This week in Bidenomics: Hating on the Fed
President Biden promised to stay mum on the Federal Reserve, unlike his predecessor, Donald Trump, who routinely hectored the Fed when he disagreed with its policies. Biden has stayed true to his word.
But Biden’s vow of silence doesn’t apply to Fed critics who seem to be piling on as the Fed struggles with overheated inflation and, now, a banking crisis that’s partly a result of its own policies. After the Fed raised interest rates by another quarter point on March 22, Bernard Baumohl of the Economic Outlook Group decried “an act of folly by the Fed.” In a sarcastic note to clients, Baumohl said, “All they have managed to unleash with today's decision is to weaken employment conditions, push the nation closer to recession and place additional stress on the banking sector. Bravo!”
Fed critics in Congress, mostly Democrats, charge the Fed with trying to put millions of Americans out of work as its main way to corral inflation. Committees in both the House and Senate will soon hold hearings on the early March failure of Silicon Valley Bank, which was the Fed’s responsibility to regulate. Through the twin challenges of inflation and bank instability, the Fed now holds the near-term fate of the U.S. economy in its polished hands, and with it Biden’s political future.
Before the March 22 quarter-point hike, the Fed had already raised interest rates by 4.5 percentage points in 12 months, one of the fastest paces of monetary tightening ever. That contributed to the trouble at Silicon Valley Bank, or SVB, which held billions of dollars’ worth of securities purchased before the Fed started raising rates, with much lower interest rates than current bonds. When deposits dropped off, the bank had to sell those securities to cover the outflows, booking losses. That created a vortex in which depositors got worried and withdrew more money, SVB sold more securities locking in bigger losses, and the government finally had to seize the bank to stop the run and prevent contagion to other banks.
SVB’s bankers should have hedged against the interest-rate shock, as many other banks did. But the Fed made their job harder by pushing rates up rapidly during the last year. And that came after the Fed was slow to recognize inflation taking root in the first place, forcing it to hike rates quickly, to catch up. The question now is how many other banks are trapped the way SVB was, and subject to deep losses if too many customers withdraw their money.
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Baumohl argues that the Fed could have simply paused for a brief spell, to stop tightening the screws on vulnerable banks. “Another hike only adds to the stress of regional banks,” he wrote. “It would not have been catastrophic if the Fed had simply paused this one time to allow banks a breather. A brief halt in the interest rate cycle would not have detonated a hyper-inflationary environment.”
Some economists disagree, and think the Fed needs to keep the pressure on inflation. Economist Michael Strain of the conservative American Enterprise Institute argues that “significant market events should not knock the Fed off course,” and it should keep hiking until inflation abates.
The Fed may also be able to gauge the level of (in)stability in the regional banking sector, through data it monitors, such as the amount of emergency borrowing from Fed accounts by banks that might be in trouble. That type of activity moderated recently, after a worrisome spike in the immediate aftermath of SBV’s failure. So the Fed may have had an inside peek at reassuring data before it hiked on March 22.
At the same time, there are signs inflation, still too high at 6%, is headed lower. Supply chains are nearly back to normal, after three years of COVID-related disruption. Shipping costs are falling, and wholesale prices declined from January to February. Year-over-year energy inflation will soon turn negative, since current prices will almost certainly be lower than year-ago levels that were driven higher by Russia’s invasion of Ukraine.
A key uncertainty is the the lag time between inflationary or deflationary forces, and their impact on the real economy. New research, for instance, suggests supply-chain snafus from 2020 through 2022 are still causing excessive inflation, because producers haven’t yet lowered the prices they charge, even though their own costs have declined. It can also take a year or more for Fed interest-rate hikes to slow economic growth and lower inflation, as the Fed wants. That means it is possible the Fed has already done enough, and may even have overshot, making a recession more likely.
Biden has been notably quiet about all of this. On March 13, he insisted the banking system is stable, but otherwise he’s left most of the talking to deputies such as Treasury Secretary Janet Yellen, who adjusts her remarks as needed to settle financial markets. Stocks and bonds have gyrated anyway, with investors unsure whether they should prepare for a crash or get in on a recovery.
Biden most certainly knows, however, that what’s playing out now will directly affect his reelection odds, assuming he decides to run again. The timing could end up very good for him. If bank runs and over-tightening generate a recession, it will probably happen by the end of this year, which means a recovery could be gathering steam by the time voters are deciding who they prefer in 2024. If the Fed’s going to blow it, the sooner the better for Biden.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman
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