The Fed should stop treating all money the same

As a cash pile mounts in the financial system, the central bank’s interest rate policy is working less well than it used to

Brendan Greeley

Every afternoon at 12.45pm, the Federal Reserve does something that seems a little odd but has a perfectly rational purpose.

It takes some of the $5.2tn in Treasuries it holds on its balance sheet, transfers ownership of some of them to money market funds and commercial banks, then credits itself with cash, in the same amount.

The next day, the Fed reverses the transaction: it buys the Treasuries back. 

But this time the Fed loses a little money. 

It buys high, then sells low. 

On purpose.

The banks and the money market funds participate because they have a lot of cash and they don’t have any better ideas of what to do with it. 

The Fed offers them this small profit as a kind of interest rate; the so-called reverse repo transaction sets a floor on interest in the money market.

Again: all perfectly rational. 

But over the past year, the daily volume of reverse repo has grown, from zero to $900bn. 

That is a lot of extra cash. 

In theory, that should give lenders the confidence to lower their own rates and make loans more attractive.

That’s the way central bankers prefer to do their jobs — buy or sell one set of assets, drag one key interest rate into the right place, set expectations and hope all the other interest rates will line up and follow. 

That’s happening now for some kinds of debt, in particular mortgages and corporate bonds. 

But it’s not working as well as it used to, for all interest rates. 

The reasons are unclear. 

It may not be the Fed’s fault. 

But it is the Fed’s problem. 

Policymakers often quote from the Federal Reserve Act’s paragraph on monetary policy: the Fed’s mandates are full employment and stable prices. 

But that’s actually only the second half of the mandate. 

The paragraph begins with instructions on how the Fed should reach those goals: the bank “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production”. 

That clause is a mouthful, and policymakers tend to treat it like an archaic law, as if Congress had given the Fed instructions on when to graze their sheep on a public green. 

But it’s also a “shall”, a legal way of saying the Fed has to do it. 

The clause instructs the Fed to make sure that different kinds of new dollars get manufactured at a steady rate, in a way that puts them to productive use. 

That’s not an incidental thing. 

It’s what the Fed does. 

The Federal Reserve doesn’t manufacture all the dollars in the economy. 

Anyone who makes a new loan makes new dollars.

When you borrow — to buy a house or a car — the lender creates brand-new dollars, then hands them to you in return for a promise to get them all back with interest. 

When there are more loans, there are more dollars. 

When borrowers pay down their loans, there are fewer dollars.

Macroeconomists used to spend a lot of time thinking about aggregates — ways to add up all the dollars. 

When someone makes a loan, those brand-new dollars show up as cash, bank deposits or money-market deposits. 

A monetary aggregate is just a way to count some or all of these dollars. 

A credit aggregate is the inverse: a way to count some of the loans.

But aggregates are hard to calculate, because every day some genius figures out a new way to make a loan. 

So in the 1980s and 1990s, the central banking community gave up on aggregates. 

The Fed does not target the total supply of dollars because you can’t aim at something you can’t see. 

Instead, like most central banks, it relies on a single interest rate and a massive assumption: if it can move that one interest rate up or down, all the other interest rates will follow.

Policymakers refer to this assumption as transmission. 

But transmission is not working equally well for all kinds of dollars. 

Interest rates on mortgages and corporate bonds still largely move in cycles around the Fed path. 

But rates on car loans started to diverge during the pandemic. 

Interest rates on credit card balances have been climbing steadily since 2011. 

The bank loans that small businesses use are not growing at the same rate as corporate bonds for larger companies.

When the Fed buys Treasuries, it creates just one kind of dollar: a reserve, a kind of deposit that commercial banks can hold. 

But reserves behave in completely different ways from the dollars that a commercial bank creates for a credit card balance, for example. 

Or for a car loan.

The Fed and most other central banks think about all these kinds of dollars. 

But they are uncomfortable with being in charge of them. They do not allocate credit, they will say — that’s for markets to decide. 

But the Fed is already allocating credit, whether it wants to or not. 

It has pushed so many reserve dollars out in the world that banks don’t know what to do with them. 

Is that increasing productive capacity, as the Fed mandate directs? 

Meanwhile, interest rates on credit card balances continue to climb. 

Short-term dollar liquidity is cheaper for banks, but more expensive for humans. 

When the Fed meets, as it will this week, we should of course ask them about the gas pedal: will they ease off? 

But the crankshaft on that engine has to connect to something. 

It has to generate productive new dollars in every part of the real economy. 

It’s time to think about all those different kinds of dollars. 

The transmission between the crank and the wheels is monetary policy. 

It’s right there in the mandate.

The writer is an FT contributing editor

The Delta Dilemma

Coronavirus Variant Has Some Worried about a New Autumn Wave

Germany’s political leaders want to avoid further lockdowns and school closures this fall. But they are also warning that there may be fresh outbreaks with the spread of the delta variant. It seems almost inevitable that some measures will need to be taken.

By Matthias Bartsch, Markus Becker, Jörg Blech, Jan Friedmann, Annette Großbongardt, Claus Hecking, Martin Knobbe, Timo Lehmann, Veit Medick, Gabriel Rinaldi, Cornelia Schmergal und Christoph Schult

It’s Wednesday morning in German Chancellor Angela Merkel’s offices. 

It’s already summer recess for parliament, but Merkel’s cabinet continues to hold meetings. 

The country has to be governed, after all. 

The issue at hand is the new delta variant of the coronavirus and a growing dispute among the German states. 

Some state governors are calling on the chancellor to make sure there are stricter controls on travelers returning to Germany and the debate is triggering irritation in the cabinet.

Interior Minister Horst Seehofer of the conservative Christian Social Union (CSU) noted in the meeting that airlines are already required to check the paperwork to make sure passengers have been tested. 

