The Fed Cannot Control Its Easy-Money Monster

By William D. Cohan

      Nicholas Konrad/The New York Times

One of the more important parlor games macroeconomists and Wall Streeters are playing is guessing when the Federal Reserve will finally stop keeping long-term interest rates at historically low levels.

The Fed’s policy, which began in the wake of the 2008 financial crisis, even has a name: quantitative easing (Q.E.), Fed-speak for when the central bank goes into the market, month after month, to buy Treasury bonds, mortgage-backed securities and other forms of long-term credit to drive up the price of these securities and lower their yields. 

In effect, this keeps long-term interest rates lower than they otherwise would be.

In the wake of the Great Recession and the onset of the Covid-19 pandemic in March 2020, that has proved to be an effective short-term strategy to kick-start the economy. 

But many people wonder if Jerome Powell, the chairman of the Fed, has reckoned with the power of the easy-money monster the central bank spawned all those years ago. 

They worry that Mr. Powell has helped inflate bubbles in housing, lumber, copper, Bitcoin and stocks, bonds and other assets. 

The evidence is mounting: The Consumer Price Index, a gauge of inflation, rose 5 percent in May from a severely depressed number a year earlier — the fastest rate in nearly 13 years. 

And that’s just one worrisome indicator.

It’s unclear whether the Fed has the will — or the ability — to end all this. 

Or if it even knows how to taper the bond-buying program without sending interest rates sky high, choking off the nascent economic recovery and freaking out everyone now addicted to low interest rates.

What happens when the easy-money monster gets too big to control?

The Q.E. numbers are staggering. 

In August 2008, a month before the acute phase of the financial crisis, the assets on the Fed’s balance sheet stood at nearly $900 billion. 

Shortly after the collapse of Lehman Brothers, which was liquidated after filing for bankruptcy in September 2008, the Fed’s bond-buying program kicked into high gear. 

By January 2015, the assets on the Fed’s balance sheet had exploded to $4.5 trillion.

For the next five years, the Fed fine-tuned its strategy while slowly reducing its bond buying in preparation for a post-Q.E. world. 

But starting in March 2020, as the economic impact of the pandemic started to become clear, the Fed doubled down on its bond buying: Its balance sheet exploded to nearly $8 trillion in assets by June 2021. 

Now the Federal Reserve Bank of New York predicts that the Fed’s balance sheet could hit $9 trillion in assets by 2022. 

That’s a policy expansion — not a contraction.

Low interest rates are everywhere. 

The yield on the seven-year Treasury bond is 1.16 percent, and the Treasury can borrow money for 30 years at an annual cost of just 2.15 percent, as of last week — historically low borrowing costs, brought to you by the Fed. 

Like floodwaters, low interest rates trickle into nearly every nook and cranny of the credit markets. 

In February 2020, before the Fed recommitted to Q.E., the average yield on a junk bond (bonds issued by companies with less than stellar credit) was around a historically low 5 percent. 

As investors reacted to the pandemic, junk bond yields spiked, reaching 11.4 percent in a month; this spike reflected the rapidly rising concerns about widespread credit defaults, bankruptcies and increasing risk. 

But after the Fed announced its springtime rescue plans and resumed its high-powered bond buying, including of junk bond funds, bond prices soared. 

Interest rates soon returned to their artificially low levels. 

The average yield on a junk bond dipped to its lowest ever, just under 4 percent, in February 2021. It remains very low, around 4.1 percent.

Anyone borrowing money in this country — that’s an awful lot of people — prefers low interest rates. 

There’s the federal government, which owes creditors more than $28 trillion. 

Every day, according to the Peterson Foundation, the government spends nearly $800 million on interest to service the growing federal debt. 

Corporations also love low interest rates: They make borrowing money cheap and thus corporate profits plentiful. 

The cost of a home mortgage remains historically low.

Who, then, hates low interest rates? 

Investors, along with people who live off their savings. 

There is nowhere to turn to get a return on an investment without taking unjustifiable risks. 

And risk is being mispriced everywhere. 

For years, investors have plowed into the stock market because their assessment of the risk and reward ratio there made more sense than in the bond market. 

