What if the Fed is wrong - again?

The Federal Reserve is only human and does make mistakes. But some of these mistakes have been whoppers.

  • Tightening the money supply at the beginning of the Depression.
  • Dumping the gold standard in 1972 with no preparation.
  • Failing to regulate the mortgage banks in the 2008 runup.

The gold standard came into being in the 18th century to solve the problem of multiple currencies and prior disasters with paper money such as John Law's plan to relieve the debt burden of the French Regency. However by the mid-20th century the size and growth of the global economy reduced its usefulness. For a time the US dollar, backed by gold, took its place. Inflation was non-existent by definition.

Nixon's administration found it hard to keep up to this standard in large part due to increasing oil imports. Rather than devalue the dollar or raise interest rates to attract gold reserves (he was running for election), Nixon talked the Federal Reserve into dropping the convertibility of dollars into gold and going the paper money route. The OPEC countries responded by tripling the price of oil in dollar terms.

The result was a prolonged recession and rapid inflation. As shown in the chart to the right, prices doubled in the next decade.

Inflation has continued since than but at a slower pace - doubling every 30 years.

The crisis of 2008 introduced a new element - quantitative easing, including outright purchase of a government's debt by its central bank. John Law rides again!

If this turns out to be a mistake and a lost decade is ahead of us, note that all asset classes had negative annual real yields for that decade except:

  • Gold (14%)
  • Real Estate (14.6%)
  • Commodities (6.2%)
June 8, 2021

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