The Fed Dilemma

For the most part in 2017 and 2018, only academics and easy-money cranks scolded the Federal Reserve for raising rates. After all, the stock market was bubbling up and the economy was strong.

The economy is still strong, but the stock market has ended its record 10-year bull-market run with a bang. The 20-percent drop in the S&P 500 during one of the worst quarters in market history classifies as a bear market, although prices rebounded at the end of 2018 and in early 2019.

Now everybody from traders to retirees as well as President Donald Trump is scolding Fed Chairman Jerome Powell for his relentless path to higher interest rates and a reduction in the Fed’s balance sheet.

To make a long story short, yes, the Fed is chiefly responsible for this and other stock-market routs, which often precede recessions. There are other contributing factors, such as worries about the Chinese economy and trade, as well as the government shutdown, which will reduce the $1 trillion yearly spending spree of the federal government. But the Fed is at the center of the storm.

And the problem didn’t begin with the Fed’s actions over the past two years. The roots of the issues we now face have their immediate origins in the last financial crisis, but ultimately can be traced back to the founding of the Federal Reserve itself.

The Current Crash

The problem on the surface right now is that the Fed is taking away easy money from market participants and economic agents through its raising of the federal funds rate as well as the $50 billion per month reduction of its balance sheet.

The Fed balance sheet, as well as the federal funds rate, is the foundation of the entire global financial system. For every dollar by which the Fed expands its balance sheet, banks and shadow banks around the world can create many dollars’ worth of debt on top of it.

Terms like balance-sheet expansion and contraction, or quantitative easing (QE) and quantitative tightening (QT), are fancy words for printing money or removing money from circulation.

Since its creation in 1913, the Fed has had the power to print money and fuel booms, and contract money and create busts. So it has to take responsibility for the vicious business cycles since its creation, such as the Great Depression or the 2008 financial crisis.

You can trace this game back to the Fed’s origins, but here, let’s confine it to recent history.

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