Why Fed Reform Could Be the Biggest Sleeper Issue of 2024

From The Daily Economy:

Joseph Sternberg, author of the “Political Economics” column at the Wall Street Journal, has been on the Federal Reserve’s case recently. He continues to take central bankers to task in his latest article. “The next president will inherit a Federal Reserve staffed by economists — and their intellectual helpmates in academia — who still don’t fully understand what has happened over the past few years, let alone over the past few decades,” Sternberg warns. He’s right. Fed officials admit to only limited and contingent culpability for high inflation in recent years.

The Fed is a flawed institution at best, and a failed institution at worst. Sternberg suggests several reforms. While potentially helpful, none go far enough.

First, Sternberg castigates the fashionable yet unfounded belief amongst policy economists that “Mr. Trump’s economic agenda of tariffs and tax cuts would be inflationary.” Sternberg is right to call out this nonsense.

Tariffs would make specific goods and services more expensive. This is a relative price effect. It only shows up in the general price level if it affects enough prices to drive up the index—and even then it doesn’t really qualify as inflation, because it’s a one-time transition to a higher price level. Inflation means a higher growth rate for the price level.

Tax cuts aren’t inflationary, either. If anything, by incentivizing additional savings and investment, tax cuts may result in a small productivity boost, and hence mild disinflation. The crude Keynesianism Sternberg calls out, despite its consistent record of failed predictions going back more than 70 years, is still alive and well amongst economists who see themselves as efficiency engineers first and social scientists second. We can safely ignore them.

Next, Sternberg laments Fed decision-makers’ “groupthink,” explained in part by the concentration of authority in the “Washington-based Board of Governors in thrall to the central bank’s research department.” The “Fed’s independence from the rest of the government” amplifies its irresponsibility. It “means politicians and voters can’t enforce accountability.” Sternberg correctly highlights the Fed’s adoption of flexible average inflation targeting (FAIT) in August 2020 as an example of deep institutional flaws. The Fed is picking its own goals and deciding whether or not it has achieved them. In other words, it’s a judge in its own cause. That’s unacceptable for anyone who cares about the rule of law.

How to fix this? Sternberg suggests changing how the Fed makes decisions, so that regional Fed branches have more input. He also wants Congress to keep a closer eye on monetary policymakers. These are probably good ideas. At the margin, they would help. But we can and should do more.

Here are a few harder-hitting ideas for Fed reform:

Get rid of the dual mandate. It’s redundant. The Fed’s monetary policy activities should solely focus on price stability.
Pare back the Fed’s regulatory powers radically. The Fed should ensure banks are adequately capitalized against short-term liabilities. That’s it.
End further credit allocation. Close the discount window.
Shrink the balance sheet. Return to a “Treasuries only” policy for open market operations.
Stop paying interest on reserves. Ditch the floor system and return to the corridor system.

For even more radical (and effective) reforms, consider the following, in ascending order of implausibility:

Compel the Fed to stabilize the dollar, or current-dollar GDP, or a related nominal anchor. If central bankers fail, they get fired.
Eliminate the FOMC. Automatically grow the monetary base by a set percentage each year. Long live Milton Friedman!
Freeze the monetary base. Outsource monetary policy to the market. From now on, financial intermediation (banking) is the sole means by which the money supply changes. The only requirement is banks must redeem their liabilities for fiat dollars, the stock of which is now fixed.
Revive commodity money. The gold standard is massively underrated. It’s not as attractive an option if the US is the only economy on gold. But it’s still worth a look.

“Fed reform could be the nerdiest sleeper issue of this campaign season,” Sternberg concludes.

I can only wish. Americans are hopping mad about dollar depreciation. But even with 9-percent consumer price inflation during 2022, Congress never seriously considered changing how the Fed works. Nevertheless, it should. I hope Sternberg is right about citizens’ appetite for reining in the central bank – the hungrier, and nerdier, the better.

From The Daily Economy:

The Fed is a flawed institution at best, and a failed institution at worst. Sternberg suggests several reforms. While potentially helpful, none go far enough.

Here are a few harder-hitting ideas for Fed reform:

Get rid of the dual mandate. It’s redundant. The Fed’s monetary policy activities should solely focus on price stability.
Pare back the Fed’s regulatory powers radically. The Fed should ensure banks are adequately capitalized against short-term liabilities. That’s it.
End further credit allocation. Close the discount window.
Shrink the balance sheet. Return to a “Treasuries only” policy for open market operations.
Stop paying interest on reserves. Ditch the floor system and return to the corridor system.

For even more radical (and effective) reforms, consider the following, in ascending order of implausibility:

Compel the Fed to stabilize the dollar, or current-dollar GDP, or a related nominal anchor. If central bankers fail, they get fired.
Eliminate the FOMC. Automatically grow the monetary base by a set percentage each year. Long live Milton Friedman!
Freeze the monetary base. Outsource monetary policy to the market. From now on, financial intermediation (banking) is the sole means by which the money supply changes. The only requirement is banks must redeem their liabilities for fiat dollars, the stock of which is now fixed.
Revive commodity money. The gold standard is massively underrated. It’s not as attractive an option if the US is the only economy on gold. But it’s still worth a look.

“Fed reform could be the nerdiest sleeper issue of this campaign season,” Sternberg concludes.

The genius of the American experiment is that it allows for course correction — but only if we remember our role. Not as subjects, but as stewards.

Your role, good sir or wise gentle lady, is to continue doing what you’ve always done: managing your affairs with clear eyes and a steady hand, educating those who’ll carry the torch, and resisting the ever-present temptation to comply just for comfort’s sake.

Yes, the government will grow. Yes, the financial world may turn inside out before breakfast — possibly before your second cup of coffee. But you still have the right to think. To choose. To invest in your own way.

For now, the mixed economic data means stocks will likely trend higher, until there’s a crisis. And when there is a crisis, the Fed will finally make its move and aggressively cut rates.

And, for now, bond yields are still near their highest level in 15 years. Bond yields, even on U.S. Treasury bonds, are over the rate of inflation.

In short, it’s not a bad time to lock in bond yields now – which will go lower during a crisis, pushing bond prices higher. And in a crisis, today’s high-flying stocks, driven by retail investors with a fear of missing out – could easily get crushed.

Markets are humming, policy dazzles, but beneath the gloss — tech booms, liquidity surges, digital currencies — the very foundations of money, governance, and investor sentiment are cracking, realigning, even smoldering.

The post-World War II Pax Americana isn’t evolving; it’s being dismantled rather quickly.

What’s emerging is accompanied by a load of distraction and showmanship. So it’s important to focus on the actual events taking place right now that are going to affect your portfolio this year.

And, we can’t overstate this, the changes that are actually happening right now to your money.

Today, digital dollars masquerade as cash, tariffs are cloaked as protection, AI layoffs spun as productivity, private assets packaged as democratized. And yet, none of it matters if the final pillar — confidence — crumbles.

When belief falters, no trumpet of “seismic event” grants you shelter.

Private equity tends to perform better than the stock market, provided you do so over time.

Private credit, a newer asset class but a rapidly growing one, also shows strong returns, as well as relatively high current income.

And if you have a retirement account, chances are you’re willing to think long-term.

Win-win, right? Not necessarily.

First, these new funds would also come with an incentive structure similar to investing in a hedge fund. That includes a higher fee than a market index ETF – think 2% compared to 0.1% (or less).

Plus, many of these funds have a hurdle rate attached to them as well. Once they clear 5% returns – which, with private credit, can be easily cleared by making deals with cash returns over 5% – additional incentive fees may kick in.