Besides, the states also need to do their jobs, he said, complaining that they and municipalities aren't doing enough to monitor adherence to the two-week mandatory quarantine for travelers returning from countries like Britain and Portugal, where the virus variant has become widespread.

In other words, the federal government versus the states, just as it has always been in this pandemic.

Merkel’s government has barely three months left in office, and things could have been so relaxed until then. 

There was still time for a few small projects, a few votes and then they would all go on their summer vacations. 

That, at least, is how some in Merkel’s cabinet envisioned things. 

Suddenly, though, an issue that only recently seemed to be reasonably under control is back: the fight against the coronavirus.

While many Germans are enjoying the return of old freedoms, flocking to restaurants and planning their vacations, the question is arising again over how to deal with the virus and whether the current state of near normality will have to end soon. 

It’s like a curse – the virus just won’t go away.

The delta variant, the highly contagious coronavirus mutant first discovered in India, is currently spreading in Germany and Europe. 

There is growing concern that the summer travel season, with millions of people on vacation, could reignite the pandemic. 

And the question is whether the German government is prepared. 

Or if it is misjudging the situation as it did last summer.

In the case of Portugal, where the virus has recently struck with a particular vengeance, the government has already pulled the emergency brake, unsettling many travelers. 

Since Tuesday, all travelers returning from Portugal to Germany are required to quarantine for 14 days, including those who have been fully vaccinated. 

But what if travelers begin bringing infections back with them from other countries? 

What if the vaccination pace slows down and school classes start again after the summer holidays? 

Will we then be threatened with a fourth wave?

The situation isn’t the same as it was last year, when all countries were largely unprotected against the virus and many in power in the government, including the chancellor, had no choice but to impose strict lockdown measures. 

In the time since, many Germans have been vaccinated, meaning there is reason to believe that a fourth wave would not be a disaster, even if the delta variant becomes more widespread. 

Some protection is in place, just not yet for everyone. 

This means that politicians will now have to consider more carefully the need to balance confidence vs. caution and freedom vs. restrictions than it did last year.

The concern is already considerable in a number of German states. 

Delta is an "invisible race against time,” warns Markus Söder, the governor of Bavaria and member of the CSU. 

"We must now be careful not to gamble away what we have achieved by being too lax with the delta variant," warns Manuela Schwesig, the governor of Mecklenberg-Western Pomerania.

The delta variant is hitting the government at a delicate time. 

If a big fuss is made about new dangers during the election campaign, it could cause public sentiment to plummet. But doing nothing could be even worse. 

Although Germany has made significant progress with its vaccination campaign, it is nowhere close to herd immunity. Some 55 percent of Germans have received their first dose of vaccine, and almost 40 percent have received both shots, but there are still large groups that are not immune.

And this creates a dilemma for Merkel’s government in its final months in office: It has to protect people who haven’t yet been fully vaccinated from the delta variant while at the same time not stripping people of their growing sense of freedom. 

And she needs a plan for the autumn, when all Germans in age groups that have been approved for vaccines will have had a chance to be vaccinated and there is no longer any reason to impose restrictions on vaccinated people. 

But what will be done then about children, who still haven’t been authorized for vaccination in Germany? 

And what if even vaccinated people can contract the variant? Or has the time come to simply accept such risks?

On Monday, the chiefs of staff for Germany’s state governors held a conference call with Helge Braun, Merkel’s chief of staff. 

The question at hand was whether entry restrictions in Germany need to be further tightened given the developments in Portugal. 

For the past several weeks, a distinction has been made between high-risk, high-incidence and virus-variant areas; it's a complicated system, and travelers can sometimes lose track of what's going on. 

As can politicians.

Braun joined the call from his car on the road, irritating some participants. 

What followed was pure confusion. 

Participants in the call say that the state of Lower Saxony finds the current system to be coherent enough. 

But the representative from Hesse criticized the fact that the Azores and Madeira, where the number of infections is low, has not been removed from quarantine requirement for travelers returning from Portugal. 

Schleswig-Holstein is in favor of more differentiated rules; Mecklenburg-Western Pomerania wants to treat areas with high infection rates and simple risk areas equally; and Hamburg is asking how sensible it really is to force people to go into two weeks of quarantine.

Braun defended the rules in place for Portugal. 

He said you can see in Israel how quickly the delta variant spreads. 

The country has even reintroduced its requirement to wear a mask indoors. 

But Braun said he was also open to changes. 

It sounded a little like he was saying: I don’t really know either. 

In any case, nothing has been decided.

The SARS-CoV-2 virus continues to spawn new variants. 

And once it infects a person, it starts multiplying. 

Some of the variants are not exact copies – there are parts that have changed in their genetic material. 

Mutations. Some of the new variants can spread better than the old ones, that’s how nature intended it. 

First there was alpha and then delta.

And there are still many unknowns about the delta variant. 

Who is hit particularly hard? 

How high is its mortality rate? 

Is this variant more dangerous for children than others? 

None of the studies completed thus far can provide definitive answers.

What is known is that delta is significantly more contagious than the first virus from Wuhan. 

In no time at all, delta has spread around the world and has now been detected in around 100 countries. 

Delta is also on its way to becoming the dominant variant in Germany,” says Sandra Ciesek, director of the Institute of Medical Virology in Frankfurt. 

In just a few days, its share of new infections is expected to officially exceed the 50 percent mark.

Because so much remains unclear, an early warning system is essential, but the federal government still seems to be conspicuously passive, despite the fact that it hasn’t shied away from imposing restrictions to stop the spread of the virus in the past months.

Merkel, for her part, is strongly opposed to strict border controls between European nations. 

Interior Minister Horst Seehofer doesn’t want to see tougher rules. 

