Well, I thought that 2018 had to be peak stupidity for humanity, but we are not off to a good start in 2019. I opened the Wall Street Journal this morning to find this article which has a falsehood in every single paragraph. 10 for 10. Let’s review this impressive mess.
First, the title, “The Fed’s Obama-Era Hangover” is just catchy politics. The Fed is an independent entity and President Obama had nothing to do with the policies enacted by the Fed, but the entire article disparages President Obama for the Fed’s actions. Look, I didn’t love a lot of what Obama did. I criticized him regularly for shrinking the Federal workforce, cash for clunkers, the healthcare plan, etc. He made some mistakes in my opinion. But the implication that he’s somehow responsible for Fed policy is underhanded politics and just wrong. Let’s move on to specifics.
Paragraph 1 starts with an outright falsehood saying “the Trump economic revival doubled economic-growth rates over the last two years”. Real GDP was 2.9% in Q3 2018, up from 1.9% in Q1 2017 when Trump took office. RGDP has averaged 2.5% in Trump’s first two years, a relatively weak historical figure by any metric since RGDP has averaged 3.2% since 1948.
Paragraph 2 states “[QE] started to pay interest on reserves, in essence paying banks not to lend.” This is not how QE works. The Fed had to pay Interest on Reserves (IOR) in case they wanted to raise rates. Remember, excess reserves put downward pressure on overnight rates because the banks try to lend them out to other banks. Since the reserve system is a closed system for the banks this drives rates to 0%. So if the Fed wants to raise rates they have to incentivize banks not to lend reserves TO ONE ANOTHER. They do this by paying IOR. This, however, does not mean banks won’t lend to non-banks. In fact, banks CANNOT lend reserves to non-banks so the argument is a non-starter.
Paragraph 3 is a political and analytical morass. First, government debt did not rise because President Obama made it rise. It rose mainly because tax receipts collapsed and automatic government spending kicked in during the financial crisis. Government debt rose because of the crisis, not because Obama was reckless. Second, the authors imply that the banks did not lend out their reserves because IOR “sterilized” the lending. Grrr. Banks don’t lend out reserves to non-banks. And IOR does not sterilize reserves because the reserve system is a closed system. The whole system, by definition, is “sterilized”.
Paragraph 4 says “banks held a total of 14 cents of reserves for every dollar of demand deposits outstanding, reflecting a normal reserve ratio in a fractional-reserve banking system.” Red card – incorrect usage of the term “fractional reserve banking”. In fact, we don’t have a fractional reserve banking system. Banks don’t lend their reserves or multiply them as the Fed and Bank of England have explained in detail.
Paragraph 5 says “strong growth of the past 18 months is now driving up the demand for bank loans, increasing interest rates, and in the process incentivizing banks to lend.” This is just wrong. Demand for loans is weak and the rate of change in loan growth has declined over the last 18 months.
Paragraph 7 says “Historically, banks held few excess reserves as the Fed did not pay interest on them.” No. Historically, banks held few reserves because the Fed was not engaged in QE which essentially forced the banks to hold a certain quantity of reserves to meet the Fed’s desired quantity of asset purchases.
Paragraph 8 – more cowbell. I mean, money multiplier.
Paragraphs 9 & 10 say “While the Fed is not forever shackled by the monetary excesses of the Obama era”.…Zzzzz. Have we all lost the ability to think objectively? Obama didn’t control the Fed. Obama didn’t cause the explosion in public debt….
Look, I don’t want to play politics here, but for some reason we’re 10 years into this recovery and right wing economists are still spewing nonsense about the money multiplier, the risk of soaring inflation and other myths that just won’t die. When will it end?
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.