Populareconomicsblog

Popular Economics Weekly

FREDavghrlypay

In the light of the recent bank failures, and the Fed’s own missteps in fighting inflation, history is telling us that the Fed’s current 2 percent target rate for inflation is too low.

Why? Because Federal Reserve policy since the 1970s has mostly benefited banks and other financial institutions that manage money.

It’s easy to see why. The Fed is in charge of keeping our banking system sound, which is implied in its mandate to maintain price stability and maximum employment. So its primary focus has always been to defend the value of their assets, and inflation diminishes asset values.

But the Fed hasn’t maintained price stability as evidenced by the recent inflation surge and was surprised by three US bank failures, causing doubts as to the soundness of our banking system.

Former FDIC Chairman Sheila Bair highlighted the dangers of such inattention in a MarketWatch interview.

“This is a risk confronting all banks,” she said. “All examiners need to be on alert for how interest-rate risk is being managed. If there is a run, they will need to sell these securities. Those are the kinds of things all-size banks, and all examiners should be worried about in our banking system.”

Current monetary policy has not improved workers’ wages, either, which haven’t kept up with inflation with the wild gyrations caused by the COVID pandemic and some $6 trillion in pandemic aid.

So isn’t it time for Fed monetary policies to focus on bringing down the record income inequality that has prevailed since then and ranked US income inequality the same as Haiti, far below that of other developed countries. per the CIA’s World-Factbook?

Why do we have red and blue states and a divided country, otherwise? Many Americans feel disenfranchised who no longer have jobs that earn what they did in the 1970s when we still had a manufacturing base in the rust belt.

The average hourly earnings of employees has never risen above the 2-3 percent range, per the St. Louis Fed’s above graph of average hourly wages dating from the 2008 Great Recession.

Chairman Powell was explicit in his press conference after the conclusion of the latest FOMC meeting, at which another 0.25 percent rate increase was announced. The labor market is still too hot, he said, and has caused wage growth to accelerate rather than decline, which the Fed deemed was necessary to bring down inflation.

So employees’ earnings have now become the culprit keeping inflation too high, when the latest research has shown excess corporate profits and the Ukraine war jump-started the current inflation surge.

In other words, the Fed has been most successful at keeping employees’ wages at or below the inflation rate since the 1970s as they labored to keep inflation in the 2 percent target range.

This is not a coincidence. Fed Governors since former Fed Chair Paul Volcker have believed conditions that prevailed since the 1970s still rule that caused the wage-price spiral and double-digit inflation of that time.

But globalization policies expanded world trade and developed just-in-time supply-chains that brought in cheaper consumer goods and exported manufacturing jobs to low wage-earning countries. Inflation became so tame during the 1990s that it was termed the Great Moderation.

So why does our Fed have a 2 percent inflation target?

Progressive labor economist Jared Bernstein opined on this matter in the Washington Post shortly after first Bernanke announced the Fed’s decision of a 2 percent target rate.

“The fact is that the target is 2 percent because the target is 2 percent. Were the target 3 percent or 4 percent, you’d be reasonably asking me, why 3 or 4? To the extent that there’s an anti-inflation bias among economic elites (and thus an anti-full-employment bias), and I think that’s often the case, I’d reiterate arguments I made here…that the debates over full employment and Federal Reserve policy are generally dominated by the interests of the minority who worry more about inflation and asset values than those who worry about jobs and paychecks.”

Is there real evidence the current 4.4-4.6 percent average hourly wage increases employees are enjoying that was reported in the February unemployment report inflationary?

No, average hourly wages could be contributing as little as 8 percent to product costs in one recent paper by EPI economist Josh Bivens that I cited above.

There is much that government can do to lessen income inequality, which would in turn lessen the yawning gap between the Haves and Havenots in this country. The Federal Reserve can do its part by lessening the inherent bias of a low inflation target that mainly targets wage earners, which includes 32 million Americans that still live below the poverty line.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Financial FAQs

FRED10yr

The wild fluctuations of the 10-year Constant Maturity Treasury yield portrayed in the above St. Louis Fed graph should have alerted Federal Governors and Chairman Powell to the dangers of raising interest rates too precipitously.

It is the reason three US banks have failed, who wouldn’t either hedge against or reduce their holdings backed by Treasury securities that lost value as interest rates rose.

It’s also why the Fed should begin to reverse course to lower their overnight rate target that is now at 4.5-4.75 percent.

The decline in confidence of our banking system can in part be attributed to the Fed Governors naiveté, or maybe outright ignorance, of the US banking system they are supposed to regulate.

