The Fed’s latest actions this past week have left many scratching their head.
There are plenty of cries from Fed critics who think this is a bridge too far. The Fed is bailing out corporations and executives but not helping Main Street at all.
The Fed has become increasingly polarizing since the start of the last financial crisis in 2007. First of all, they didn’t see it coming ahead of time. And second of all, many argue they overstayed their welcome after the fact and potentially made things worse.
I understand the sentiment.
These are crazy times. People are on edge and millions of people are losing their jobs as the economy is put on ice. The handling of this crisis leaves a lot to be desired.
But I think the anger at the Fed is misdirected. There are two reasons for this:
1. Most people don’t understand what the Fed actually does. Hand up. I’ll admit going into and coming out of the 2008 crisis I didn’t really understand how the Fed worked. All of the arguments about the coming inflation from quantitative easing made sense on the surface but never came to fruition because the people making them didn’t understand how the banking system actually works.
I had to read intelligent people like Mark Dow, Tim Duy, and Cullen Roche to gain a better understanding that was both technical and explained in plain English to figure out what exactly was going on with these programs and why most people were wrong about the ramifications.
There are still certain aspects that are confusing but I also performed a deep dive on the history of monetary policy and the Fed for Don’t Fall For It. This was the introduction to my chapter on John Law (one of the founding fathers of monetary policy):
From 1853 through 1933, the United States experienced a recession or depression once every 3.9 years. The average contraction in GDP during this time was a ghastly 23%. Each of those 22 economic downturns, save for one, saw GDP fall by double digits (and the remaining instance saw GDP fall 9.7%.)
Contrast these numbers with the period from 1934 through 2018. The last time there was a double-digit contraction in GDP was in the short recession of 1945 following World War II. Before that it was the 1937–1938 downturn. The Great Recession of 2007–2009 saw GDP fall a little over 5%, a blip on the radar screen compared to the late-nineteenth and early-twentieth century economic experience. Since 1933, the average recession in the US has seen economic growth fall by an average of just 4.3%. The two longest economic expansions in US history have both come since 1990.
There are several explanations you could offer as to why recessions have gotten shallower over time while expansions have lasted longer. The US was basically an emerging market back then. We have a far more mature, diverse, and dynamic economy now. But the reason I chose 1933 as the cut-off point, aside from the fact it was towards the end of the Great Depression, is that was the year Franklin D. Roosevelt took the US off the gold standard. An act of Congress severed the tie between gold and the dollar, effectively allowing the price of gold to float more freely and giving the Federal Reserve more ammunition to fight the forces of inflation and deflation without being hamstrung by having our currency backed by a yellow rock.
Central banks and paper currencies are by no means perfect, and they don’t prevent developed nations such as the US from experiencing recessions. But it would be foolish to think they haven’t played a role in making our economy more stable over time. The Fed acts as something of a lender of last resort for the banking system, which is one of the reasons we didn’t have a run on the banks in 2008 and fall into a deep depression. Central banks also set short-term interest rates and manage the flow of credit when necessary, which acts as a shock absorber to the system.
Not everyone agrees with the modern monetary system we have in place, but it’s much better than the alternative of massive inflationary booms and deflationary busts every few years in the old system. In fact, the US didn’t have a true central bank until 1913. There were attempts to create such a structure on numerous occasions, but the banking system remained disorganized, inefficient, and antiquated until the panic of 1907 forced government officials to make a change. That was the year John Pierpont Morgan single-handedly saved the banking system from complete collapse by lending his own money and basically forcing other banks to do the same to keep the system afloat. A banker sent Morgan a note at the time that read, “the safety and welfare of the financial structure of this country depends almost entirely upon you.” The Federal Reserve Act of 1913 was created in the aftermath of this panic which set in place the current monetary system used today.
In essence, the Fed was created to help stem the tide during panics and ensure the economy continues to function. As bad as people think the Fed is, the alternative is worse. Without them these panics would be much worse.
It’s also easy to hate on something you don’t understand. So people throw around phrases like “money printing” and “currency debasement” and “Fed manipulation” without realizing much of what they do on their balance sheet involves both liabilities and assets.
The Fed is not literally printing hundred dollar bills and handing them out to corporations in giant duffle bags. But that makes for a good story and it’s easier to understand stories than what the Fed is actually doing most of the time.
2. The Fed is not made up of elected officials. Citizens don’t vote in the members of the Federal Reserve. There’s no our team vs. their team element involved like there is with politics.
The Fed chair is technically named by the president but many of them end up serving across different presidential terms and political parties. So the Fed is apolitical.
This actually makes it easier for more people to be disgusted with the Fed since so many people are hunkered down in their own political ideology these days. Those on the left and the right never want to blame their own parties or politicians when things go wrong so the Fed makes for a convenient scapegoat.
The Fed is doing what they can with the limited tools that are available to them. If the Fed had the ability to send citizens money I’m sure they would do so. Do you want to know who definitely has the power to send money to citizens in need?
Congress!
They just proved it with this fiscal rescue plan. They are the ones who should be doing more to help out normal people.
If you want to be mad at anybody, be mad at Congress for not doing enough to help Main Street. They are the ones who have made wealth inequality worse over the years and let these problems fester.
Be angry at your elected officials for not instituting a higher minimum wage.
Be angry at our country for not creating a bigger social safety net for those who are being hurt the most from this economic shutdown.
Be angry that millions of people are losing their healthcare because they lost their job during a pandemic.
Be angry that the government didn’t do more to bailout homeowners during the 2008 crisis or send some of the bankers to jail for their actions.
It’s ridiculous that the Fed seems to get more blame than the government in all of this. The Fed is doing what they can.
Are their policies perfect? Of course not. You could quibble with many of the details of their plan (buying some junk bond ETFs for instance). But the Fed’s massive response to the crises we’ve experienced this century is them trying to keep the system together because the federal government has planned so poorly and not held up their end of the bargain.
The Fed is simply playing the hand they were dealt.
I would love it if these bailouts were used to take equity in some of these companies so the taxpayer could take part in the eventual recovery. And we should use this crisis as an opportunity to cap executive pay at these corporations as well.
In fact, the language of the Fed’s latest actions (which I’m guessing most people haven’t even read) actually says they are placing some restrictions on the companies that take part in their loan programs:
Firms seeking Main Street loans must commit to make reasonable efforts to maintain payroll and retain workers. Borrowers must also follow compensation, stock repurchase, and dividend restrictions that apply to direct loan programs under the CARES Act.
Again, this is not perfect and I wish they would do more to help out normal people but that’s not the Fed’s job. This is the government’s job and they have failed the people who voted them in office for years.
The current Fed actions are hard to wrap your head around. It’s all coming so hard and fast. But if you want to be angry about moral hazard or wealth inequality or the bailout of corporations at the expense of individuals don’t point a finger at the Federal Reserve.
Be angry with our elected officials (in both parties).
They are the ones who should be doing more to bail out Main Street.
