Is It Time To Wind Down The US Federal Reserve?

British author and senior journalist Gillian Tett has written an important article for the Financial Times. She is amazed that financial market distortions did not figure in the discussion in Jackson Hole. She is right to raise the flag or raise an alarm. This is the comment I left on her column:

It will be a big omission if I did not mention the blistering Op-Ed that Kevin Warsh, former member of the Federal Open Market Committee, wrote in the Wall Street Journal on August 24. That he served in the Federal Reserve for five years makes his critique all the more special and important.

The full piece must be read and re-read. But, I will just point out few sentences:

It expresses grave concern about income inequality while refusing to acknowledge that its policies unfairly increased asset inequality.

I will also be remiss if I do not mention a more recent Edit by Wall Street Journal itself. Again, the full Edit is well worth a read. Some excerpts:

As I was searching for the proper link for the Kevin Warsh article cited above, I ran into this piece co-authored by him with Stanley Druckenmiller:

Yes, the biggest crime of policymaking in the last 30 years or so is the deliberate distortion of wealth creation process as described below to one driven by consumption driven by borrowing driven by low interest rates and based on rising asset prices as collateral, engineered, in turn, by monetary policy induced liquidity:

Perhaps, it is appropriate to conclude this (already long) post with a reference to a recent piece by Nobel Laureate Michael Spence. He points out there are two forms of secular stagnation – one that is beyond policymakers’ control and he calls it SS1. It is caused by “growth-destroying headwinds that are impossible to counter in the near term without endangering future growth and stability.” – I have paraphrased him.

Then, there is SS2 – Secular Stagnation 2 – which is caused by adopting the wrong policy mix. He says the right policy mix would have measures that address income inequality – redistribution through taxation and social security measures, higher interest rates combined with capital controls and active fiscal policy, particularly in Europe.

I like his piece because he makes a beginning by acknowledging that growth cannot be engineered by monetary policy that is aimed at boosting asset prices through liquidity provision. Frankly, when I spell it out like this, it feels so dumb to me. Yet, the persistence of such wrong policies and the extraordinary amount of patronage and support they draw from the so-called intelligentsia is proof that only enduring reality is human irrationality.

I like his split of growth-impeding forces into SS1 and SS2. But, the SS2 solutions are somewhat underwhelming. My own view is that SS1 can be addressed and must be confronted by acknowledging that short-term growth and stability would take a hit and directing policy to ameliorating the ill-effects of short-term growth and stability pains particularly for those who cannot handle it themselves. The rest have to adjust to downsize and if the resulting growth pattern for the world is slower for longer, then all the better. We have grown too fast for too long relying on too much debt. That needs to change and there is no change that does not involve pain.

Let us then get back to the growth model that is briefly recapitulated above by Warsh and Druckenmiller – growth through savings, investment, productivity and employment.

So, what shall we do with the Federal Reserve? Well, if it cannot wind down its balance sheet, it is time to wind down the Federal Reserve itself.

This piece was first published on The Gold Standard and has been republished here with permission.