And even the rules on Portugal could be scrapped again soon, even though they were just put in place.

During a meeting of her cabinet on Wednesday, the chancellor herself commented on the measures. 

Because it is not yet scientifically certain to what extend people who have received two doses of a vaccine can also pass the delta variant on to others or contract it themselves, the two-week quarantine requirement for people returning from countries that have been designated as virus variant areas also applies to fully immunized people. 

It’s not possible to get a test after five days and end the quarantine early. 

But fully vaccinated people who remain in Germany enjoy extensive freedoms even though the delta variant is also spreading here.

This, the chancellor noted, was a "breach of logic,” and not legally justifiable in the long run. 

Essentially, it seemed, she was saying the rules made no sense.

The cabinet agreed that the rule should be overturned soon or that restrictions on vaccinated people should be introduced in other areas as well. 

It’s also possible the problem will go away on its own soon. 

If Germany itself becomes a virus variant area, it no longer makes sense to declare other countries as such.

A vaccination station in front of a bar in Berlin: Many argue that Germany needs to be doing more to convince skeptics to get vaccinated.

Even Health Minister Jens Spahn isn’t giving the impression that he is in any way panicking about the delta variant. 

And yet he can’t rule out the possibility there will be a fourth wave. 

Officials in his ministry are hopeful that the country is better prepared this time around. 

Germany has sufficient capacities for PCR tests and a network for rapid antigen tests is also in place. 

Public health offices, which were still sending faxes at the beginning of the pandemic, are now connected to the digital system Sormas in many states.

So far, Spahn has not wanted to make any changes to the rules for travelers returning from simple risk areas. 

The current provisions require that anyone who boards a plane to Germany has to present a valid test, proof of vaccination or evidence that they have already had COVID-19 and recovered it before they can board a plane. 

And those who enter by land can be checked by the police. 

Seehofer has announced that he plans to increase the number of controls on the borders.

It may sound easy enough, but there are many possible consequences: traffic jams on the highways and chaos at the airports. 

On Monday, four aviation associations sent an angry letter to leaders of the European Union member states complaining that the handling of vaccination certificates in the member states has been a "worrying patchwork.” 

They said that if this isn’t changed quickly, it will lead to long lines and thus new health risks. 

"The risk of chaos at Europe’s airports is real,” the letter stated. 

In this pandemic, everything seems to be interconnected.

On the one hand, Spahn’s optimism is understandable. 

From an epidemiological point of view, the situation right now is better than it has been in a long time. 

The infection rate is at rock bottom, the intensive care units are emptying out, and even if delta is considerably more contagious, that doesn’t mean that it is necessarily deadlier. 

The vaccines also appear to protect very well against serious progressions of COVID-19 caused by the delta variant. 

One study found that two doses of the BioNTech/Pfizer vaccine have a 96 percent effectiveness against the need for hospitalization.

On the other hand, though, there’s also the bad news out there. 

Like Israel. 

The country reopened its schools and restaurants in March and now the delta variant is rampant and the infection rate is rising. 

Younger people are getting hit hard by it – around half of those newly infected are schoolchildren.

Or take Australia: A country that used to be a model for COVID prevention has now become a problem child. 

The larger metropolitan areas in the country are back in lockdown. 

An outbreak of the coronavirus in Sydney has the city on tenterhooks. 

The disease is believed to have spread in a matter of seconds at a mall in the city.

Or Scotland: According to the authorities there, nearly 2,000 fans were infected there in events relating to the European Football Championship. 

They say that two-thirds of those infected were Scots who had traveled to London for games.

In view of those outbreaks, the wait-and-see attitude of the government in Berlin is causing nervousness in some states. 

Memories are still fresh of how the government miscalculated last summer when it came to travelers returning and the second wave rolling into Germany in the fall. 

Memories are also still fresh of how Spahn, as the health minister, was fully relaxed at the beginning of the pandemic, even when the virus had long already been in the country and then, suddenly, sprang into action with knee-jerk responses.

Söder, the governor of Bavaria, is concerned that a similar dynamic is taking shape this year. 

He accuses the federal government of "refusing to deal in any fundamental way with the issue” of travelers returning to the country. 

He is calling for stringent controls on buses, trains and at airports for proof of testing. 

"We have no desire whatsoever to be where we were last year when this September roles around,” says Söder.

The governors from German states where the center-left Social Democrats are in power are also growing restless. 

"We can’t make the same mistake as last year and be too careless with travelers returning from risk areas,” warns Manuela Schwesig. 

Together with Malu Dreyer and Stephan Weil, the governors of Rhineland-Palatinate and Lower Saxony, she is pushing for a double testing requirement for people returning from risk areas. 

They say that the single test that is required now is insufficient. 

Because if someone tests negative on entry, they could still test positive days later. 

Chancellor Merkel reportedly wants to consult with the states and try to find a common approach.

Ultimately, though, the question of whether delta can be controlled probably depends more on progress with the vaccination campaign than how travelers are dealt with. 

The more people who have had two doses of vaccine, the greater the protection against delta – the calculation is as simple as that.

And at the moment, the campaign is going well. Germany is receiving more supplies of vaccine right now than it ever has before. 

So far, though, the number of doses being administered has not risen accordingly. 

One of the reasons is that most people who are willing to get vaccinated will likely have done so soon. 

At that point, it will be a matter of reaching and convincing people who are skeptical or wary of the vaccination. 

But getting those people to get their jabs is the only way herd immunity can be reached. 

And that could prove to be very difficult, as seen in the United States, where the pace of vaccinations has slowed significantly.

Officials in Spahn’s ministry are also taking note of the growing surplus of vaccine doses. 

They are anticipating that there will soon be so much mRNA vaccine that the states may have trouble keeping the doses stored at -70 degrees Celsius.

