2023-03-20 11:27:02 ET
Summary
- The Federal Reserve must continue to try and reduce inflation, but it must also work to keep members of the financial system from failing.
- The fight against inflation cannot be set aside at this time because that would make it even harder for the Fed to come back and fight it later.
- Furthermore, the Federal Reserve needs to be less "rigid" in conducting policy and get away from model-based policy programs, so as to be more "market" sensitive.
- This will be a difficult time for investors, and investors not only need to take their time in making investments, but must also be aware of how regulators are moving to correct things.
- Policymakers have created this environment over a long period of time, and things are not going to be corrected overnight.
Inflation must be brought under control!
The Federal Reserve needs to raise its policy rate of interest by at least 25 basis points this week.
Inflation is a longer-term problem, and a substantial cause of all the disequilibrium that exists within the banking system and, also, in the real economy.
If the fight against inflation is put to the side for the time being, the financial system and the economy will remain distorted for a much longer time.
The problems in the banking system?
Yes, the Federal Reserve, the FDIC, the Department of Justice, and the Securities and Exchange Commission need to be active. Bank customers need to be protected.
But, inflation is not going to go away all by itself, and the longer the inflation is allowed to survive, the longer it is going to take to bring inflation under control.
The situation did not arise all by itself.
We read in the Financial Times that Larry Fink, the founder and chief executive of the $8.6 trillion fund BlackRock, claims, in a letter to investors and chief executives, that the current situation we find ourselves in is the "price we're paying for decades of easy money."
In other words, decades of easy money has created the distortions and disequilibrium positions the economy now finds itself facing.
Mr. Fink goes on to talk about how everything is starting to fall apart.
Add to this the geopolitical tensions that exist and the global fragmentation that has happened and you have real problems.
If this round of inflation is not put to rest, the "inflation will persist and be more difficult for bankers to tame" in the future.
This approach will not be easy, but it must be done.
The problem is that policymakers have created the current disarray that exists and now must deal with it.
"Kicking the can further down the path" is not going to provide us with a solution.
Yes, the resolution of the distortions may be very costly, but the policymakers are the ones that got us here and we don't want to let them get away by pushing the problems onto another generation of policymakers.
We need to put a stop to inflation...now!!!
Insight
But, Kevin Warsh gives us some other advice.
Mr. Warsh was formerly a member of the Board of Governors of the Federal Reserve System.
He argues in an op-ed piece in the Wall Street Journal , that the Federal Reserve needs to "break conventions" to break inflation,
The Federal Reserve, Mr. Warsh writes:
"should get out of the business of forward guidance. It should stop providing forecasts for the path of interest rates."
"The economy is irreducible to a model or a machine; it's a dynamic, fragile ecosystem."
"The Fed needs complete agency to adjust its policies in a rapidly changing environment."
Federal Reserve officials need to be market driven and not dependent upon complex macro-econometric models.
Should the Fed buy $120.0 billion in securities every month for about 20 months, regardless of anything else going on in the market place?
This was the period referred to as "Q4" or "quantitative easing 4" which took place under the leadership of Jerome Powell.
Mr. Warsh ends by writing, "A regime change in economic policy is necessary to bolster the American economy and rebuild public consent."
Moving Ahead
We don't want a lot of bank failures in the banking system in the near future.
So, policymakers must pay attention to the conditions of the banking system.
One thing we do observe, even within the recent failures: the commercial banking system and commercial banks have lots and lots of cash around, more than $3.0 trillion.
Commercial banks also seem to be well capitalized, in general.
But, how commercial bank managements have managed their balance sheets, especially middle-sized and small commercial banks, have left a lot of banks exposed to events like those exhibited by SVB (SIVB) and Signature (SBNY) banks. This is also true of First Republic Bank (FRC) and, also internationally, Credit Suisse (CS), and some other European banks.
Some figures coming to light indicate that maybe 200 American banks are at risk of "coming up short" in the near future. These banks have securities underwater or have some not-so-good assets on their balance sheets.
The government and the regulators need to be prepared to handle this potential failures.
But, the government also needs to fight inflation.
As Mr. Fink warns us, in his letters to the public, the damage has been done over a long time.
People were lulled into not fully doing their jobs. People were fooled by the use of the new information technology. People, thought times were pretty good, going through the longest period of economic expansion in U.S. history.
And, now, we must deal with what we didn't deal with in the past.
Hard Time For Investors
This makes it a hard time for investors.
The government must combat inflation.
Government must protect the banking system.
And, investors must fit somewhere into this picture.
One real problem is that many bank failures will be surprises, much as the recent mix of failures went primarily unrecognized.
But, within such an environment there will be some real buys.
I would say right now, the commercial banking industry is going to experience a rough year or two. And, inflation is not going to be easy to bring down. Mr. Fink, inflation can only come down to the 3.5 percent to 4.0 percent range in the near future.
This will mean that the Fed will need to keep the pressure on to fight inflation for some time still.
And, this will not help stock market prices.
Investors are going to need to be patient and careful.
For further details see:
The Federal Reserve Must Stop Inflation