It’s only been a couple weeks since I made the argument that the Fed has always been a political tool, and always will be.
Let’s talk about the dual mandate today. Then the unofficial third one. Then how it looks like it is abandoning one of them.
I’m starting to think it doesn’t have a choice, and it mirrors a classic long-term instability in physics — the “three body problem.”
Don’t worry, I won’t go into the weeds too far, and yes, it matters to us. Especially these days.
The Fed as we know it came into existence in 1913 with one mandate — monetary stability. It was a natural consequence of moving away from a true gold standard and, as contentious as the Fed’s creation was, it managed to walk on eggshells long enough to silence its initial critics.
Over time, mostly due to the nature of the economy in the decades following, this extended into what we call the “Dual Mandate.”
Monetary stability is partially dependent on maximum employment. This makes sense, even more so back in the day. America was still a very insular nation. It produced almost all of what it needed and imports were limited to some high-end finished goods and some niche raw materials.
While this added a lot of complexity, it was manageable as far as monetary policy goes. Almost all of the repercussions reflected back into the domestic economy for consumer spending, monetary velocity, and a host of other metrics.
The “third mandate,” financial stability, took off as Americans invested in the stock market, largely moved away from the old pension systems, and corporations that worked on a national scale went global.
Now the third mandate is too big to fail. The last “taper tantrum” in the markets when the Fed merely hinted at slowing down the monetary printing press scared the Fed more than anything in decades.
Never before had it backtracked so quickly, and the underlying cause is clear. It was entirely unwilling to let the markets, stocks and bonds, choose their own response to its policy outlook.
That monumental flinch mattered more than anything. That recalcitrance spoke louder than any words from Fed board members. Once bitten, twice shy.
While this all seemed stable over short time frames, small changes over time have resulted in massive disruptions to all three mandates. This is at the heart of the three body problem, and there is no truly stable solution.
One of the three will always suffer. In physics, it means either a cataclysmic failure or the complete removal of one.
If you have five minutes and don’t mind watching a video, this will help make this comparison make sense.
The Fed is fully committed to the Biden-era printing press, though even that is an extension that stretches back a dozen years.
It’s doubled down on bond buying, direct market intervention, and reacting to day-to-day market moves instead of a long-term outlook that would smooth over market movement.
As a result, there is early yet strong evidence that the Fed is now too entangled in “financial stability,” meaning protecting the high valuations of the stock and bond markets, regardless of what that means for the original first and second mandates.
In short, one has to go, and it looks like the Fed has made its choice.
The unofficial “three mandate system” is in a transitory phase to obsolescence. The financial stability “third mandate” has been promoted to the first mandate and monetary stability is in the process of being ejected entirely.
One must go to maintain the others. The choice the Fed made is clear, but it can’t admit it — definitely not to the public, perhaps even to itself.
This is why they tried to be so calm while papering over the atrocious employment report. This is why they are already saying they’ll ignore inflationary pressure in spite of all the evidence — base commodity prices spiking, empty warehouses and logistics, idled production lines, etc. — that hint at a spike in inflation.
Something has to go to save the other two.
I don’t want to abandon the markets. Now is not the time. But I am all for having a hedge for the two mandates that will suffer as the Fed shuffles its priorities and all but abandons long-term monetary stability for the sake of the only two mandates it still cares about.
Nothing else works quite like gold in that regard, and Luke Burgess has you covered for that. But the instability and implications of it are clear.
We live in strange and changing times. We can’t take anything for granted; something has to be sacrificed, and we can’t trust those entrusted to maintain the old paradigm to work for us in the new one.