They are looking for storage space now. 

The government’s stated goal is to offer every adult in the country the chance to get vaccinated this summer.

Opposition parties are nonetheless urging Spahn to do more and also launch his own vaccination campaign aimed at getting people who are skeptical to get their shots. 

The business-friendly Free Democratic Party (FDP) is calling for more mobile vaccination teams. 

"That’s particularly important for socio-economically disadvantaged areas,” says Marco Buschmann, a senior official in the party.

It’s unlikely the federal government will be able to remain as casual as it has been about the coronavirus until the fall. 

The infection rate is still going down, but that could change quickly. 

Once the weather starts to cool down and people start sitting in restaurants or going to concert halls again, it’s likely the numbers will start increasing again. 

The fact that the delta variant has been proven to be more infectious than the original virus "increases the probability of transmission in places like large events, for example,” warns virologist Ciesek.

Meanwhile, the Health Ministry is currently reviewing whether the data that is currently being used to make decisions on restrictions is still the appropriate criteria. 

Is there still a corollary between the rate of intensive care occupancy and the incidence of infection? 

Andreas Gassen, head of the National Association of Statutory Health Insurance Physicians, is pushing for an addition to the incidence criteria. 

He says the infection rate alone is "unsuitable” as a sole parameter. 

"There is also a need to include hospital occupancy, age distribution of infections, intensive care occupancy, regionality and similar parameters,” he says. 

He says the data must be "swiftly collected and evaluated” so that officials can react appropriately to developments. 

He argues that blanket lockdowns are a "rather ineffective” tool.

But Karl Lauterbach, a doctor and member of parliament with the SPD who has been a prominent expert in the pandemic, argues "it would be wrong to abandon the infection rate” as a determining factor in virus containment measures. 

"It shows us how quickly the number of cases is rising,” he says. 

But Lauterbach is also against imposing overly stringent measures if case numbers start to soar again. "

A new lockdown can’t be the way then – we would have to put up a big fight,” he says. 

He believes times have changed. 

"The willingness of the population to accept a new lockdown is simply too low.

Some state governors hold a similar view. 

"There will be a fourth wave, but the situation is different today than it was a year ago,” says Thuringia Governor Bodo Ramelow. 

He says nationwide lockdowns will be unnecessary as well as a law passed last spring that allows the federal government to impose national restrictions if infections get out of control. 

Rainer Haseloff, the governor of Saxony-Anhalt, argues that move was superfluous. 

"If the infection figures rise again in autumn, the states and local authorities will react appropriately.

Lauterbach urges those children aged 12 and over should now be vaccinated as a matter of urgency in order to reduce the delta risk among that group too." 

But the Standing Commission on Vaccination (STIKO), which is affiliated with Germany’s center for disease control, has decided not to make the recommendation for youth to get vaccinated, even though the vaccine has been approved for all children over the age of 12. 

"At the moment, there is no reason for a hasty change, even if this has been demanded at times,” says STIKO chairman Thomas Mertens. 

The expert says a "higher pathogenicity of the variant for children” has not been shown. 

As such, he argues, the vaccination of parents, grandparents and teachers should remain the priority.

Health Ministry officials are ken to get more children vaccinated in the states soon and they were unhappy with the decision made by STIKO. Spahn expects that enough vaccine will still be available for all 12- to 18-year-olds to be vaccinated by the end of August if they want to. 

Time is short. Within the government, there is concern that schools could become hotbeds for the virus in the fall. 

Would they then have to close them or return to hybrid learning with split classes?

That’s not the kind of issue politicians want to come up during the election campaign.

The federal government knows that it would be a massive failure if it isn’t able to work together to come up with a way of having schools operate at least halfway normally in the autumn. 

In some places, air purifiers are now being ordered. 

Bavaria, for example, wants to have a device installed in every classroom after the summer. 

But there hasn’t been any coordinated procurement effort.

And German Education and Research Minister Anja Karliczek of the center-right Christian Democratic Union (CDU) says she doesn’t want to guarantee that the school year will be normal because we don’t know enough about the delta variant. 

"We have to be prepared for the fact that there can always be outbreaks at individual schools after summer vacation, especially during the winter months,” she says.

 Karliczek says the aim needs to be identifying those infections quickly "so that there are, at most, short-term interruptions” to classes.

She says that hybrid education is out of the question for the fall. 

"Students across all grades should be taught together again in their classes next school year," Karliczek says, delta or no delta.

Parents might love hearing that.

But there is some bad news: No matter what happens in the coming weeks, the curse of the mutants is likely to continue. 

It’s not enough to defeat delta. 

At any time, a new variant can emerge somewhere in the world that is even more contagious.

In fact, virologists in Europe just discovered a version of the virus that could be the next to spread. 

Its name: delta plus.  

Lenin’s rope may help tame the dominance of Big Tech

The emergence of small insurgent companies could unleash the next wave of creative destruction

John Thornhill

Those struggling to curb the power of Big Tech should consider the theory of Vladimir Lenin’s rope. 

“When it comes time to hang the capitalists, they will vie with each other for the rope contract,” Lenin is supposed to have said (even if there is little evidence that he ever did).

As regulators have recently been discovering, it is tough challenging the dominance of the Big Tech companies. 

Last week, a US federal court struck down two landmark law cases brought against Facebook, arguing the Federal Trade Commission had failed to prove that the social network exercised “monopoly power”.

But there remains an argument that, by empowering future competitors with new tools and technologies, the dominant capitalists may be unwittingly selling the rope with which they will eventually be hanged. 

As is the way of the world, the next generation of technology often solves the problems created by the previous one. 

Smart innovators invent new ways of doing things that render the old ways obsolete. 

