The Federal Reserve Playing With Fire

The speech that Federal Reserve Chairman Jerome Powell was to pronounce on Aug. 26, at the annual meeting of current and former central bankers in Jackson Hole, was anxiously awaited, as he was going to reveal what the global financial system would die of. In the end, he delivered a shock to all those who hoped he would pooh-pooh inflation and resume an expansive monetary policy, including to help the Democrats in the coming November mid-term elections. But the head of the U.S. central bank announced that “reducing inflation is likely to require a sustained period of below-trend growth”, monetary policy “will be sufficiently restrictive;” and defeating inflation “will likely require maintaining a restrictive policy stance for some time”.

In other words, the Federal Reserve will do nothing to avoid a recession. Assuming the role of a modern-day Marquis de Sade, he added that the fight against inflation will bring “some pain” to producers and households. Between the frying pan of inflation and the fire of an economic recession – with company foreclosures, layoffs and impoverishment for millions — Powell seems to have chosen the latter.

Many analysts have compared Powell’s choice of policy to Paul Volcker’s famous monetary squeeze following the 1973-74 oil shock, forgetting that Volcker had raised central bank rates up to 21.5%. The mini-steps of half a point announced by Powell are just tickling the current double-digit inflation rate. But they further penalize producers and consumers already plagued by astronomically high energy prices and rising producer costs and consumer prices.

Some economists insist that a prolonged recession, by reducing the global demand for energy and material supplies from the productive sector, will curb inflation by “naturally” re-balancing supply and demand. Such academic theories do not come to grips with the fact that an economic downturn will generate a chain-reaction of insolvencies and a collapse of the transatlantic financial system.

Instead, liquidity should be drawn out of the global financial bubble in a targeted way, including out of the energy bubble, which central banks have created through decades of monetary expansion. This can be done if a Glass-Steagall type of bank separation reform is implemented globally, insulating the commercial-industrial sector of the financial system, and implementing a two-tier credit policy: high interest rates for merely financial activities, investment banking and hedge funds, and low interest rates for commercial banks, and credit to producers and households.