Greg Ip Unwittingly Reveals the Fed's Toothless Existence

Several weeks ago Wall Street Journal columnist Greg Ip got it half right. In an article with the subhead of “The Federal Reserve and other central banks for years had the power to steer booms and busts,” Ip acknowledged that the alleged power of the wannabe fine-tuners to plan growth spurts and contractions is on the wane.

Ip’s mistake was in presuming the Fed ever had the power to engineer economic outcomes in the first place. No, not really. Evidence supporting the previous claim has long been the size of the U.S. economy itself. If it had ever been so easily susceptible to Fed planning, then it’s a safe bet that the U.S. economy would never have been big enough to steer to begin with. Central planning fails, and it always has. To believe as Ip supposes, that the Fed was in the past literally orchestrating the good and bad times of the most dynamic economy in the world, is hard to take seriously.

Never forget that interest rates are, other than the dollar, the most important prices in the world. They are simply because they represent the cost of accessing all goods, services and labor on offer. If central bankers were actually planning these prices, imagine the chaos. The Fed’s power has always been quite a bit more theoretical than real.

And what’s true in the U.S. is true for the rest of the world. Figure that Nigeria has a central bank, so does Kenya, and so does Peru. Knowing this, does anyone seriously think that each impoverished country listed would boom if the “right” central bankers were pulling the proverbial economic strings? The question answers itself.

Which brings us to Ip’s column from January 30th. He was addressing the belief expressed by climate alarmists at Davos that banks have the power to arrest the theory that is global warming. Among others, prominent warming alarmist Greta Thunberg demanded that financial institutions “Immediately and completely divest from fossil fuels.” Ip’s response to Thunberg’s illiterate rantings was quite a bit more than good.

As Ip put it about the laughable notion of divestment, “it isn’t going to shrink the fossil-fuel industry. Capital and oil are the world’s two most fungible commodities. Choke off one source of money – say, bank loans – and another will fill the void.” Readers would be wise to read, and re-read the Ip quote. As for central bankers, along with the myriad economists, politicians and reporters who naively worship at the altar of central banking, they would be wise to tape Ip’s rejection of Thunberg to their bathroom mirrors, and anywhere else they find themselves staring with any kind of frequency.

Though he may not have meant it, Ip pithily explained why central banks aren’t powerful now, and why they’ve never been. The dictionary definition of “fungible” is “able to replace or be replaced by another identical item, mutually interchangeable.” The dollars businesses seek that are globally exchangeable for goods, services and labor are the picture definition of interchangeable, which is a reminder that the Fed’s power has once again always been theoretical.

For all this time economists, pundits and reporters have bought into the laugh line that the Fed can increase or shrink capital access through a rate mechanism meant to influence the quantity of loanable funds at U.S. banks. Ok, but U.S. banks are but one source of dollars in a world where dollars facilitate resource allocation globally. Nothing is more interchangeable, and nothing is more fungible, than the dollar.

At which point money goes to where it’s treated best. That’s why dollars are abundant in Greenwich, but rather scarce 28 miles up I-95 in Bridgeport. The dollar disparity between the two cities isn’t a central bank thing, or a planned outcome engineered by economists, rather money migrates to where it can get a return. And it migrates away from where it won’t.

Applied to the Fed, implicit in the mysticism surrounding its faux monetary magic is that the central bank can expand and contract the U.S. economy by simply fiddling with interest rates, so-called “money supply,” “yield caps,” and countless other tricks dreamed up by the unoriginal minds in its employ. Actually, the Fed can’t. Ip explains why: “Choke off one source of money – say, bank loans – and another will fill the void.” Exactly.

Whatever the Fed allegedly takes, the global credit system will return within seconds. Dollars are relentlessly circulating around the world as a reflection of goods, services and labor relentlessly being pushed by market forces to their highest use. It’s a reminder that if the Fed presumes to “tighten” and market actors disagree, the Fed’s actions will be utterly meaningless. If anyone doubts this truth, imagine the Fed selling bonds in size fashion to Greenwich banks with an eye on shrinking loanable dollars there. How long do readers think such an attempt to choke off credit access will last?

Conversely, imagine the Fed buying bonds from Bridgeport banks in size in order to increase loanable funds there. Do any readers seriously think such a situation won’t be corrected by market forces within seconds?

Applied to the U.S. economy overall, Fed authored “rate hikes” have long been billed as evidence of “tightening,” and “rate cuts” evidence of “ease.” Oh please. Just as the alarmist crowd could never keep funds from flowing to oil companies, neither can the Fed keep funds from migrating to the growth parts of the overall economy. The Fed can’t overwhelm market realities; at best it can confirm them.

It’s said a lot in this column, but in time what’s obvious about the Fed’s ineffectual nature will be accepted wisdom. Maybe a few more years. Soon enough the proverbial light bulb will switch on for more and more people about capital’s fungible nature, and by extension how limited is the Fed’s ability to influence anything. Ip’s arguably unintentional utterance on the printed page is only the beginning.