The Federal Reserve is Irrelevant

The US federal Reserve met on July 7 and much was decided after a sumptuous lunch of baloney. With straight faces and expensive suits, they looked the camera in the eye and said that they had decided not to forecast the weather and that they were not perfectly sure about the future of interest rates and monetary policy. But they were quite certain that they would meet again and bring up the fact maybe possibly they might change policy. Exciting stuff. 

Apparently the private sector financial players have turned into a bunch of meanies. They lurk in dark places just waiting for the next taper tantrum. That is, they apparently sit around all day and wait for a Fed official to say something about tapering Federal Reserve purchases of government bonds. Such a taper would reduce the demand and prices of government bonds in the markets and thus cause interest rates to rise. Just the smell of such a possibility has private sector vultures ready to swoop first. If they move before the Fed moves, then they are able to "sell high and buy low" -- the dream of all financial players.  Of course, this has the market effect of forcing up interest rates even before the Fed does anything. 

So it behooves the Fed to say confusing and meaningless things so that the private sector meanies don't mess up the economy. 

While the above is a lot of fun and almost makes some sense, there is a more somber picture hiding out there. None of the above mentions the real culprit in all this monetary policy hooey -- our friends in government. By government I mean President Joe and his colleagues and the people who run Congress. The Fed and monetary policy are not exactly immune or walled off from what that government does. 

I am not talking about DC hot dog weenie roasts or the late night parties. I am referring to the thing we dearly called the government deficit. While there is quite an IQ deficit in government, the deficit we can measure is called the Federal Government Budget Deficit. If you haven't looked lately, it now amounts to about $3 trillion per year. That $3 trillion dwarfs anything that went before it. 

So what? A bunch of DC accountants come up with a big negative number. Who cares? Well, you do and so does the Fed. That $3 trillion government deficit means that the government cannot pay for all its goodies. It is $3 trillion short this year (and last year). Where do they get that $3 trillion so they can spend it? They don't get a personal loan from Donald Trump or Bill Gates, that's for sure.

They borrow it from you! Well maybe not you but they borrow it from the general public. They sell government bonds and we buy them. Money that we might have used to buy Amazon stock or a new roll of toilet paper, we instead send to Joe and he sends us a piece of paper called a government bond. And you thought the government just printed a bunch of $100 dollar bills. No way, it is just as easy to sell bonds. They will give us our money back later. No big deal. In the meantime Joe gets $3 tril.

So what? Here's where the Fed comes in. During a time when the government is flooding the market with bonds, financial markets go crazy. A modest amount of bond sales would be fine. But $3 trillion? Wow. Now that's a story.  The $3 trillion of bonds for sale greatly exceeds the demand for bonds so the price of bonds falls...and interest rates rise. 

Aha. It is Joe and his buddies -- not the Fed -- who are the real causes of higher interest rates. And that harm has already been done. Bam. Government deficits cause interest rates to rise. Period. 

All that mumbo jumbo about inflation and how the Fed will react to it is supposed to divert your attention. It makes for great newspaper sales and for colorful evening news. And even though Joe and his buddies are the real culprits, we focus our misguided attention on the Fed. And the Fed, not having the courage to tell the truth, does the government's bidding. The Fed jumps in the market and buys all (or some of) those bonds that are sitting around unsold. What a tag team! Joe and his buddies sell a bunch of bonds and the Fed buys them like they were tacos at Taco Bell. And yes, the rumor is true. The Fed can create money and buy as much they want. 

The net effect is to forestall the downward price of the bonds and viola -- and puts a ceiling on the interest rates. Well, maybe. Maybe for a second.  If the Fed pumps in too much money and keeps rates too low, then inflation, which is always lurking in the shadows, will come back to haunt us -- eventually raising interest rates and causing all sorts of havoc. 

So we come back to the Fed. Will they or won't they? It really doesn't matter because the real problem is Joe and his buddies. They show no signs of conducting an honorable fiscal policy. So long as they choose to spend like drunken sailors, things will not be well in the metropolis. Doesn't matter much what the Fed says or does.  Taper tantrum or not. Those evil financial firms understand all this and they are ready to pounce at a moment's notice.