Who cares about VHS’s dominance of the video cassette market any more?

From one perspective, we are right to worry about, and act against, the concentration of corporate economic power. 

The dominant tech companies enjoy massive network effects, unrivalled data-derived insights into consumer behaviour and torrential cash flow that can be spent on the smartest employees, the most powerful computers and snapping up any uppity upstarts that threaten their business.

But from another perspective, these very same platform companies, such as Amazon, Google, Facebook, Apple and Microsoft, are making it easier and cheaper to launch and scale new digital businesses, which may yet stimulate the next wave of creative destruction. 

Technology is simultaneously concentrating economic power and democratising it.

Take the experience of Bret Taylor, a serial entrepreneur who is now Salesforce’s chief operating officer. 

When Taylor launched his first social networking company FriendFeed in 2007, he built his own server because it was the cheapest thing to do. 

When he founded his second, a productivity software company called Quip in 2012, he built it all on the cloud, hosted by Amazon Web Services, making the process a lot quicker and cheaper. 

“The opportunity to build a digital business is easier than it has ever been. 

The next Silicon Valley is the cloud,” he told me.

It is a similar story with software. 

Until relatively recently, it tended to be the biggest companies employing the highest paid developers who wrote the most sophisticated software. 

But open source software, freely available on the GitHub platform now owned by Microsoft, and easy-to-use “no code/low code” programs are enabling every company to become a tech company.

Anyone with an internet connection can now access these software libraries to create their own services, just like clicking together Lego bricks, says Nadia Eghbal, author of Working in Public, a book on open source software. 

“We often pit the platforms and the creators against each other. 

But they are in a symbiotic relationship. 

Creators are waking up to the realisation that they have a lot of power,” she says.

The technology companies are also offering their customers powerful machine learning services, such as Google’s TensorFlow and Facebook’s PyTorch. 

This week, Microsoft announced the release of a new AI tool called GitHub Copilot to help programmers co-create code. 

These kinds of platforms have enabled companies to develop their own AI-powered services, such as customer chatbots, that are becoming increasingly ubiquitous.

Yet the counter-narrative about the decentralisation of tech only goes so far, says Richard Kramer, founder of Arete, an independent research firm. 

Kids anywhere can launch a new business using the latest tech tools, but they are still likely to depend on the uncompetitive infrastructure dominated by Big Tech, such as Apple’s and Google’s app stores. 

“This democratisation of tech story is very seductive until you ask who owns the tools and platforms on which they all rely,” he says.

That means we still desperately need regulators to hold the Big Tech companies to account by robustly enforcing existing antitrust rules and rewriting legislation fit for the digital age. 

But it will take time, resources and political resolve to loosen the grip of the incumbents. 

In the meantime, we should do everything possible to support the emergence of the insurgents and encourage competition between the tech companies to sell them more rope.

Elections

The real risk to America’s democracy

Partisan election administration is a greater worry than voter suppression

Having campaigned for the presidency on a promise to rejuvenate democracy around the world, Joe Biden finds himself in a battle to defend it at home. 

In June, 200 prominent American scholars of democracy signed a letter warning that changes to state laws are “transforming several states into political systems that no longer meet the minimum conditions for free and fair elections”. 

Another longtime student of American democracy, the Republican leader in the Senate, Mitch McConnell, said in January that if an election could be overturned by fact-free allegations from the losing side, “Our democracy would enter a death spiral.” 

Yet that is just what his party is facilitating.

For Democrats the threat to elections is about who can cast votes. 

They decry changes to laws on identification, postal ballots and so on, which they call “the new Jim Crow”. 

Although there is no excuse for restricting such things as Sunday voting, which is popular with African-American churches, their fears are overblown. 

Under the old Jim Crow, only 2% of African-Americans were registered to vote in some southern states. 

By contrast, political scientists are unsure whether today’s schemes will affect turnout at all.

Instead the real threat comes after votes have been cast. 

In Arizona, for example, the legislature wants to limit the independence of the chief elections officer; a state representative introduced a law letting the legislature overturn the results of a presidential election, and then started campaigning to oversee elections herself. 

In Georgia the state legislature can now replace the leadership of county election boards. 

Texas is considering a bill that makes it easier to prosecute election officials. Across the country, the officials who administer elections in states where Republicans hold sway have been attacked for upholding the election results. 

Many are at risk of being replaced.

These might seem like distant, bureaucratic changes. 

In fact they raise the chances of a contested election that the courts cannot sort out. 

They weaken America’s voting system in ways that will outlast the hysteria over the 2020 result.

The inspiration behind this is Donald Trump, who continues to use every chance he has to insist that the election was stolen. 

Though it is hard to know how seriously to take him, Mr Trump is already holding campaign rallies for 2024 (to win the White House for the third time in a row, naturally).

Claiming to be winning while actually losing might seem a joke. 

Yet most Republican voters take it literally. 

Two in three think that Mr Biden did not win November’s election and just short of half think the result should have been overturned. 

That leaves Trump-sceptics among the Republican elite in a familiar dilemma. 

Caught between their primary voters and loyalty to the constitution, most have concluded that, unless the Capitol is under siege, the best course of action is simply to stay silent.

Yet the threats from Mr Trump and the threat to the constitution operate on different time-scales. Mr Trump may or may not run again. 

By contrast, the changes to state election machinery being made by Republican legislators will be in place in 2024 and beyond for a candidate of either party to exploit. 

To understand why this is so troubling, consider three fail-safe mechanisms built into American elections.

The first is the principle that the loser concedes. 

Mr Trump ditched that one in 2020. 

The second is the integrity of local election officials, no matter what their partisan allegiances. 

Despite coming under great pressure to do otherwise last year, they stood firm. 

As a reward, their powers have been stripped away or new felonies created that may be used to browbeat them. 

