Will the Federal Reserve Finally be Reformed?
Weekly Investment Update | By Brian Schreiner
Stocks were mixed last week as bonds edged lower. While commodities generally trended up, the real shockwave hit the precious metals market on Friday. Silver plummeted 30%—its worst single-day drop since 1980—and gold tumbled as the nomination of Kevin Warsh for Fed Chair eased fears about the stability of the dollar. Despite the late-week sell-off, both metals finished January in positive territory.
On Wednesday, the Federal Reserve’s Open Market Committee decided to maintain the federal funds rate at 3.5% to 3.75%. During the subsequent press conference, Claire Jones of the Financial Times asked Chairman Jerome Powell to address the recent decline in the U.S. dollar.
Powell’s response was telling:
“So, Claire, as you probably know, we don't comment on the dollar. Really, the Administration and especially the Treasury Department has the job of oversight over the currency... It's not our role. So, I have nothing for you.”
This is a startling admission. The Federal Reserve’s primary Congressional mandate is to maintain price stability—which is, by definition, managing the purchasing power of the dollar. For the Chairman to claim the currency isn’t "his role" is like a meteorologist refusing to comment on the weather.
Cover of The Economist magazine April 23, 2022
Fundamental Flaw
Why does the Fed avoid discussing the currency they are tasked to manage? Because the current leadership is steeped in Keynesianism. They treat inflation as a "temperature" problem—a symptom of the economy running too hot.
As Monetarists like Milton Friedman correctly explained, inflation is a supply problem—specifically, the supply of too much money. By ignoring the money supply and focusing on "fine-tuning" demand, the Fed has become unhinged from reality, leading to the many policy failures we’ve seen in recent decades.
A Legacy of Distortions
Some of us recognised that the Fed was working on misguided fundamentals years ago, when they held interest rates near zero for a decade—even during long periods of strong economic growth. (The Fed held interest rates between 0%–0.25% for a total of nearly 10 years across two distinct periods: December 2008 to December 2015, and again from March 2020 until March 2022.) Others took notice during the inflation spike of 2021–2022 when prices were rising over 9% annually. Unfortunately, most financial professionals and the media continue to ignore their policy mistakes and the devastating for the average Americans:
The Wealth Gap: Asset price bubbles benefitted Wall Street while punishing savers and middle-class families.
The K-Shaped Economy: The working-class have been squeezed by persistently high inflation—including a 9% inflation spike in 2021-2022—while the middle class saw the purchasing power of their wages evaporate.
Currency Debasement: The purchasing power of the U.S. dollar has declined by 52% over the past 25 years—an average annual inflation rate of about 3%, persistently above the Fed’s supposed “target” of 2%.
Kevin Warsh: Architect of Reform?
On Friday, when President Trump announced that his nomination to succeed Jerome Powell will be Kevin Warsh. Gold and silver prices reacted instantly because the markets recognize that Warsh represents regime change at the Fed.
A former Fed Governor and current fellow at Stanford’s Hoover Institution, Warsh has been a vocal critic of the Fed’s institutional drift. The Fed has wandered too far into fiscal and social policy—even attempting to address climate change with its regulatory policies—while losing sight of its essential mandate: price stability.
In a recent interview with Peter Robinson on Uncommon Knowledge, Warsh described the post-2008 era as "the complacency era," where the Fed became addicted to crisis tools like Quantitative Easing (QE). He says the 2021 transitory narrative, “the greatest mistake in macroeconomic policy in 45 years.”
Warsh believes the elevated inflation we’re seeing now is an echo of the “Great Inflation” of the 1970s. Pandemic stimulus, QE-to-infinity and institutional "drift" has led them to ignore the money supply, which is the true driver of inflation that has widened the wealth gap and driven the affordability crisis.
Warsh will face many challenges to his objectives, but when he takes over Fed leadership in May, he’s going to work to reduce inflation, shrink the Fed’s balance sheet and restore public trust in the institution and the dollar.
Many well respected voices have come out in support of Warsh, including the Wall Street Journal Editorial Board: “Mr. Warsh has an extraordinary opportunity to reform the Fed so it resumes its role as a steward of price stability to underpin stable growth and rising incomes.”
“Inflation is a choice.”
~ Kevin Warsh, President Trump’s nominee to succeed Jerome Powell
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