The Catch 22 of Fed Independence

Central bank independence is critically important to maintaining confidence in the dollar. Yet the Fed’s abysmal performance over the past 25 years shows that it also needs major reforms to maintain that confidence. But reforming the Fed by definition means taking away some of that independence… which then erodes confidence.

Call it the Catch 22 of Fed independence. It’s a circular problem with no real way out.

While on the subject of Fed independence, let’s talk about that op-ed that Treasury Secretary Scott Bessent wrote for the Wall Street Journal last week.

Bessent wrote that “The Fed’s new operating model is effectively a gain-of-function monetary policy experiment. Overuse of nonstandard policies, mission creep and institutional bloat threaten the central bank’s independence.”

We should just assume that all politicians with high and mighty words have ulterior motives… or that they are flat-out lying to us. That’s generally a safe assumption, and we know was Bessent wants here. He and President Trump want the Fed to aggressively cut rates.

But that doesn’t mean he’s wrong about experimental monetary policy, and I’ve made many of the same arguments myself about the Fed’s expanded role.

Yes, the Fed has overused nonstandard policies like quantitative easing to the point of making the market dependent on them like a drug addict.

Mission creep has massively expanded its mandate far beyond what Congress originally imagined for the bank.

And institutional bloat effectively locks the mission creep in place and leaves the economy and stock market dangerously dependent on the Fed’s actions.

Let’s take a look at some of Bessent’s other observations…

Successive interventions during and after the financial crisis of 2008 created what amounted to a de facto backstop for asset owners. This harmful cycle concentrated national wealth among those who already owned assets. Within the corporate sector, large firms thrived by locking in cheap debt, while smaller firms reliant on floating-rate loans were squeezed as rates rose. Homeowners saw their property values soar, largely insulated by fixed-rate mortgages. Meanwhile, younger and less affluent households, shut out of ownership and hit hardest by inflation, missed out on appreciation.

Yes, yes, and yes.

While 2008 was the start, the interventions massively accelerated during the pandemic, inflating asset prices. Home prices are about 50% higher than they were at the beginning of 2020, and stock prices are 120% higher. Meanwhile, real GDP is about 12% higher. Asset prices have massively outstripped economic growth.

The Fed added $5 trillion to its balance sheet, creating a lot more dollars to chase a limited number of real assets. The result was a bubble in virtually everything… one that’s still inflating today.

40 years ago, the median house cost 3.6 times the median income. Today, the number is 5.3 times.

We can see the same trend in the National Association of Realtors’ Housing Affordability Index. Anything above 100 suggests that the average family can afford the average house. Well, the index plunged in 2020 and 2021, during the Fed’s stimulus orgy, and it’s been trending lower ever since.

Oh, and Bessent is just getting started. There’s more.

…the Fed has blurred the lines between monetary and fiscal policy... Entanglement with Treasury debt management creates the perception that monetary policy is being used to accommodate fiscal needs. Expanded powers have fostered a culture in Washington that relies on the Fed to bail out the government after poor fiscal choices. Instead of accountability, presidents and Congress have expected intervention when their policies falter. This “only game in town” dynamic has created perverse incentives for irresponsibility.

Perverse incentives for irresponsibility. Gee, ya think?

The Fed doesn’t directly finance the government. It acts indirectly, buying bonds on the open market. But that is really a distinction without a difference. The Fed is still the buyer.

The Fed’s willingness to Hoover up government bonds gave Congress every possible incentive to spend well beyond its means. If the Treasury had to truly go to the public hat-in-hand to ask for money, do you think interest rates would be anything close to what they are today?

Of course not. They’d be massively higher, which would dissuade Congress from borrowing $2 trillion per year. Our government is addicted to deficit spending, and the Fed is the dealer providing the fix.

So, what’s the solution?

Bessent recommends limiting quantitative easing (i.e. mass bond buying) to true emergencies.

That’s a start. I recommended as much back in August.

But it doesn’t go nearly far enough. So long as the Fed is allowed to set interest rates, it’s going to be pressured by politicians to keep rates artificially low. It’s going to have the temptation to tinker…and inflate asset bubbles. Interest rates – the price of money – should be set by the market, just like the prices of houses, cars or tomatoes.

That isn’t going to happen any time soon. No government agency ever willingly gives up power, and Washington is too dependent on cheap interest rates to ever leave that responsibility to the free market.

So, what do you do about it?

You hold on to your gold and any other dollar hedges you can get your hands on. It really is that simple.

We’re up about 77% in gold since I recommended it in December 2023. The yellow metal is still trending higher, and I have no reason to think that’s going to change any time soon.

You don’t have to go nuts and dump your entire life savings into gold. That’s certainly not something I would ever do or recommend. But you should definitely keep at least some of your wealth in gold. It would be stupid not to.

Charles Lewis Sizemore, CFA