For instance, Fed Governors did not seem to realize the risk to depositors of banks holding deposits worth more than the $250,000 ceiling set by the FDIC for insured deposits. It was 97 percent in the case of Silicon Valley Bank.

The Fed seems to have been its own worst enemy in not realizing the effect of its policy actions, as evidenced by February’s FOMC minutes.

“With respect to the relationship between monetary policy and financial stability, some participants noted that evidence regarding the link between the policy stance and elevated financial vulnerabilities was limited, with a couple of participants further observing that there were not many episodes of persistently low interest rates.”

Yet Silicon Valley Bank had been on the San Francisco Fed’s watch list for more than one year as the Fed Governors charged ahead with their rate hike policy. “By July 2022,” as reported by the NYTimes, “Silicon Valley Bank was in full supervisory review, and was ultimately rated deficient for governance and controls.”

“In addition,” continued the FOMC minutes, “some past episodes of heightened financial vulnerabilities were associated with excessive risk-taking behavior that did not seem to be very responsive to typical changes in interest rates.”

Really? The NY Times and others have reported on the hands-off attitude of Fed regulators in not doing more to demand that banks—particularly those vulnerable to large uninsured deposits—crack down on such risky behavior.

So the Fed might call a halt to its policy of taming an inflation that is mostly caused by factors outside of the Fed’s control, and focus more on banking supervision that is under its direct control.

A 2022 Gallup survey found that just 27 percent of Americans had a “great deal/quite a lot” of confidence in our banks.

At the very least, the Fed should reverse course and begin to bring down interest rates before more banks fail, and more Americans lose faith in our banking system.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Popular Economics Weekly

FREDcpi

The retail Consumer Price Index rose from essentially zero in May 2020 to 8.9 percent YoY in June 2022. It has dropped to 6 percent in February, per the US Census Bureau’s latest inflation report.

This is what panicked Federal Reserve officials to begin the draconion interest rate increases that have caused at least two bank failures, and maybe more, of mid-size banks whose oversight was weakened with a modification of the Dodd-Frank legislation in 2018.

The largest failure to date is the Silicon Valley Bank, whose depositors withdrew a record $42 billion in a matter of days. Taxpayers might now be picking up the tab because of the promise by the US Treasury and FDIC to make all depositers whole (but not stock and bond holders).

The rising costs of renting and homeownership accounted for more than 70 percent of the increase in consumer prices last month due to the well-documented housing shortage.

The cost of recreation, plane tickets, auto insurance and furniture also rose sharply because the service sector is booming. Leisure/Hospitality, Education & Health had the fastest job growth in last Friday’s February unemployment report.

More good news was that the cost of energy, including gas and natural gas, declined in February. And grocery prices rose 0.3 percent to mark the smallest increase in 21 months. They are still up 10.2 percent in the past year, however.

The wholesale cost of goods also fell last month in the Bureau of Labor Statistic’s Producer Price Index as well, led by the third straight decline in food prices. Notably, wholesale egg prices sank 41 percent. The cost of eggs had soared since the fall, doubling in price in some parts of the country.

The PPI report captures what companies pay for supplies such as fuel, metals, packaging and so forth. These costs are often passed on to customers at the retail level and give an idea of whether inflation is rising or falling.

Crunching the numbers, it has taken nine months for CPI inflation to drop to 6 percent from its peak last June. It should take approximately six months to return to the Fed’s 2 percent inflation target, if it continues to decline at the same rate that it rose, which is sometime in the fall.

But supply chains are taking longer to recover because of China’s COVID missteps and the Ukraine war that has no end in sight.

So what is the Fed to do? It would be a good time to pause and see if inflation continues to decline, as well as to ascertain whether higher interest rates do more damage to the banking industry that may have invested too heavily in certain assets.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Popular Economics Weekly

MarketWatch

February’s very strong unemployment report has raised fears the Fed may go back to 0.50 percent rate hikes, or even 0.75 percent (which it did four times), because of the continuing strength of the labor market.

But maybe not, because the failure of the Silicon Valley Bank and several smaller banks may set off alarm bells at the Fed that they might have raised interest rates too fast, catching some smaller banks off guard that invested heavily in Treasury and Mortgage-backed securities when rates were at rock bottom.

Job strength was mainly in the service sector, according to the Labor Department’s unemployment report. Leisure/Hospitality and Education/Health once again added most new payroll jobs in February followed by retail trade, professional services and government, as we recover from COVID-19.

