If You Must Point Fingers on Inflation, Here’s Where to Point Them

As the midterm elections draw nearer, a central conservative narrative is coming into sharp focus: President Biden and the Democratic-controlled Congress have made a mess of the American economy. Republicans see pure political gold in this year’s slow-motion stock market crash, which seems to be accelerating at the perfect time for a party seeking to regain control of Congress in the fall.

The National Republican Congressional Committee in a tweet last month quipped that the Democratic House agenda includes a “tanking stock market.” Conservatives have been highlighting a video clip from 2020 in which President Donald Trump warned about a Biden presidency, “If he’s elected, the stock market will crash.” The right-wing pundit Sean Hannity’s blog featured the clip under the headline “Trump Was Right.”

But the narrative pinning blame for the economy’s woes squarely on Democrats’ shoulders elides the true culprit: the Federal Reserve. The financial earthquakes of 2022 trace their origin to underground pressures the Fed has been steadily creating for over a decade.

It started back in 2010, when the Fed embarked on the unprecedented and experimental path of using its power to create money as a primary engine of American economic growth. To put it simply, the Fed created years of supereasy money, with short-term interest rates held near zero while it pumped trillions of dollars into the banking system. One way to understand the scale of these programs is to measure the size of the Fed’s balance sheet. The balance sheet was about $900 billion in mid-2008, before the financial market crash. It rose to $4.5 trillion in 2015 and is just short of $9 trillion today.

All of this easy money had a distinct impact on our financial system: It incentivized investors to push their money into ever riskier bets. Wall Street types coined a term for this effect: “search for yield.” What that means is the Fed pushed a lot of money into a system that was searching for assets to buy that might, in return, provide a decent profit, or yield. So money poured into relatively risky assets like technology stocks, corporate junk debt, commercial real estate bonds and even cryptocurrencies and nonfungible tokens, or NFTs. This drove the prices of those risky assets higher, drawing in yet more investment.

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The Fed has steadily inflated stock prices over the past decade by keeping interest rates extremely low and buying up bonds — through a program called quantitative easing — which has the effect of pushing new cash into asset markets and driving up prices. The Fed then supercharged those stock prices after the pandemic meltdown of 2020 by pumping trillions into the banking system. It was the Fed that primarily dropped the ball on addressing inflation in 2021, missing the opportunity to act quickly and effectively as the Fed chairman, Jerome Powell, reassured the public that inflation was likely to be merely transitory even as it gained steam. And it’s the Fed that is playing a frantic game of financial catch-up, hiking rates quickly and precipitating a wrenching market correction.

So now the bill is coming due. Unexpectedly high inflation — running at the hottest levels in four decades — is forcing the Fed to do what it has avoided doing for years: tighten the money supply quickly and forcefully. Last month the Fed raised short-term rates by half a percentage point, the largest single rate hike since 2000. The aggressiveness of the move signaled that the Fed could take similarly dramatic measures again this year.

A sobering realization is now unfolding on Wall Street. The decade of supereasy money is likely over. Because of inflation’s impact, the Fed likely won’t be able to turn on the money spigots at will if asset prices collapse. This is the driving force behind falling stock prices and why the end of the collapse is probably not yet in sight. The reality of a higher-interest-rate world is working its way through the corridors of Wall Street and will likely topple more fragile structures before it’s all over.

After the stock and bond markets adjust downward, for example, investors must evaluate the true value of other fragile towers of risky assets, like corporate junk debt. The enormous market for corporate debt began to collapse in 2020, but the Fed stopped the carnage by directly bailing out junk debt for the first time. This didn’t just save the corporate debt market but also added fuel to it, helping since 2021 to inflate bond prices. Now those bonds will have to be repriced in light of higher interest rates, and history indicates that their prices will not go up.

And while the Fed is a prime driver of this year’s volatility, the central bank continues to evade public accountability for it.

Just last month, for instance, the Senate confirmed Mr. Powell to serve another four-year term as Fed chairman. The vote — more than four to one in favor — reflects the amazingly high level of bipartisan support that Mr. Powell enjoys. The president, at a White House meeting in May, presented Mr. Powell as an ally in the fight against inflation rather than the culprit for much of this year’s financial market volatility. “My plan is to address inflation. It starts with a simple proposition: Respect the Fed and respect the Fed’s independence,” the president said.

This leaves the field open for the Republican Party to pin the blame for Wall Street’s woes on the Democratic Party’s inaction. As Representative Jim Jordan, Republican of Ohio, phrased it on Twitter recently, “Your 401k misses President Trump.” This almost certainly presages a Republican line of attack over the summer and fall. It won’t matter that this rhetoric is the opposite of Mr. Trump’s in 2018 and 2019, when the Fed was tightening and causing markets to teeter. Back then he attacked Mr. Powell on Twitter and pressured the Fed chairman to cut interest rates even though the economy was growing. (The Fed complied in the summer of 2019.) But things are different now. Mr. Biden is in office, and the Fed’s tightening paves a clear pathway for the Republican Party to claim majorities in the House and Senate.

Republicans have also homed in on Mr. Biden’s $1.9 trillion American Rescue Plan, meant to mitigate the impact of the Covid-19 pandemic, as a cause for runaway inflation. Treasury Secretary Janet Yellen rejected that, noting in testimony before members of Congress: “We’re seeing high inflation in almost all of the developed countries around the world. And they have very different fiscal policies. So it can’t be the case that the bulk of the inflation that we’re experiencing reflects the impact” of the American Rescue Plan.

Democrats would be wise to point to the source of the problem: a decade of easy money policies at the Fed, not from anything done at the White House or in Congress over the past year and a half.

The real tragedy is that this fall’s elections might reinforce the very dynamics that created the problem in the first place. During the 2010s, Congress fell into a state of dysfunction and paralysis at the very moment its economic policymaking power was needed most. It should be viewed as no coincidence that the Fed announced that it would intensify its experiments in quantitative easing on Nov. 3, 2010, the day after members of the Tea Party movement were swept into power in the House. The Fed was seen as the only federal agency equipped to forcefully drive economic growth as Congress relegated itself to the sidelines.

With prices for gas, food and other goods still on the rise and the stock market in a state of flux, there may still be considerable pain ahead for consumers. But Americans shouldn’t fall for simplistic rhetoric that blames this all on Mr. Biden. More than a decade of monetary policy brought us to this moment, not 17 months of Democratic control in Washington. Voters should be cleareyed about the cause of this economic chaos and vote for the party they think can best lead us out of it.

Christopher Leonard (@CLeonardNews) is the author, most recently, of “The Lords of Easy Money: How the Federal Reserve Broke the American Economy” and the executive director of the Watchdog Writers Group at the Missouri School of Journalism.

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