarsh To WhiteWarsh

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After a not-so-stellar initial press conference in July (FOMC HogWarsh), Fed Chair Warsh spoke clearly last week regarding the Fed’s latest interest rate decision…

“Today’s policy action will support a timelier return to the Committee’s 2 percent goal. This Committee will deliver price stability.”  Also, “The plain fact is that inflation is too high and has been for too long.”

In explaining the Committee’s (FOMC) reasoning for increasing the Fed Funds target rate by 1⁄4 percentage point to 3 3⁄4 – 4 percent, Warsh said:

“Credit flows have been robust, particularly for businesses. And as I said at the policy symposium in Jackson Hole, I would be hard-pressed to describe broad financial conditions as restrictive. This view was widely shared by the Committee. So we removed a dose of accommodation.”  

The decision to raise rates was expected; however, the 12-0 unanimous vote was not. Chair Warsh seemed to add a degree of certainty as to what we might expect in the future…

“We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Today, the FOMC decided that this standard has not been satisfied. The committee’s unanimous vote shows our resolve to achieve price stability on a timelier basis. We aim to ensure that credit and financial conditions are consistent over time with our mandate, that relative price changes in some sectors of the economy do not broaden, that inflation compensation in market prices stays low, and that inflation expectations remain well-anchored. 

Below are my responses to Fed Chair Warsh’s statements.

FED’S 2% INFLATION TARGET 

A formal, precise inflation target rate of 2% was adopted at the FOMC meeting on January 24, 2012. In my article The Fed’s 2% Inflation Target Is Pointless, I said…

“…if an inflation target is justified, why 2%?  Why not a lower number? Or any other number? In truth, it probably doesn’t make any difference. From the Fed’s perspective, it gives them a license to openly discharge their firearms in the public square. If they miss, they can just reload and fire again. Should they happen to hit the target, they can either maintain their current posture or tweak it accordingly so as not to overshoot in the future.

But they will never “hit” their target.  Especially this one.  Why not? Because it is a moving target, comprised of moving parts. And it is the result of the Fed’s own previous actions.”

There is only one cause of inflation: government.  The term government also includes central banks, especially the US Federal Reserve Bank. What most people refer to as ‘inflation’ or its causes is neither. They are the effects of inflation.   The “increase in the general level of prices for goods and services” is the result of the inflation that was previously created.

Inflation has always “been too high and… for too long.” Absolutely true. Since its inception in 1913, the Federal Reserve has inflated away more than 99% of the U.S. dollar’s purchasing power via fractional reserve/no reserve banking.

WE REMOVED A DOSE OF ACCOMMODATION

Both Treasury Secretary Bessent and Fed Chair Warsh have specifically stated their commitment to “ample reserves and liquidity” in the financial system.

While acknowledging that broad financial conditions are not restrictive, yet admitting the need for “removing a dose of accommodation “, the action is like spiking the punch and raising the cost after the fact, while encouraging all to continue imbibing.

CONCLUSION 

Price stability is an elusive goal. The Fed will remain forever reactive to the effects of its own errant policies and the unpredictable, volatile effects of inflation it has created for more than a century.

Paraphrasing Warsh’s earlier reference to inflation (too high for too long), the Federal Reserve’s reaction to circumstances beyond its control is historically too much, too late; or too little, too soon. (also see Bessent On Bonds; Warsh On Inflation)

 

Bessent On Bonds; Warsh On Inflation

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BESSENT ON BONDS LAST WEEK

Treasury Secretary Bessent said last Wednesday that Treasury would roughly double long-dated buybacks (of U.S. Treasuries) to at least $4 billion per operation beginning in September. The bond market responded strongly, and so did gold, while the U.S. dollar fell sharply against other fiat currencies.

At the time, the markets seemed to see more than is readily apparent. The plain facts of the action pale considerably when you consider these facts…

  1. $4 billion is a drop in the bucket compared to the total market for U.S. Treasuries, which totals something north of $31 trillion. The proposed monthly buyback addition is the equivalent of .000129% – not exactly a substantial amount.
  2. Government intervention and manipulation in the currency and credit markets are part of day-to-day activities. Why should an insignificant amount of activity generate such big reactions?

Possibly, the markets were looking beyond the specifics at an assumed effort by Treasury to contain yields, especially long-term ones, where a large amount of Treasury debt is concentrated. Treasury has also emphasized that the buyback program is not about altering maturities as much as it is designed to improve liquidity.

That is well and good, but is it deserving of the strongly positive upward spike in bond prices that occurred? Apparently not, since most of that gain was given back quickly.

WHAT ABOUT GOLD AND THE DOLLAR? 

For the U.S. dollar, traders must have thought the bugler had sounded retreat. Similar action followed Secretary Bessent’s announcement that the U.S. had intervened in the currency markets to help prop up the Japanese Yen less than two weeks ago, ostensibly to limit volatility in the markets. Is Treasury’s latest foray into battle a reason to expect dollar weakness? Or just the opposite? If the Treasury is serious about curbing inflation, that would seem to be positive for the U.S. dollar.

As far as gold is concerned, the action resembled poking a sleeping bear. Apparently, the bear had not gone back to sleep. Some of gold’s reaction is certainly tied to a weaker dollar, although gold remains down nearly 20% from its peak price earlier this year.

KEVIN WARSH ON INFLATION THIS WEEK

Kevin Warsh spoke more plainly on Friday (28th) about the Fed’s intentions as related to inflation: “Inflation is running above our 2% target. So the Fed’s predominant focus right now should be on prices.” Investors pounced on this and the odds favoring a rate hike at the Fed’s September meeting increased dramatically.

The U.S. dollar was sharply higher on currency markets, and gold fell more than 3%. The Warsh remarks provoked a decidedly different reaction than accorded to Mr Bessent’s announcement. Why?

BESSENT ON BONDS

Treasury Secretary Bessent’s remarks in August – 1) intervention re: Japanese yen; 2) purchase of long-dated Treasuries – indicate justifiable concern about two major issues affecting the financial markets: volatility and liquidity. These issues are harder to address through the lens of credibility, given the Treasury’s limitless appetite for deficits and debt.

The increase in direct (official) intervention was a clear sign of intention to support the bond market; i.e., the Treasury bond market. That was interpreted as “quantitative easing” and lessened the odds (in investors’ eyes) of higher interest rates. Hence, temporarily higher bond prices, a weaker US dollar, and higher gold prices.

Regardless of statements and respective actions, the risks of more volatility and collapse in bonds and stocks (all markets) remain heightened. (see Bond Market Crack Widens)

WARSH ON INFLATION

Warsh’s comments about the Fed’s primary focus on price stability, and that inflation is higher than desired, sound reasonable. It also resembles the old story of running to close the barn door after the horses get out.

Inflation starts with the Federal Reserve. Since its inception in 1913, the Fed has debased the currency by continually expanding the supply of money and credit. If the Fed were serious about “fighting inflation”, then STOP INFLATING.

The consequences of inflation are volatile and unpredictable, but there is always an ending. Most of the time, the ending is ugly. (see An End To Inflation)