Why the Fed’s taper won’t work
Asset values will come under pressure, but inflation in real goods and services will persist
The United States’ central bank is the Federal Reserve System. Referred to often as “the Fed,” its primary function is to implement the nation’s monetary policy. It does so by managing interest rates through the purchase and sale of securities such as bonds. The stated goal is maximizing employment while while promoting stable prices.
One of the Federal Reserve’s biggest tools they have utilized is expansion of its balance sheet. You may be familiar with the term “quantitative easing,” or “QE,” a euphemism for effectively printing money and buying up assets. Rumors have been swirling in recent weeks regarding when the Federal Reserve will begin their tapering process. This refers to when the Fed will decelerate the expansion of its balance sheet. The taper is supposed to be the central bank’s answer to curbing inflation. That won’t be the effect.
It’s no mystery inflation is ripping through the economy. The Bureau of Labor Statistics’ most recent read on the Consumer Price Index for the past 12 months as of September 2021 was 5.4%.1 Prices for goods and services are skyrocketing as a consequence of governments’ policies, stimulus programs, and monetary recklessness by the Federal Reserve. When recessions occur, supply and demand recede accordingly. This natural market mechanism reorients the economy’s resources to build from a more solid footing. The problem is as supply declined, demand was relentlessly stimulated through direct depositing cash into consumers’ bank accounts. For the second half of 2021, these one-time bursts of stimulus turned into a rolling monthly check for millions of Americans. I describe the rolling stimulus here.
New money emanating from the federal government via the Fed sifts through the economy driving up prices for producers of goods. Hesitant to pass these losses onto the consumer, the manufacturers eat the cost increases for a time. The subsequent margin decay cycles through supply chains and creates a certain demand destruction. Eventually, producers have no other choice but to pass the costs onto consumers where they see retail prices go up.
Byproducts of inflation as it accelerates are shortages. This is where inflation reaches into Phase 2. Consumer psychology beings to shift and internalize increase rises in prices. Individuals begin purchasing more than what they need for fear the cost will be more tomorrow, if the goods are even available at all. The inflationary spiral spins out of control inducing panic buying, akin to a Black Friday shopping frenzy only for basic food staples.
As described above, the Federal Reserve’s primary duty is managing the nation’s monetary policy. In response to these rising prices, the Fed is feeling pressured to combat it through contractionary means. What needs to occur is for interest rates to rise. As Warren Buffett quipped, interest rates are to asset values what gravity is to matter.2 Higher rates through withdrawing liquidity from the economy will put pressure on all prices, stymying the inflationary spiral.
Unfortunately, the tapering process is not that at all. Not even close. The taper will just reduce the growth of the Fed’s balance sheet; it will still be expanding during this time. The scuttlebutt is the central bank will begin tapering in November 2021 by $15 billion/month. With the current QE set at $120 billion/month in expansion of the Federal Reserve’s balance sheet, this process will take 8 months until it plateaus in June 2022.
This does not pull money out of the system. Inflation will continue to rip until the Fed decides to get serious. The problem is fighting inflation puts pressure on debtors and the Fed’s biggest partner is the US government, the biggest debtor of them all. What the stalling out of the balance sheet will accomplish is throttling back the fuel feeding the asset bubbles throughout the economy. Without that new energy being pumped in, the financial markets lose their mojo. Asset values come under pressure.
These developments will not mitigate inflationary effects for consumers. Prices for everyday goods will still be rocketing higher. Shortages will be persistent. Money will leak out of the prevailing asset bubbles and migrate into the general economy aggravating the situation even more. The Federal Reserve isn’t even close to getting serious when it comes to combating inflation.
What’s more, the Fed’s only concern is getting the CPI to a 2% level. Prices that have risen and which will rise further in the future will not be clawed back. They are permanently at these new levels where the central bank only hopes to downshift to a modest annual climb. The result will be a permanently impaired consumer and a lower standard of living for all of us.
Holmes, Frank. October 19, 2021. Shadow Inflation Could be a Bigger Problem Than You Realize. Forbes. https://www.forbes.com/sites/greatspeculations/2021/10/19/shadow-inflation-could-be-a-bigger-problem-than-you-realize/?sh=3edcfb2034a8
Annual Berkshire Hathaway Shareholders Meeting. May 1, 2021. Warren Buffett: Interest rates basically are to the value of assets what gravity is to matter. Yahoo! Finance. https://news.yahoo.com/warren-buffett-interest-rates-basically-201339088.html