LN Exclusive with Fergus Hodgson: Can the Fed Fight Inflation?

The Federal Reserve treated the economic ailments of the coronavirus pandemic with a special dose of quantitative easing. But now that the central bank has pulled the prescription, will the patient suffer from withdrawal symptoms? In an exclusive interview with Liberty Nation, Fergus Hodgson, director of the economic and financial intelligence organization Econ Americas, sorted the reality from the fantasy coming out of the world’s most powerful institution.

The Disease and the Cure

This is what the Fed's game plan appears to be: End the $120-billion-a-month asset-buying program in the next couple of months, raise interest rates, and then potentially unwind its $8 trillion balance sheet. The plan seems simple enough and all wrapped up in a neat little package. The problem is that the institution will need to perform a juggling act, balancing the fight against inflation with growing the post-crisis economy and keeping the bull market alive.

Because of the exceptional consequences that could unfold due to these monetary policy endeavors, all eyes will be on the Federal Open Market Committee's (FOMC) policy meeting later this month. Fed Chair Jerome Powell and his colleagues will extend the financial markets the courtesy of guidance. According to the CME Group FedWatch tool, the markets are penciling in a 25-basis-point rate hike at the March FOMC powwow. And based the performance of the leading stock market indexes, investors are preparing for an era of quantitative tightening. But will these efforts achieve anything, particularly with its chief objective of grappling with four-decade high inflation?

"No, not at all. In fact, it's almost laughable. I don't think they believe their own words when they postulate such an idea," said Fergus Hodgson. "The highest level I've seen is a projected four rate hikes over the coming year. That would still mean a negative real interest rate of five-plus percent. It's a bit laughable, really. It's such a minute change. Also, even if they were to reduce their balance sheet, it would only be by a small portion of the enormous explosion that has gone on over the last two years. It's really just window dressing."

The last time inflation was this high – June 1982 – the fed funds rate was around 11%. Today, the benchmark target rate is 0-25%. Considering how much money has been printed and injected into the United States economy, Powell will need to channel the spirit of one of his predecessors: Paul Volcker.

But because the financial stadium’s foundation has been held together by trillions in fiat money, making the occupants inside addicted to these injections of easy credit, does this mean a correction is on the horizon? In fact, it might already be, at least based on the abysmal year-to-date performance of the Nasdaq Composite Index, which slumped close to 9%.

"The simple answer is that we'll have a major correction across many markets, many asset classes. The multiples or the valuations in the United States right now are at absolute record highs," Hodgsdon explained.

Flaws in the System

Over the last two years, the Eccles Building’s influence on both the equities arena and the broader economy has been on full display. For years, perhaps the worst-kept secret in the Swamp has been how much of a role the Fed plays in the nation’s economic performance. According to Hodgson, this is a notable flaw emanating from Keynesian orthodoxy that the central bank must intervene in the economy, which manufactures a series of distortions and malinvestments.

"It should have no involvement in trying to manipulate the economy in one direction or another," averred Hodgson. "Trying to expect the central bank to both restrain inflation and let's say stimulate or catalyze investment is silly. It's a short-term, I hate to say, but a foolhardy approach."

He adds that the Fed is engaged in an unhealthy "mission creep" that supports the expansion of the federal government, enabling Washington "to keep spending beyond its means in a foolish manner."

Reading the Fed Tea Leaves

So, next year, will the Federal Reserve be plastering a “Mission Accomplished” banner outside of the Eccles Building? Powell has conceded that rampant price inflation will remain elevated throughout much of 2022, potentially subsiding close to the end of the year. President Joe Biden and his administration are also anticipating the consumer price index (CPI) coming down later this year. But these were all the same individuals who initially dismissed it and then tergiversated by calling red-hot inflation a “transitory” phenomenon. They eventually threw their arms up in the air and conceded defeat on the issue, prompting the White House to start blaming everyone else.

For the sake of the Fed’s credibility, Powell will need to pray to the central bankers in the heavens (or in the pits of hell) that the expert class entrenched in the Swamp is correct this time. Although the consensus among market analysts and many economists is that inflation will begin to dissipate over the next 24 months, Hodgson does not believe that’s a realistic expectation at this point.

"The Federal Reserve is using words as a policy tool. Federal officials are trying to change or manipulate our inflation expectations," he noted. "The problem is they've lost credibility, because all this transitory talk has just turned out to be a lot of rubbish. The level of inflation has even surprised me, and I'm not exactly optimistic about the U.S. dollar. Now that they've had basically six months of elevated inflation, despite all their talk about things being transitory, they're really in a bind."

After a year of the famous Chico Marx bit from Duck Soup being played out in real life – “who are you going to believe? Me or your own eyes?” –  the American people are not buying it anymore. A recent Federal Reserve Bank of New York (FRBNY) Survey of Consumer Expectations report for December suggests Americans think inflation will hover around 6% over the next year, while the University of Michigan’s consumer inflation expectations for the next year stands at 4.9%.

Forget It, Jake. It’s Fed Town

Legendary economist Thomas Sowell quipped: "It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong." The Federal Reserve System has fumbled the ball so many times since the early days of the COVID-19 public health crisis. But what happened? Powell was re-nominated, Lael Brainard was promoted to second-in-command, and the more than century-old institution still stands today. Of course, this is hardly surprising since the Fed is the facilitator of reckless spending, an enabler of horrific habits, and the destroyer of economies. What is befuddling, however, is why any of the world’s central banks still follow its lead.

~ Read more from Andrew Moran.