The FED now has a new head. Kevin Wars took over as president of the US Federal Bank. What does that mean for the bank's markets and policies? To decode him, one must see his timeless views.
Wars is an old Fed acquaintance. Appointed to her board during the Bush junior presidency, she faced the 2008 crisis. Although he voted both the first and the second quantitative relaxation program, in 2008 and 2010, he always maintained his reservations. Deeply influenced by Milton Friedman, with whom he had worked as a student in Stanford, he firmly believes that the process of quantitative relaxation involves exceptional risks and is not panacea. Friedman constantly stressed that inflation is not a result, but a choice, and where inflation exists, there is an increase in the amount of money.
It is therefore appropriate to look back on the FED's policy and its implications. For almost 20 years.
Money is nothing but a declaration of faith. Faith that this paper (or the number anyone now sees in a mobile) can buy other goods or save. Money is created every time a private person gets a loan or every time he gets a loan. «Commercial» Bank borrows from the central bank. Money is created from nothing, and it is worth it from the faith we give it. The economy balances through a complex interest rate mechanism, and inflation remains under control. Of course, if you mess with the interest rate mechanism and start creating a lot more money, strange phenomena happen.
In undeveloped countries, money is constantly being created. Autocratic governments «print» cards with many zeros and values multiply. Unknown phenomena to the West. With the independence of central banks, money is limited, and the interest rates they set are a boring process that nobody deals with. In 2008 this changed. With quantitative relaxation, the FED purchased hundreds of billions of state American bonds and housing loans.
With money created from nothing. This process saved the economy. With the crash in the markets, liquidity had disappeared. Fear had prevailed and money was frozen. There were no transactions. Making FED money out of nothing and starting to buy bonds and loans, «It's gone.» the non-liquid financial system. From «boring» State organization overnight became the largest investor in the economy
Wars. He was totally in agreement with that. Extreme situations such as the 2008 crisis also need extreme measures. This process has been repeated three more times. In 2010, 2012 and 2020 (at pandemic). Money in the system in 2008 was about a trillion dollars. Now it's seven times more.
We now have the consequences of this.rod «tsunami» liquidityThe last decade, after the first three quantitative relaxations, was characterized by euphoria. Stock exchanges were rising without interruptions, inflation was nonexistent and growth satisfactory. Economists thought we were in a new era. Inflation belonged to the past. With unlimited money, the world becomes richer, having more valuable assets such as shares and properties, buying very cheap products from abroad and investing in new technologies and innovative ideas inside.
With the pandemic in 2020, the same prescription was used. The FED «Print» Once more money. Everything froze but the markets broke every record. The Trump government spent about 3 trillion to save the economy. But conditions had changed. With the supply chains having collapsed, the war in Ukraine and a Biden government that spent an additional $4 trillion with its election, quantitative relaxation showed its bad side. With $9 trillion in 2022 out of just 1 trillion in 2008, and state deficits unprecedented, inflation reached 9%. The unlimited money from the central bank had now distorted the economy. The tool introduced by the FED in 2008 as a lifeline from the worst debt crisis since 1929, has evolved into a low interest rate addiction that stopped responding to reality.
Wars thinks that Return to contractual monetary policy is necessary. He has repeatedly said that liquidity must shrink. Like Paul Volker in the early 1980s raised interest rates to 20% to fight inflation, so Wars assume will follow a corresponding recipe. He is not an advocate of high interest rates but has made it clear that he will try to normalize the liquidity now reaching $7 trillion. He wants to reduce it without creating turbulence in the global financial system. He has stated that this will be difficult.
At an initial stage, the credibility of the FED will be restored as guardian of inflation, which now for the fifth year exceeds the 2% target. Then a message will be sent to Congress and the White House, that the bank is no longer a pillar of budgetary policy. With quantitative relaxations, the precedent has been created and the belief that in every crisis, liquidity will increase and governments will have a blank cheque for reckless government spending. Wars wants this to stop.
With the only lever the short term interest rates, it will return to its original role, i.e. facilitating liquidity through the banking system. The reduction of US bonds in the central bank portfolio means that the US State will be directly exposed to the markets and therefore forced to impose budgetary discipline.
Where the equation becomes harder is on the part of housing loans. In addition to government bonds, the FED holds about $2 trillion in housing loans. This intervention, particularly in 2020-2021, created one of the largest explosions in property values in the US. Millions of Americans bought homes, locking very low interest rates, about 2%, for 30 years. Now, with housing rates close to 7%, the house market is impossible. If Wars reduces this portfolio, their interest rates will increase even more.
The reality facing the new president is Very complex. Η μαζική συρρίκνωση της ρευστότητας είναι ένα φαινόμενο που θα συμβεί για πρώτη φορά. Η επιστροφή στην κανονικότητα, μετά από σχεδόν 20 χρόνια χαλαρής νομισματικής πολιτικής, μοιάζει με ειδική αποστολή στα τυφλά. Το πετρελαϊκό σοκ που ζει η οικονομία δυσκολεύει την αποστολή. Η Τεχνητή Νοημοσύνη, από την άλλη, υπόσχεται έκρηξη της παραγωγικότητας και της ανάπτυξης.
Αν το πετρελαϊκό σοκ κοπάσει και η Τεχνητή Νοημοσύνη φέρει πράγματι μεγάλη ανάπτυξη, τότε η δουλειά του Γουόρς θα περάσει απαρατήρητη. Η οικονομία θα προσαρμοστεί, και η FED θα υποχωρήσει στο παρασκήνιο. Ειδάλλως, μπορεί να περάσει από δυσκολίες όπως αυτές της περιόδου Βόλκερ.
Είναι ο Γουόρς, ο νέος Βόλκερ;
* Elias Arvanitakis is an Economist – Analyst, Morgan Stanley