The U.S, has created 4,349,000 jobs since February 2022, so quickly has been the recovery. That’s more than 362,000 jobs per month, unheard of in a post-WWII recovery, and the rest of the world is playing catch-up.

Calculated Risk

In fact, February 2022 to February 2023 has been the best 12 month period of job creation since 1980 per the Calculated Risk graph.

So the pandemic has been a two-edged sword, killing more than one million Americans and seven million worldwide, but causing governments to spend freely to speed the recovery.

It now looks like the sudden rise in inflation since the pandemic has panicked Fed officials into raising interest rates too quickly—4.5 percent since last May. The result may cause more small banks to fail, which might cause the Fed in turn to pause their rate hikes, or even reverse course.

It’s becoming evident that the sudden rate increases have caught some banks flatfooted. Barron’s Magazine has just listed 20 banks in a similar position to fail, if the bad news precipitates more depositor withdrawals.

Greenspan’s Fed boosted its rate 4 percent more gradually in 0.25 percent increments over two years. Yet it still precipitated the Great Recession, in part because the GW Bush administration stopped regulating Wall Street firms, which permitted the liar loans that ultimately failed and caused the busted housing bubble.

The Trump administration has acted similarly by easing oversight on mid-sized banks that could have precipitated the current missteps.

So are we looking at another banking crisis, such as occurred during Alan Greenspan’s Fed and the Bush administration?

We should be in a different world because of the banking reforms post-Great Recession. Banks’ balance sheets have been greatly strengthened and financial markets are more tightly regulated.

There are many inflation elements outside of the Fed’s control that should continue to bring down inflation. Supply chains are returning to normal, and corporate profits are coming down from the stratosphere. The Biden administration is also attempting to reduce trade tariffs to bring down import costs that businesses pass on to consumers.

But the Fed has never raised interest rates so quickly before in their history. The latest failures should be a lesson that might change some minds at the Fed.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Financial FAQs

EPI.org

A headline reporting on Fed Chairman Powell’s latest testimony to congress said the Fed will battle inflation until it is subdued, sounding more hawkish because January numbers for retail spending, employment and inflation were stronger than expected.

The problem is most inflation is being caused by factors outside of the Fed’s control.

So good luck, I say, in continuing to boost interest rates without causing a recession. The last time the Fed was in such a position—battling surging inflation in early 2000 that brought on the housing bubble and was due to circumstances largely beyond its control (The War on Terror)—it resulted in the Great Recession.

The Fed had so over-reacted by raising interest rates 16 consecutive times under Fed Chair Alan Greenspan that it took his successor Ben Bernanke’s emergency Quantitative Easing policies to keep the U.S. and world economies from turning it into a second Great Depression.

The cost this time of the Fed holding to its 2 percent inflation target could be 2 million workers losing their jobs, according to Massachusetts Senator Elizabeth Warren.

Today’s Fed hasn’t seemed to even acknowledge that a major component of the current inflation is record corporate profits from the post-pandemic recovery when corporations took advantage of the supply shortages to goose their profit margins.

Economic Policy Institute economist Josh Bivens estimates that at least half of the current inflation was caused by said increase in corporate profits in a study out last year (see EPI graph).

“Since the trough of the COVID-19 recession in the second quarter of 2020, overall prices in the NFCorporate sector have risen at an annualized rate of 6.1%—a pronounced acceleration over the 1.8% price growth that characterized the pre-pandemic business cycle of 2007–2019. Strikingly, over half of this increase (53.9%) can be attributed to fatter profit margins, with labor costs contributing less than 8% of this increase.”

January’s consumer spending was also boosted by the 8 percent inflation-adjusted rise in Social Security payments in the New Year.

Consumers reacted accordingly with January consumer spending up 1.8 percent, while personal incomes rose 0.6 percent in the BEA’s latest personal income (PCE) report.

Fear of what Fed Chair Powell may say and do next is already affecting what consumers and businesses may do next. The Conference Board Index of Leading Economic Indicators (LEI) already predicts a recession sometime this year.

Conference Board

“Among the leading indicators, deteriorating manufacturing new orders, consumers’ expectations of business conditions, and credit conditions more than offset strengths in labor markets and stock prices to drive the index lower in the month,” said said Ataman Ozyildirim, Senior Director, Economics, at The Conference Board.

Maybe Powell’s Fed is just playing it safe in hinting that more pain is possible if January’s boost in spending and inflation isn’t a temporary glitch as more data from February come in.

Friday’s upcoming unemployment report is one such sign, since January’s red-hot employment report of 537,000 new jobs scared the Fed into believing higher inflation could be prolonged.

Harlan Green © 2023

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen