You make a very persuasive argument for the Fed’s recent policy decisions not working. But now it’s too late, they’re between a rock and a hard place, and as the economy tanks and banks fail, they are going to come under great pressure to ‘fix’ it. I don’t see any good options left for them. Do you see a course that could remedy all the problems, or has that horse not only left the barn but ran screaming down the road?

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Keep in mind the essential point I am making here: interest rates have squat to do with inflation. If you look at interest rates vs inflation going back to the 1970s, in no time frame do interest rate manipulations correlate to inflation reduction or inflation expansion.

It didn't even happen when Volcker did it.

So we can take interest rates off the table as a solution set--and should have. Setting interest rates creates many more problems than it solves.

The reality of historical yields means that existing low-yield assets cannot hold value in an environment marked by rising interest rates. It is mathematically impossible. Still, the assets themselves are not toxic on their face. Treasuries are not defaulting, and even mortgage-backed securities are not plagued with defaults as was the case in the 2008 Great Financial Crisis. The only problem is that if a holder of low-yield securities is compelled to sell them in a market with rising interest rates, he has to take a loss--and the higher the market interest rates the greater the loss.

If we throw concerns about moral hazard aside and empower the Fed to address this inevitable disequilibrium (which carries its own complications, mind you), then an essential step in the process has to be the Fed creating a facility to remove those low-yield assets from bank balance sheets--in effect, the Fed needs to return to the bank its capital currently tied up in these assets. Put those assets off in a notional "bad bank" where they can just roll off the balance sheet normally, without a sale.

Resolving inflation has to entail rewarding deposits with greater yields. Banks have to either raise the interest rate they are willing to pay on savings accounts and similar products or the deposits have to be allowed to flow elsewhere (i.e., Apple's savings account, SoFi, Chime, et cetera). If people's preference reverts to saving rather than spending, THAT is what will bring inflation down. THAT is the key element in combating inflation that Milton Friedman laid out in the 1960s.

Doing that involves recognizing the importance not just of money supply but of money velocity--and what we are seeing in inflation correlates more to changes in money velocity than to changes in money supply. Right now, money velocity is rising, and that is in spite of the federal funds hikes. As long as money velocity increases, there will be inflationary pressure on prices for which the only remedy is shrinking the money supply. Persuading people to save rather than spend reduces money velocity.

This is a path the Fed is distinctly not taking. They are not attempting to persuade savings vs spending, but attempting to ratchet down spending, period. This has always been their strategy--it's what Tom Barkin laid out last June and it's what Jay Powell laid out last August at Jackson Hole.

It's never a question of it being "too late" to change strategies or monetary directions. A prudent monetary policy will always proceed from the current reality towards explicit monetary objectives. We move from where we are, not from where we wish we had been.

The prudent monetary policy would be to stop trying to use it to goose or inhibit economic growth. That's not something a central bank can do well--as we have seen proven repeatedly throughout history and around the world.

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May 4, 2023Liked by Peter Nayland Kust

And that will lead to "digital money" in which we all will bank with GOOGLE or some similar on-line entity which will be controlled ultimately by China. At least the little "people."

Or, the alternative is Nuclear War.

“But because the human ego is loathe to admit it’s been duped, many patriotic Democrats will continue allowing themselves to be led like sheep into the closing noose of the hammer and sickle. By the time they realize what happened, it will be too late.”

—John Eidson

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May 4, 2023·edited May 4, 2023Author

Actually, this situation is more likely to prevent a CBDC rather than encourage it.

Keep in mind that the leading fiat currencies of the world are already "digital", in the sense that they exist as bits and bytes on a computer, and not as actual printed or minted currency. So if money in electronic form is our fear, well that ship sailed decades ago, even before the formation of the SWIFT system.

But if a CBDC is instead something akin to China's eCNY, then no, this situation does not--and cannot--lead to one for the US.

China itself is the best exemplar of why. CBDCs on their own don't solve anything for the ordinary consumer. They don't even really solve the issue of "frictionless" cross-border payments. Which is why the eCNY has had minimal adoption in China despite having been around for over 2 years.

In order to force people to switch to a CBDC, the existing currency has to suffer a complete loss of confidence--and despite what many will say online about having no confidence in the dollar or fiat money in general, if they buy anything they still have confidence in it by definition.

A forced adoption of a CBDC by the Federal Reserve would by its very nature be a repudiation of the existing dollar, and with it the trillions of dollar-denominated assets and quadrillion+ of derivatives. Even without considering the ramifications this would have for fiat currencies worldwide (if the dollar is the foundation of the fiat money system, since anything times zero is zero, if the dollar is worthless then immediately so too is the euro, the pound, the yuan, et cetera), that would be an economic dislocation of civilization-ending magnitudes. Global finance would cease--would be forced to cease. To borrow a metaphor from Dune, "the spice would not flow".

Everything the Fed does in response to either inflation or the banking situation ultimately has one overarching goal--promote confidence in the dollar. If the Fed should fail in this, then the end result is not a digital dollar, but no dollar--and no euro, and no yuan, digital or otherwise. If the dollar loses confidence then the financial system predicated on fiat money also ends (and even if by some quirk of fate another fiat currency displaces the dollar as the global reserve this year, the same situation applies).

Even without the apocalypse, CBDCs don't solve economic problems. Nigeria is learning that with their CBDC, the eNaira.

It's not a question of the Fed/Google/Big Brother not being willing to deploy a CBDC and exert dominion over half the earth, it's a question of them not being able to do so. Even the most ruthless tyranny on the planet (China) cannot escape the inevitable consequences that arise from all choices, including economic ones.

The one difference everyone overlooks between "Wealth of Nations" and "Das Kapital"--while both Smith and Marx repudiated mercantilist economics, Smith attempted to describe how economics actually functions, and Marx argued how it ought to function. Smith was descriptive, Marx was prescriptive.

Since reality is always going to win, the best ideas are those which seek to understand reality rather than impose upon it.

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