If Fed Cuts Result In Inflation, Then Chair Powell Has Nothing To Fear

Credit is produced. Repeat the previous truth over and over again, and after internalizing the simple truth that we borrow money for what it can exchanged for.

That we borrow dollars to get things lays waste to the popular notion within the various economic religions that an “easy” Fed is an inflationary Fed. No, that’s not how it works. Markets are wise. The Fed can’t decree credit easy or tight, and they can’t because there’s no credit by decree in the first place. Credit is once again produced in the form of market goods and labor. The Fed produces neither, which is yet another comment that the Fed’s ability to influence economic activity is well overstated.

Still, for fun let’s imagine a la Wall Street Journal Fed-watcher Nick Timiraos that the Fed is capable of easing or tightening credit conditions by fiddling with the Fed funds rate. Timiraos suggests the Fed’s powers have put Fed Chairman Jerome Powell in a “No-Win Scenario.” In his words, the Fed could “cut rates sharply as Trump wants and risk fueling inflation that damages its credibility with markets. Or it could maintain its current wait-and-see stance, and face further bullying that would weaken its standing if the economy slows sharply and the administration is validated in its view that inflation shouldn’t be a worry.” Timiraos’s description of the Fed’s allegedly difficult choices firstly implies a false definition of inflation. In his defense, it’s the Fed’s false definition.

Specifically, economic growth does not cause inflation as Timiraos implies. If it did, Iran, Lebanon and Zimbabwe would be some of the highest growth locales on earth. More realistically, inflation is devaluation. Nothing else. That’s precisely why the rial, Lebanese pound, and the Zimbabwean dollar don’t much circulate in the countries mentioned. No producer would be so foolish as to exchange labor and market goods for “money” that has no trust in the marketplace.

From there, it must be said that economic growth by its very description is a sign of falling prices as is. That’s because economic growth is just another term for rising productivity, and the latter is an effect of investment that increases the production of more and more in the way of market goods at prices that continue to fall.

Still, let’s imagine inflation as Timiraos does, which is just the Journal reporter correctly reporting on what the Fed deems inflation. To its central bankers, lower rates of interest are the same as “easy credit” (the latter an impossibility, but let’s roll with it) that will allegedly cause the economy to grow and prices to rise. Ok, but if so, the allegedly higher inflation born of the Fed’s ease would logically result in higher market rates of borrowing. Geti it? If Fed fiddling is inflationary, credit sources eager to not lend in return for reduced returns will logically rein in their own lending.

Assuming the reverse whereby the Fed maintains its “wait-and-see” approach, the reverse applies. Assuming the Fed is the source of credit that economists imagine (it’s not, but let’s just assume), what it takes through so-called “tightness” will be made up for by credit providers outside the Fed, and who see an opportunity to lend profitably.

It’s just a comment about what’s true, that the only “closed economy” is the world economy. Assuming the Fed’s definition of inflation is real (it’s not), and assuming the Fed is a provider of credit (it’s not), the no-win scenario ascribed by Timiraos to Powell is anything but. Markets are powerful, and to say they can overcome central plans insults understatement.