Why does the Fed want higher inflation?
''The Fed believes we should welcome their efforts to boost inflation so that the market-determined interest rate will rise higher, thereby allowing the Fed to step in and cut the market rate a lot (versus a little). That idea is worse than silly - it is economists attempting to construct their latest, idealistic vision of how the U.S. economy and financial markets should operate.
The one thing we do know from history is that the Fed will fail, and we will be the worse off for it. Economic history is littered with economist-instigated damage. Much of it was well intentioned, but flawed - usually by looking backwards, fearing the last problem and relying too much on ivory tower thinking.
Inflation! It is a burden that produces dislocations and inequalities throughout the economy, growing more serious the higher it goes. Moreover, inflation creates its own significant, but economically unproductive, activity aimed at dealing with, compensating for and protecting from inflation. Additionally, it creates incentives and fears that cause people to take actions they later regret.
How bad is inflation, really? Looking at what has happened recently, the average $12+ trillion of dollars in short-term accounts and investments over the past ten years have lost about 15% of their purchasing power (about 20% inflation minus about 5% interest received from 3-month UST Bills). Remember, this loss was in a ''too low'' inflationary environment.
In dollars, the lost purchasing power was about $1.8 trillion. Add in a ''real'' rate of return and the loss could be double that figure. Which raises the question (and provides the answer) about their being ''losers'' from the Fed's near-0% interest rate policy carried out for so many years. So, clearly savers were stiffed. How about the benefit -- how did the wealth transfer from savers (and investors and institutions that needed to hold cash reserves) benefit the country? Obviously, there are the borrowers, but then we hit the unknown -- what did they do with that low-cost money?
Importantly, inflation (degradation and debasement) is an age-old problem that has caused many crises. In an old investment book, I read this insightful comment by a wealthy man: ''Inflation! It is my greatest concern. I would gladly give up half of my assets if I could be assured that the other half would retain its current value.''
So, will the Fed back down?
Probably not. The Fed self-touts its lengthy low interest rate policy as a success. Without opposition to that view, the Fed has the support and independence for carrying out this higher inflation strategy.
As investors, we may well be reentering the bad-ol' days of the 1970s of big deficits, big debt, higher-than-desired inflation and… yes, higher than desired interest rates. The lesson from that time underscores the significant risk of having the Fed pursue higher inflation. By the late 1970s, the inflation engine was running so fast and the effects were so widespread that the then-current Fed could do nothing about it. It took Ronald Reagan's new fiscal policies and the drastic steps of his new Fed Chairman, Paul Volker, to bring inflation under control. However, prior to mid-1982, when the stock market jumped as it saw success around the corner, the first 18 months into Reagan's initial term were mighty uncertain and unhappy days.''