The FOMC released its latest monetary policy statement. The Fed is hiking its target rate by 25 basis points. It was not completely certain this time around with the new banking crisis. It was possible that the Fed could have paused its rate hikes.

In the second paragraph of the statement, it states: “The U.S. banking system is sound and resilient.”

That is the howler of the year right there. If you ever want to understand the term gaslighting, that is it right there.

The Fed might just as well say: “It’s ok, citizens. We just hit a minor bump in the road. Never mind the inverted yield curve. Never mind price inflation. Never mind the failing banks. Unemployment is low and the economy is looking good. We just need to tweak a few things.”

In Jerome Powell’s press conference, he assured us that the balance sheet expansion was just temporary.

Monetary Inflation – Two Steps Forward, One Tiny Step Back

If you look at the Implementation Note from the statement, there are a couple of key bullet points that stayed the same.

The Fed will continue to roll over Treasury securities exceeding $60 billion per month and mortgage-backed securities exceeding $35 billion per month.

This means that the Fed will not roll over $95 billion per month. So the maturing debt will come off the balance sheet. The balance sheet – the base money supply – should be going down by about $95 billion per month.

But in the previous two weeks in the midst of a banking crisis, the Fed added about $300 billion to its balance sheet. So it negated over three months worth of balance sheet reduction in a matter of a couple of weeks.

So it’s real nice of the Fed to fight price inflation by draining its balance sheet by not rolling over some maturing debt, but they are adding new debt to the balance sheet in some other form.

What kind of a game is this? Does it make a difference if you don’t roll over $95 billion in maturing debt but then just add $300 billion in new debt? It would be the same thing as rolling over all of the maturing debt and just adding an additional $205 billion this month.

But don’t worry, the U.S. banking system is sound and resilient.

Resiliency with a Money Making Machine

Maybe it’s not wrong to refer to the banking system as sound and resilient. Anything can be sound and resilient with nearly unlimited funds.

The primary goal of the Federal Reserve isn’t low unemployment and price stability. The primary goal is to act as a lender of last resort to the major banks. March 2023 has demonstrated that well. (Its other main goal is to fund the deficits from Congress.)

The Fed is not exactly bailing out the banks that are failing in this case. They seem to be letting the people running the banks off the hook, but the banks will likely technically go bankrupt. But the Fed is bailing out the depositors.

They are also implicitly bailing out the entire banking system by giving assurance that they will do anything necessary to stop major bank runs.

So if a bank looks shaky, depositors are far less likely to make a run on the bank, knowing that the Fed is there. The “Fed put” isn’t on the stock market. The “Fed put” is on the banking system. It encourages bad banking practices to continue.

Tight Money or Loose Money?

While the Fed has expanded its balance sheet in recent weeks, it just hiked its target federal funds rate by 25 basis points.

There is a major disconnect there. Prior to 2008, the Fed generally controlled its balance sheet by raising or lowering its target rate. A higher rate generally correlates with a stable or declining money supply.

It’s not likely that the Fed can continue this practice easily. This may have been the last rate hike for a long while. Maybe we’ll see one more 25 basis point hike at the next meeting if things stay relatively calm.

Regardless of the Fed’s rate hike, the balance sheet has expanded again. It is difficult to fight price inflation when you are expanding the money supply.

We could go in either direction at this point. It could be a major recession, or it could be higher price inflation. It’s possible that we will get both.