Many Republican officials who certified the election results have been censured by their local party committees and have also received death threats. 

Brad Raffensperger, Georgia’s Republican secretary of state, was notable in 2020 for his willingness to stand up to Mr Trump when he was directly asked to “find” the votes needed to overturn the results. 

Georgia’s state legislature has responded by taking away some of his authority.

That leaves the third fail-safe—the courts. 

These too performed well under stress, and they probably would do so the next time round. 

Yet to put the primary responsibility for making elections legitimate onto the judicial branch in election after election risks overloading it and, ultimately, breaking it. 

How long would it be before a Supreme Court decision were ignored?

Catastrophising about democracy in America has been common on parts of the right: remember “the Flight 93 Election” in 2016, which called on patriots to storm the cockpit to deny Hillary Clinton the presidency? 

It has since spread to the left and centre, too. 

Talk of democracy in peril raises the spectre of a country under an autocrat of the type renounced on the Fourth of July 1776. 

The greater risk is that the chaos following the 2020 election becomes normal. 

By recent standards 2020 was not that close. 

Imagine a contest so tight that no national consensus could settle on who was ahead. 

America would be, to quote Mr McConnell again, on “a poisonous path where only the winners of an election actually accept the result”.

My party, right or wrong

Republican Party elites are in a bind of their own making. 

Under pressure from Mr Trump and his allies, state legislatures are making changes that will weaken American democracy. 

The solution is for leaders to uphold the norm that election administrators are above party. 

However, they have indulged the lie of a stolen election to such an extent that affirming the fraud has become an essential qualification for administering the next vote.

The silent non-Trump faction of the Republican Party may hope that all this will blow over and that those sounding the alarm about democracy are exaggerating. 

They may believe they can play a greater role in safeguarding America so long as they stay on good terms with their base. 

Yet that logic has proved faulty since Mr Trump’s inauguration in 2016. 

Meanwhile, the composition of their party is changing around them. 

It would be safer for the constitution, and more in keeping with the flag-waving spirit of the Fourth of July, for Republicans to speak out now before speaking out becomes even harder. 

Federal Reserve Folly

By John Mauldin 

Great news: The US economy is officially out of recession. 

We know this because the National Bureau of Economic Research’s official recession-calling committee said so this week. 

The economy has been in an expansion phase since last April, making this the shortest recession on record at only two months.

The NBER committee always makes these calls in hindsight—both the beginning and end of recessions. 

Literally everyone could see the economy coming to a halt in March and April. 

The signs weren’t subtle. 

Yet it wasn’t until June 8, 2020, that they said the economy had peaked in February, marking the recession’s onset. 

I don’t blame them for waiting to see the data, though. Caution is appropriate on these things.

But really, 15 months to affirm the economy has been expanding? 

Their statement was quite specific. 

They call April 2020 the bottom because that month showed clear troughs in unemployment, GDP, PCE, and personal income ex-transfers. 

All this was known long ago.

Unlike NBER, a private group with no formal power, the Federal Reserve can actually do something with this kind of information. 

Nor does the Federal Open Market Committee have to wait for confirmation. 

It can act whenever it sees a need, which it certainly did when the pandemic struck.

Here’s a handy timeline summarizing the Fed’s near-daily actions in March and April 2020. 

They did far more than just open the Quantitative Easing spigots ($120 billion a month and counting) and lower the Fed Funds rates to zero.

Source: AAF

As I said back then, the Fed’s dramatic response (accompanied by the federal government’s equally dramatic fiscal response) was appropriate given what was known at the time. 

It was an unprecedented situation, potentially threatening the economy and financial system’s core stability. 

They had to act quickly and aggressively.

Where we can/should blame Fed leadership, though, is in the failure to recognize the time to slowly end the extraordinary measures, which are now having extraordinary and harmful side effects. 

Today I want to describe what is happening and tell you what I think the Fed should do. 

Though, to be frank, I have little hope they will.

Let me be very clear. 

I believe the Federal Reserve has already made a significant policy error that can lead directly to recession. 

An accompanying fiscal policy error by the US Congress could compound the Fed’s error, although that remains to be seen, as it is not clear what will pass Congress.

Unneeded Fire Trucks

I greatly admire the skill and bravery of firefighters. 

I once had the personal benefit of their help (recounted here) and was glad they came.

In watching how firefighters work, I have noticed some patterns. 

When notified of an emergency like a high-rise fire, which could be either very serious or a mild annoyance, they assume the worst. 

They arrive quickly and in force. 

Once on-scene, they decide exactly what is needed and the chief then either calls for reinforcements or releases the extra capacity to go elsewhere. 

But they initially bring it all “just in case.” 

This is prudent when lives may be at stake.

What they don’t do is stay on the scene in full force once the emergency is over. 

Of course, large fires can smolder for days. 

They might leave a small crew to extinguish any flare-ups but they won’t tie up the entire department when it may be needed elsewhere.

Now imagine the Federal Reserve is our financial fire department. 

It got a 12-alarm call in March 2020 and rolled out every truck it had. 

That was the right response. 

But within a few months, or at most a few quarters later, it was clear the Fed’s part of the emergency was over.

COVID-19 wasn’t over, of course (and still isn’t), nor was the economy in a great position. 

But the systemic meltdown risk had passed. 

The fire was still smoldering but at that point, it was mainly a fiscal fire. 

Fire Chief Jerome Powell himself said so, repeatedly begging Congress to deal with unemployment and business failures more effectively. 

He admitted there was little else his fire trucks could do but he kept them there anyway in the form of massive quantitative easing and keeping rates at the zero bound. 

They are still on-scene now.

It is my opinion that this has the potential to go down as the greatest policy error in central bank history. 

I know that’s saying a lot. 

Arthur Burns and G. William Miller letting inflation rise in the 1960s and 1970s ranks up there. 

Alan Greenspan kept rates too low for too long. 

Failing to better regulate the mortgage industry was a major problem. 

Powell’s predecessors Ben Bernanke and Janet Yellen also kept fire trucks on scene even though the crisis was over. 

In fact, they even deployed additional trucks (QE2 etc.) long after the recession ended. 

But Powell is doing it on a vastly larger scale.

This might be tolerable if these financial fire trucks were just parked and waiting. 

That’s not the case. 

They are blocking traffic, preventing deliveries, and slowing progress. 

Their revved-up engines are spewing fumes, choking innocent bystanders. 

And the highly-skilled firefighters are actually losing their skills as the needless deployment consumes their training time.

Leaving rates at the zero bound is financial repression. 

It harms savers and retirees. 

Buying $40 billion worth of mortgage bonds every month to hold down mortgage rates in the midst of an extraordinarily significant rise in housing costs seems counterproductive, especially for first-time buyers.

Even more egregious is the Fed seems to have assumed a third mandate: keeping the stock market rising. 

Not only does this exacerbate wealth disparity, it borders on malpractice because, at some point, the Fed will have to take its foot off the accelerator. 

When that happens the potential for another “taper tantrum” is significant. 

The Fed absolutely should not think the stock market is its responsibility. 

To do so (as I believe they are) sets up all of us for extreme future volatility.

Supply chain problems are going to get fixed, albeit slower than we would like. 

Eventually, the fiscal stimulus will go away and everyone will have to adjust. 

Monetary policy isn’t the solution for that particular problem.

This has to stop. 

The economy is growing now. Unemployment, while still elevated, is improving. 

Creditworthy borrowers can easily get financing. 

Even if another major COVID-19 wave strikes, we have thankfully progressed beyond the need for economy-stifling restrictions.

The emergency is over, at least from the perspective of the need for quantitative easing and low rates. The Fed should bring its fire trucks home.

Unfortunately, that’s not happening… and it’s having an effect.

Slamming the Brakes

Everyone agrees inflation would be a problem if we had enough of it for an extended period. 

Then the agreement breaks down. 

Are rising inflation benchmarks “transitory” or will they persist? 

If they do persist, do they even mean anything for most people?

We wrestled with these questions at the SIC in May (see Expecting Inflation and Deflation Talk). 

I’ve been more on the “transitory” side, but small differences matter. 

The Fed has a 2% inflation target. 

Sounds minor, but 2% annual inflation compounds to 22% higher prices over 10 years. 

Fed leaders think it’s fine. 

It is not fine. 

Even “low” inflation harms savers and consumers.

Worse, the Consumer Price Index is a terrible proxy for consumer prices. 

It is massaged and adjusted, sometimes for good reasons, but the adjustments disguise inflation’s impact on segments like housing. 

The “cost of living” grows faster than official inflation for many people, and in some cases far faster. 

The inflation we see today is especially pernicious for the lower 60% of the income and wealth brackets.

One argument, to which I am somewhat sympathetic, is that this doesn’t matter because the Fed can’t generate inflation even if it wants to. 

It’s been trying and failing for over a decade. 

What we see now is less about Fed policy and more about pandemic-driven supply chain disruptions. 

As that passes, the Fed will be trapped again.

Moreover, some of this is outside the Fed’s control. 

The rising prices that add up to inflation are the result of producer and consumer expectations for the future. 

It’s a decentralized, complex process that can easily get out of hand—and force the Fed’s hand.

In general, a loose monetary policy is by definition inflationary. 

And while Powell can make a real argument about inflation being “transitory,” his monetary policy, coupled with an expansionary fiscal policy, is extending the period of time that we call transitory.

Businesses are raising prices. 

You can see businesses, small and large, specifically saying so in their quarterly calls, in the Beige Book, and other sources. 

You can also see it when you go to the store or shop online. 

Prices are rising. 

Clearly wages are rising. 

Those price increases and especially wage increases are going to be “sticky.” 

Consumer inflation expectations are growing. 

Inflation fear embedding itself into the average economic mindset. 

That is dangerous. 

Those of us who lived through the 1970s know inflation expectations have a way of becoming ingrained.

The always-excellent Jesse Felder described it well in one of his letters last week (Over My Shoulder members can read it here), A brief excerpt:

… (T)he Fed might be able to afford to pursue the most aggressive monetary policy experiment in US history so long as inflation expectations remain in check. 

However, if inflation expectations take off then the jig is up.

Because once inflation expectations become unanchored, consumer and business behavior shifts in a way to ensure that inflation is more than “transitory.” 

People begin stockpiling things they fear they won’t be able to get in the future due to rising prices or shortages. 

This pushes up prices further, exacerbating these very fears, inspiring even more stockpiling and so on.

At this point, the Fed would be forced to break the inflationary psychology by rapidly reversing monetary policy to something far more hawkish than almost any market participant can imagine today. 

For some perspective, the last time core CPI hit 4.5%, as it did last month, the Fed Funds rate was over 5% versus 0% today.

As Mohamed El-Erian put it, “The facts on the ground call for the world’s most powerful central bank to start easing its foot off the stimulus accelerator. 

By refusing to do so, the Fed runs a higher risk of having to slam the policy brakes down the road.” 

The longer the central bank waits to curb inflationary psychology, the harder they will have to hit the brakes when the time comes.

See, at some point inflation gets worse simply because enough people expect inflation to get worse. 

Then what?

In the 1970s, Burns and then Miller accommodated that inflation, not wanting to risk recession in order to control inflation. 

Then things got out of hand. 

Rather than small, controlled tightening efforts, we needed a massive shock to the system, producing the worst back-to-back recessions since World War II.

