The popular notion that an increase in the stock of money is socially and economically beneficial and desirable is one of the great fallacies of our time. It has lived on throughout the centuries, embraced by kings and presidents, politicians and businessmen. It has shattered numerous currencies, inflicted incalculable harm, and caused social and political upheavals.
Ambrose Evans-Pritchard has written a piece entitled “The Yellen Fed risks Faustian pact with inflation.” In it he calls on Faust, Mephistopheles, and the Sword of Damocles. A deal with the devil is an appropriate analogy. As to Damocles, please pass a pair of scissors; I will do the honors.
It is clear that the US Federal Reserve is now trapped.
Most certainly. A mere 0.25% increase in December sent markets into a frenzy. Additionally, Ambrose notes that offshore markets are buried under mountains of USD-denominated debt – more than five-times higher than the levels in 2000. Further, debt ratios are 36 percentage points higher (compared to GDP) than pre-Lehman.
The Fed has been forced by circumstances to act as the world's central bank, nursing a fragile and treacherous financial system struggling with unprecedented leverage.
To the extent one agrees that the Fed is “forced by circumstances” to do anything, the circumstances are entirely of the making of those employed by the Fed.
They are searching for excuses not to tighten, either by discovering yet more “slack” in the shadows of the penumbras of the remotest corners of the jobs market, or by dismissing the inflation data as spikey, transient, and unreliable
…however well-intentioned, the Fed’s policy is fast becoming untenable.
When the Fed’s policy was slowly becoming untenable, voices in the Austrian community were saying so. Ambrose regularly would mock those voices (here and here); he hasn’t stopped, even now:
…this time the warnings are coming from people who know what they are talking about.
According to Ambrose, before the policy became “untenable” the warnings were made from ignorance; only when it is too late, the smart people finally see it. I will remind readers that Ambrose was cheerleading those supposedly smart people all along, admittedly, knowing that this cheerleading was based on his faith in magic.
With all of this said, I agree with Ambrose on one point:
In the end, the bond vigilantes will dictate Fed policy by pushing long-term bond yields much higher. The spread between 10-year US Treasuries and the real yield on 10-year TIPS has already climbed by 35 basis points over the last month.
"We think a marked acceleration in inflation will force the Fed to raise rates much faster than is widely appreciated," said Steve Murphy from Capital Economics. He expects four rate rises this year, whatever the Fed's own 'dot plot' purports to say.
Which might cause one to ask: if a central bank will only act when forced by the markets to act, why have a central bank?
End the Fed.