Looming Monetary Reset

It has been called the grandmother test i.e. your understanding of a concept is best demonstrated by your ability to successfully explain it to your grandmother. I am pleased to serve as both your facilitator and grandmother as we gather to discuss a subject that is both vitally important and (to some) devilishly obscure: monetary policy and its role in a divided America. 

This introduction may come across as cheeky, overwrought, and irreverent but it stems from the sincere desire to better understand monetary policy through a substantive discussion of the following thesis: yet another devolution in our monetary system looms (furthering the move from a free-market to a nationalized economy) should the Federal Reserve successfully implement its central bank digital currency (CBDC) initiative.

The backdrop to the session is the phenomenon we discussed some three months ago (MM 6/8/20 WTF: What The Fed) centered around the astounding degree to which central bank intervention has undermined the integrity of our financial system. Established in the early years of the twentieth century in the aftermath of a banking crisis, the Federal Reserve System, consisting of twelve regional banks, was charged with managing the country's money supply. Of particular note was the envisioned private nature of this enterprise to serve as the ultimate liquidity backstop in times of financial stress through its extension of loans into the banking sector on reasonable terms and for good collateral. Its charter was "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

How quaint. We chronicled the ensuing compromises to the charter and independence of this increasingly activist body including the outright purchase of assets employing "special purpose vehicle" partnerships with the government to end-run the lender-only limitations implicit in its charter. The foregoing is but one example of the way in which the Federal Reserve has insinuated itself into an otherwise market-driven economy. The distortions wrought by such interventions can be seen by the unnaturally low (to negative) interest rates which, in turn, have enabled everything from the orgy of public, corporate, and individual debt to the very real disparity of wealth in the country. Perhaps the protests these days miss the real mark.

Now comes the latest gambit which would highly compromise our free-market system. The Federal Reserve is actively considering the roll-out of a system known as the U.S. Digital Dollar Project (click, U.S. Digital Dollar Project) in which central bank digital currency (CBDC) would be wired directly into individual accounts, thereby bypassing the reserve system entirely. The idea has moved well beyond simple backroom chatter and was, in fact, part of the draft (later retracted) of last spring's stimulus bill. Simon Potter, former head of the Fed's "Plunge Protection Team," spoke in terms of the need for a "separate infrastructure" to buy bonds, as a percent of GDP, in support of direct deposits (presumably cryptocurrency) in response to the tracked unemployment rate.

It's been described as the "most efficient" macroeconomic tool to "generate real inflation." But, be careful what you wish for. We've heard over and over about the Fed's purported need to reach a higher inflation target (2%), a subject in its own right. Aside from the fact we are already experiencing massive asset inflation a separate question arises about the legitimacy of the supposedly subdued CPI inflation -- one private estimate pegged the actual rate to be 8% when measured using the same methodology applied in the 70s. Indeed, inflation as measured (more properly) as the growth in the money supply is astronomical. The fact that the money excess has not (yet) shown up as elevated street inflation is largely due to it being carried as a reserve on the banks' balance sheet, such that it enters the real economy only through actual bank lending, now minimized in response to the main street recession.

There seems little these days in the way of external mechanisms to constrain this runaway monetary growth. Once upon a time the dollar had at least some measure of market discipline through its forced tie to something tangible, much to the consternation of the Keynesians who bridled under any such market constraint. They insisted on the flexibility to address the natural business cycle through monetary expansion in the bad times and monetary contraction in the good. That has since morphed into today's always-loose policy. There seems to have been little  constraint ever since Nixon severed gold convertibility in 1971 (other than that force of nature of Paul Volcker's iron fist in the 80s).

The real point of the above is that there is now nothing to stem unlimited monetary growth -- except, that is, for the prospect of inflation. So long as inflation is deemed to be low, school's out when it comes to everything monetary, whether it be further drops in interest rates (benefiting asset holders) or the introduction of Modern Monetary Theory (the expedient of the government simply printing what it needs). But all that begs questions about how to measure the true inflation rate, how to maintain the dollar's reserve status, and how/whether to respond if residual trust in the (management of) the dollar is forever lost. 

Consider all this in the context of the Fed's appetite for an even wider mandate. A recent op-ed piece authored by a former regional president said the Fed, "should have a third mandate on racial inequality." Putting aside for the moment a discussion on the merits of that specific goal, the question remains whether the Federal Reserve -- remember, it's a non-elected body -- has any business whatsoever meddling in such matters (next step, reparations)? 

The overriding concern is that the digital dollar initiative paves the way for targeted monetary injections, thereby granting the Fed the power to favor certain sectors, even individual enterprises. Already the Fed has joined forces with (private hedge fund) Black Rock to purchase selected assets, including the debt instruments of companies that would otherwise face insolvency, an action that is so far afield from its loans-only original charter.   

Finally (cynicism alert) is the question of the inherent conflicts of interest that can reside within a structure having the power to manage affairs at such a micro level. What comes to mind is that classic characterization of the very firm that gave birth to and trained so many of the players in today's economic arena, "The world's most powerful investment bank is a vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money" (Vampire Squid). It just seems, at times, as though that money-smell is the middle class.

Okay, grandmother, does any of this make any sense at all? . . . . grandma?, grandma? . . . . oh good grief, it appears as though she just passed.