June 17, 2024 | In this issue of The Institutional Risk Analyst, we feature a discussion with another close observer of the Federal Open Market Committee, economist Brian Barnier. Brian is co-founder and editor of economic and market site Fed Dashboard & Fundamentals, where he applies decision science analysis to bust market and economic myths. Brian’s work deciphering Fedspeak is more akin to Ghostbusters than a polite lab experiment, and always insightful.
The IRA: So Brian, great to connect again. We sent you a bunch of questions about the economy and inflation, and how the Fed is handling both parts of the mandate in Humphrey-Hawkins. In typical fashion, you have responded with two cool graphics from Fed Dashboard.
Barnier: In terms of inflation, the first chart tells the true story of price increases across different sectors of the economy. In Chart 1, the rather complicated circle in the negative in terms of price inflation are, in order: Sports and RVs, household maintenance, fuel oil, personal care products, furniture, schools, men and boy’s clothing, postal service, photo equipment, other clothing and footwear, water supply and sanitation and rental value of farm dwellings.
The IRA: Yes, auto prices were decelerating last year as the effect of COVID on loss severities was reversed. Everything else is going up in price. This suggests that the Fed has not even begun to address inflation to date, only the future rate of increase. We’d need high rates for longer to deflate these prices, but the collateral damage of such a deflation would be horrible. Does the FOMC actually realize the extent to which they have been marginalized?
Barnier: The FOMC has been in never-never land since the economy globalized in the early to mid-1990s. Some people date this trend toward globalization starting in the late 1980s and increasing globalized financial markets. Some products and services face rising and falling prices – see my immediate past version of Chart 1 below.
The IRA: What does this chart tell us?
Barnier: The FOMC cannot control the economy the way they did in the post-WWII period. For example, today, the FOMC cannot control building permits or all cash buyers for housing. The CPI for the entire country was recently distorted by higher Detroit imputed rents. Thus, imputed rent is beyond the FOMC’s reach – this was not always the case. In the 1950s through maybe into the late 1990s, the FOMC could control mortgage interest rates and building permits flowed freely for expanding families.
The IRA: Neverland is a realm where many people refuse to grow up. In our interaction with Fed people, they seem to understand much of what is happening in the markets, but perhaps we are too kind. We have been screaming about commercial real estate for some while now, but this fiasco is very much a private affair. Commercial defaults happen quietly, in conference rooms with lawyers. The impact arrives years later.
Barnier: The FOMC has minimal CMBS in their portfolio. Where I live and where I travel, I see numerous “for lease” signs, occupancy (parking spaces low) and hear lectures about commercial landlords handing the keys back to the lender.
The IRA: This time it’s different in a sense that commercial is leading the way. We just suggested to the folks as FDIC that banks need to start disclosing credit risk transfer transactions soon. Numbers will simply be too large. But even as the mainstream narrative has been talking about rate cuts, you are arguing that the Fed is not actually tightening now. Tell us why.
Barnier: As Chart 2 above shows, we are tightening and also we still are well above historical levels for most of the FOMC’s Balance Sheet (this chart is just securities). A little over one year ago, I participated on a panel from the NYC Bar Association, that addressed these bank regulation issues. Then, of course, we must consider the Treasury’s deficit spending.
The IRA: We are in the midst of re-editing the portion of “Inflated” that deals with the Progressive crusade for silver coinage in the post-Civil War era. The vast inflation created by the Treasury purchasing physical silver paid for in fiat paper greenbacks probably led to the financial crises starting from the 1880s through to the Great Depression. We worry that the COVID era inflation, likewise, will result in a maxi economic reset later in this decade, a deflation led downward first by commercial and then by residential housing. The Fed has no impact on residential home prices at all, yet we are talking about rate cuts. How do we make sense of this mess?
Barnier: The big political question for me is 1) when will the FOMC realize that it lacks the control over the economy that it once had and 2) when will the Fed seek a more engaged relationship with the U.S. Treasury. Certainly not that the FOMC must finance budget deficits. Creating a more productive economy for residents. Open the conversation to the public. Like when the Great Depression ended and after WWII. Until this issue of “control” is resolved, the FOMC will be in a quandary.
The IRA: We always smile when economists recite the profession of faith with respect to central bank independence. The last Fed Chairmen to assert independence from the Treasury were Thomas McCabe and William McChesney Martin. Chairmen Volcker and Greenspan focused on keeping the system afloat. But the Fed is now the tail, a mere appendage given that we are borrowing one quarter of public spending every year. The Treasury is the dog and the financial alter ego of the central bank.
Barnier: You said it with “keeping the system afloat.” Looking back at the data, we can easily see the turn. It was after Volcker, Greenspan maybe did not notice as the pattern was not yet clear. William McChesney Martin is the one we should follow today -- he was a balancing act. For a good Greenspan biography, I like Sidney L. Jones.
The IRA: Thanks Brian.
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