That trade paid off, at least early on in the Q.E. experiment.

But now the stock market is at all-time highs, too. 

What are investors to do in an era in which the Fed has manipulated interest rates to their lowest levels ever without any sign, or willingness, to change course? 

It’s no wonder manias abound, in meme stocks like Game Stop and AMC, in cryptocurrencies such as Bitcoin and Dogecoin, in the bizarre phenomenon of nonfungible tokens and in the crazy story of the $113 million deli in Paulsboro, N.J. 

There are few traditional — read: safer — places investors can turn to get the outsize returns they crave.

In a conversation at the Economic Club of New York, Lawrence Summers, a former Treasury secretary, and Glenn Hubbard, a former chair of the Council of Economic Advisers, expressed concern. 

Mr. Summers, who served in Democratic presidential administrations, has repeatedly voiced his worry that the combination of current monetary and fiscal policy will spur unwanted inflation — a worry affirmed by this month’s Consumer Price Index report. 

“Future financial historians will be mystified by why we were spending $50 billion a month buying mortgage-backed securities in the face of a housing price explosion,” he said. 

Mr. Hubbard, a former Republican official, said he did not “see an argument” for the Fed’s current approach “without telling the public what an exit path is going to be.”

So far, that exit path has not materialized. 

When asked in March if the Fed was “talking about talking about” ending Q.E., Mr. Powell said, “Not yet.” 

The next month, he reiterated that the time had not come. 

That sounds like a man facing pressure to maintain the status quo.

Of course, there’s a counterargument: that concerns about wild inflation are overblown and that it will take time to rebalance supply and demand equations after much of the world economy was shut down for more than a year. 

But that’s no rationale for again expanding the Q.E. program.

At some point, the years of excess in the financial markets will likely lead to a volcanic economic disruption. 

Capital markets will seize up, and debt and equity financing will be largely unavailable. 

Years of economic pain and turmoil will follow, with the worst of it, as ever, borne by those least able to handle its consequences. 

Just as in the aftermath of 2008, the blame will be diffuse.

But there are alternatives. 

Brian Deese, the director of the National Economic Council, should encourage President Biden to urge Mr. Powell to begin tapering the Fed’s bond-buying program and to keep doing it even after the markets have their tantrum. 

Ron Wyden, the chair of the Senate Finance Committee, could invite the survivors of the 2008 financial crisis to remind us how close we all came to the abyss last time. 

The Fed could make the decision to change direction on Q.E. at the Federal Open Market Committee meetings this week.

If not, we’ll scratch our heads in collective amazement that we again find ourselves in the midst of a financial crisis — a thoroughly avoidable one.

William Cohan, a former investment banker, is a founding partner of Puck, a new media platform, and the author of several books about Wall Street.

The Logic of Effective Climate Action

The starting point for addressing climate change, economists agree, is a tax on carbon. But while the resulting reduction in emissions would benefit virtually everyone on the planet, those who bear a disproportionate share of the costs will mobilize in opposition – that is, unless they are given a reason not to.

Barry Eichengreen

BERKELEY – In his classic book, The Logic of Collective Action, the late great Mancur Olson explained that the hardest policies to implement are those with diffuse benefits and concentrated costs. 

Olson’s argument was straightforward: individuals bearing the costs will vigorously oppose the policy, while the beneficiaries will free ride, preferring that someone else take up the cudgels.

Olson’s insight applies to the single most pressing policy challenge facing humanity today, namely climate change. 

The starting point for addressing it, economists agree, is a tax on carbon. 

The resulting reduction in emissions would deliver benefits to virtually everyone on the planet. 

But specific segments of society – Olson’s concentrated interests – will bear a disproportionate share of the costs and mobilize in opposition.

A case in point are the French gilets jaunes (“yellow vests”). 

Like any mass movement, the gilets jaunes had multiple grievances. 

But their most animating complaint was a fuel-tax increase imposed in the name of combating climate change. 

Rural residents rely more on their cars, trucks, and tractors than do urban dwellers, who can ride a bicycle or take the subway to work. 

The tax increase hit them where it hurt, in the pocketbook.

The diffuse interests represented in France’s National Assembly had agreed to increase gas taxes in 2014. 

But after farmers and their sympathizers closed down roads and took their fight to the cities, President Emmanuel Macron’s government backed down and rescinded the tax hike in 2018. 

Olson would not have been surprised.

Other countries can expect similar resistance, and not just from farmers. 

In the United States, President Joe Biden’s administration had to overcome the opposition of fishermen and whale watchers to approve an offshore wind farm near Martha’s Vineyard, canceling a more ambitious project off the coast of Cape Cod. 

We can also expect opposition to a carbon tax to be regionally concentrated. 

In the US, that means states like Texas, North Dakota, and others producing oil, gas, and coal.

In addition, there is the danger that carbon taxes will worsen political polarization and provoke a populist reaction similar to the response to the China shock. 

Workers displaced from the energy and transport sectors will blame the tax, even if the root causes lie elsewhere. 

Parents struggling to feed their kids and fill their gas tanks will dismiss carbon taxation as an elite project championed by pointy-headed intellectuals. 

The China shock gave us Donald Trump. A carbon tax, imposed willy-nilly, could result in even worse.

But Olson also suggested how to overcome the problem of concentrated interests, namely by buying them off. 

In policy-wonk speak, revenues from a carbon tax could be redistributed to those who bear the costs. 

Besides enabling abatement of climate change, this would limit undesirable political consequences.

We know that carbon taxation imposes higher costs on residents of small municipalities and rural areas than on urbanites. 

Similarly, poorer households spend a larger share of their income on food and transport, which are carbon intensive, than do wealthier households, which spend more on more environmentally friendly services. 

One US study estimates that the share of income absorbed by a carbon tax would be three times higher for the lowest income quintile than for the highest.

Thus, a more progressive income tax that compensates the less well-off for the burden of a regressive carbon tax could overcome concentrated opposition. 

(The scheme would have to include a negative income tax to compensate those who do not earn enough to pay income tax.) 

But making policy on this basis – determining how much more progressive a future income tax should be – will require more nuanced analysis of carbon taxes in practice. 

And it will be important to link introduction of carbon taxes explicitly and visibly to the change in income tax, so that the compensation is clear to the public.

Then there is the question of regions specializing in the production of carbon-intensive fuels. 

A more progressive income tax won’t solve Texas’s problems, because corporations based there, not to mention the state government, rely on revenues from oil and gas production.

Biden’s budget and the European Union’s recovery fund both feature measures to discourage production of carbon-based fuels and speed the transition to wind and solar. 

The opposition sure to come from Texas and its counterparts in other countries suggests that these policies should have a more prominent regional dimension. 

They need to avoid creating more Appalachias, Appalachia having been decimated by the decline of employment in coal mining.

Unfortunately, experience with “place-based” policies is not good. 

Just ask Sicily. 

But this is not a counsel of despair; it is an argument for trying harder. 

Subsidies for bringing broadband to rural areas at risk of missing out on the rise of service-sector employment would be a start. 

More generally, regional policies, alongside progressive taxation, will be an indispensable aspect of any politically viable strategy to combat climate change.

Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. He is the author of many books, including The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era. 

The Party Is Not Forever

As the Communist Party of China prepares to mark its centennial on July 1, the poor longevity record of other dictatorial parties in modern times should give its leaders cause for worry. If the CPC is not on the right track with its neo-Maoist revival, its upcoming milestone maybe its last.

Minxin Pei

CLAREMONT, CALIFORNIA – Human beings approaching 100 normally think about death. 

But political parties celebrating their centennial, as the Communist Party of China (CPC) will on July 1, are obsessed with immortality. 

Such optimism seems odd for parties that rule dictatorships, because their longevity record does not inspire confidence. 

The fact that no other such party in modern times has survived for a century should give China’s leaders cause for worry, not celebration.

One obvious reason for the relatively short lifespan of communist or authoritarian parties is that party-dominated modern dictatorships, unlike democracies, emerged only in the twentieth century. 

The Soviet Union, the first such dictatorship, was founded in 1922. 

The Kuomintang (KMT) in China, a quasi-Leninist party, gained nominal control of the country in 1927. 

The Nazis did not come to power in Germany until 1933. 

Nearly all of the world’s communist regimes were established after World War II.

But there is a more fundamental explanation than historical coincidence. 

The political environment in which dictatorial parties operate implies an existence that is far more Hobbesian – “nasty, brutish, and short” – than that of their democratic counterparts.

One sure way for dictatorial parties to die is to wage a war and lose, a fate that befell the Nazis and Mussolini’s Fascists in Italy. 

But most exit power in a far less dramatic (or traumatic) fashion.

In non-communist regimes, long-standing and forward-looking ruling parties, such as the KMT in Taiwan and Mexico’s Institutional Revolutionary Party (PRI), saw the writing on the wall and initiated democratizing reforms before they lost all legitimacy. 

Although these parties were eventually voted out of office, they remained politically viable and subsequently returned to power by winning competitive elections (in Taiwan in 2008 and Mexico in 2012).

In contrast, communist regimes trying to appease their populations through limited democratic reforms have all ended up collapsing. 

In the former Soviet bloc, liberalizing measures in the 1980s quickly triggered revolutions that swept the communists – and the Soviet Union itself – into the dustbin of history.

The CPC does not want to dwell on that history during its upcoming centennial festivities. 

Chinese President Xi Jinping and his colleagues obviously want to project an image of confidence and optimism. 

But political bravado is no substitute for a survival strategy, and once the CPC rules out reform as too dangerous, its available options are extremely limited.

Before Xi came to power in 2012, some Chinese leaders looked to Singapore’s model. 

The People’s Action Party (PAP), which has ruled the city-state without interruption since 1959, seems to have it all: a near-total monopoly of power, competent governance, superior economic performance, and dependable popular support. 

But the more the CPC looked – and it dispatched tens of thousands of officials to Singapore to study it – the less it wanted to become a giant version of the PAP. 

China’s communists certainly wanted to have the PAP’s hold on power, but they did not want to adopt the same methods and institutions that help maintain the PAP’s supremacy.

Of all the institutional ingredients that have made the PAP’s dominance special, the CPC least likes Singapore’s legalized opposition parties, relatively clean elections, and rule of law. 

Chinese leaders understand that these institutions, vital to the PAP’s success, would fatally weaken the CPC’s political monopoly if introduced in China.

That is perhaps why the Singapore model has lost its luster in the Xi era, whereas the North Korean model – totalitarian political repression, a cult of the supreme leader, and juche (economic self-reliance) – has grown more appealing. 

True, China has not yet become a giant North Korea, but a number of trends over the last eight years have moved the country in that direction.

Politically, the rule of fear has returned, not only for ordinary people, but also for the CPC’s elites, as Xi has reinstated purges under the guise of a perpetual anti-corruption campaign. 

Censorship is at its highest level in the post-Mao era, and Xi’s regime has all but eliminated space for civil society, including NGOs. 

The authorities have even reined in China’s freewheeling private entrepreneurs with regulatory crackdowns, criminal prosecution, and confiscation of wealth.

And Xi has assiduously nurtured a personality cult. 

These days, the front page of the People’s Daily newspaper is filled with coverage of Xi’s activities and personal edicts. 

The abridged history of the CPC, recently released to mark the party’s centennial, devotes a quarter of its content to Xi’s eight years in power, while giving only half as much space to Deng Xiaoping, the CPC’s true savior.

Economically, China has yet to embrace juche fully. 

But the CPC’s new Five-Year Plan projects a vision of technological self-sufficiency and economic security centered on domestic growth. 

Although the party has a reasonable excuse – America’s strategy of economic and technological decoupling leaves it no alternative – few Western democracies will want to remain economically coupled with a country that sees North Korea as its future political model.

When China’s leaders toast the CPC’s centennial, they should ask whether the party is on the right track. 

If it is not, the CPC’s upcoming milestone may be its last.

Minxin Pei is Professor of Government at Claremont McKenna College and a non-resident senior fellow at the German Marshall Fund of the United States.