Filenews 21 November 2024 - by Steve Forbes
The second Trump administration is heading for a colossal clash with the Federal Reserve. Almost all media will side with Fed Chair Jerome Powell and his institution. They will parrot the central bank's line (that any attack on the Fed jeopardizes its independence) and inflation forecasts.
Do not buy this "bubble".
The looming conflict is not about the independence of the Fed, but about the performance of the US central bank. In particular, it concerns the models on which it bases its decisions. The basic assumption of these models is that prosperity creates inflation. Economist A.W. Phillips suggested that there is a link between inflation and unemployment. If you want less unemployment, you will have higher inflation. And vice versa.
The so-called "Phillips curve" is a "sacred text" for the Fed and most central banks. And it has two major flaws, in addition to being contradicted by facts in the real world. The curve is wrong.
In recent years, for example, unemployment in the US has remained low, even as we experienced the worst increase in the cost of living in more than 40 years.
The Fed is confused, but refuses to reconsider its core credo. Admitting that its "theology" is flawed is difficult for any institution, so the central bank clings to its spurious indoctrination.
The first major flaw is the Federal Reserve's refusal to make the basic distinction between the two kinds of inflation.
Non-monetary inflation stems from large disruptions in production. A natural disaster like an earthquake will drive up prices, as will the disruptions caused by war, not to mention pandemic lockdowns. Regulations and taxes can also increase costs. The Fed can't do anything about nonmonetary inflation. Raising interest rates will not cure port bottlenecks.
Monetary inflation comes from a decrease in the value of a currency, usually because it exists in surplus in the market. In short, the cure for monetary inflation is not to slow down or degrade the economy, but to stabilize the value of a currency. After all, money measures value just as a clock measures time or a ruler measures length. However, neither the Fed nor other central banks ever talk about the stability of the currency.
This brings us to the second major flaw: the irrational and destructive belief that a "living" economy must slow down. Running parallel to this perception is the idea that a central bank can – genuinely and constructively – steer economic activity by manipulating interest rates. If you think about it, this is akin to rent control. But, in this case, not an apartment is rented, but money.
And we come to why the next Trump administration is heading for a massive clash with the Fed. Powell and his colleagues will warn that Trump's agenda will reignite inflation and that the central bank may have to raise interest rates.
"Fiscal sustainability," Powell now proclaims. A brave statement from a man who, desiring President Biden's renomination, remained silent as the White House and Congress spent and spent and spent... skyrocketing the deficit.
For starters, Trump's team will have to document why the Fed's models are wrong, and then mentally kill the dragon lurking in the Phillips curve.
Performance – editing: Michalis Papantonopoulos