That’s how we got Paul Volcker, incidentally. 

Jimmy Carter installed him in 1979 because inflation was so high. Volcker then did what should have been done earlier. 

Neither Powell nor any likely successors appear eager to normalize Federal Reserve policy. 

That creates severe economic danger, possibly forcing the Fed toward things it doesn’t want to do.

Force-Feeding Liquidity

There’s another way to look at the inflation question: Maybe we actually have major inflation already. 

Instead of CPI or PCE, it’s showing up mostly in asset prices—mainly stocks and residential real estate. 

Both have risen significantly lately, arguably due to Fed policies and programs.

The connection is real. 

Stock prices and home prices both respond to liquidity, and the Fed is stuffing the economy with as much liquidity as it can. 

It injects another $120 billion into Treasury securities and mortgage-backed securities every month. 

Recent activity far outstrips what they did in the Great Financial Crisis and following, which was itself unprecedented at the time.

Source: FRED

Look at the upper right of this chart. 

That sharp vertical line is the Fed responding aggressively and quickly to the unfolding crisis last year. 

They injected staggering amounts of liquidity which, at the time, made sense. 

Maybe they overdid it but, like those fire trucks I described above, they erred on the side of having too much help ready. 

Okay, fine.

But what happened after the initial alarm is less forgivable. 

Instead of pulling back, they brought in yet more horsepower, as shown in the jagged line. 

This is why stocks and home prices are rising. 

It’s not so much the near-zero short-term interest rates, though that helps too. 

The Fed is simply force-feeding liquidity into the economy and it has to go somewhere. These assets are the path of least resistance.

Now, you might say Fed officials surely know this. 

Why are they still pumping? 

An excellent question. 

We may get an answer someday, years from now, when the people making those calls are able to talk more freely. 

For now we can only guess, and my best guess is that the Fed is effectively monetizing the giant and fast-growing government debt. 

They aren’t technically monetizing because they don’t have that authority, but it amounts to the same thing.

But why do that? 

Why encourage fiscal profligacy? 

Maybe because they think it will happen anyway, and they want to minimize the economic hit. 

The alternative is to let the Treasury issue trillions in new debt that would push interest rates far higher. 

That might end the inflation threat, but would have other serious consequences.

The Right Course

As I’ve said in the past, decades of policy errors leave the Fed with no good options. 

All the choices are bad and they can only choose the least bad. 

Not a good position to be in, but it’s where they are. 

And the rest of us are with them, like it or not.

I was critical during the last period of tightening, with the Fed both raising rates and reducing their balance sheet at the same time. 

It was a risky two-variable experiment. 

Today is somewhat different. 

Here’s what the Fed should do, in my opinion:

• Slowly begin reducing balance sheet growth, say by $10 or $20 billion a month, and sometime early next year begin slowly raising the Fed funds rate, meeting by meeting, Greenspan style.
• Stop being an arm of the US Treasury, which they certainly appear to be today, and let the government be responsible for its own mistakes.

The Fed’s primary job is to control price inflation. 

I think its obsession with 2% inflation is a serious mistake. 

It’s not “price stability” to reduce everyone’s buying power by 22% in 10 years and 50% in 36 years.

It is certainly not beneficial to retirees who no longer have the ability to earn income and under the current financial repression can’t even keep up with inflation. 

And while I know that Congress gave the Fed a mandate to maximize employment, nobody has been able to explain to me how monetary policy can do that. 

Yes, low rates make it easier for businesses to expand, but they also harm savers and retirees. 

Robbing Peter to pay Paul distorts markets.

I would like to go back to a time when we didn’t wake up in the morning wondering what the Federal Reserve would do. 

Its actions have distorted the economy, repressed savers, and made the wealth and income divide far greater than it should be.

Quick plug: There are things you can do as an investor to hedge/protect/grow your portfolio. I don’t mean the normal approach to markets. 

There is an entire world of outstanding alternative investments out there. 

By the way, over the last month, we had a “small” opportunity to participate in a very unique income fund, mostly funded by large, well-known endowments and pensions. 

Our connectivity gave us a small slice that we showed to current clients. 

You really do want to be at the table when those opportunities present themselves. 

It didn’t take a lot of time to develop that relationship, but it will pay big dividends.

Washington, DC, Maine, Colorado, and Personal Losses

I plan to go to Washington, DC, for a few days before heading out to Grand Lake Stream for Camp Kotok, the annual fishing and economic fest. 

This year my youngest son Trey (who is now 26) will once again accompany me, which he has done for most years since he was 12. 

Then I will go to Steamboat, Colorado, for a speaking engagement at Gobundance. 

Sounds like a fun group.

Those of us of a certain age begin to notice more and more of our friends “shuffle off this mortal coil” way too frequently. 

This week I was deeply grieved that my longtime friend Toby Goodman died of a heart attack at the relatively young age of 72. 

He was my personal/family lawyer but so much more. 

He personally rewrote the family law code while he was in the Texas House of Representatives. 

He was deeply involved in the community, but to me he was a confidant and friend. 

It is without exaggeration that I can say we shared at least 100 Italian meals, talking politics, philosophy, and personal lives. 

Requiescat in Pace, Toby.

On a lighter note, Shane and I and friends went to a small park in downtown San Juan and took salsa lessons. 

It was fun, and we will do it again, but you won’t see me on Dancing with the Stars. 

Maybe Shane. 

And Trey and Tiffani, granddaughter Lively and friends show up this next week.

And with that I will hit the send button. 

Don’t forget to follow me on Twitter. 

I seem to binge once or twice a week, and for the most part enjoy the intellectual back and forth.

You have a great week. 

I think I will spend more time on the phone with friends.

Your not happy about Fed policy analyst,