The Good, the Bad, and the Fed Part 2: Inflation, Incompetence, and Interest Rates

In August 2014 oil prices started to decline from the $100 – $110 range. They declined steadily into November. On November 7, 2014, Saudi Energy Minister Al-Naimi announced in Vienna they would not cut oil production to support prices. They would maintain production rates to maintain their market share and let the U.S. companies which were developing “tight” formations go out of business.  

So started a price war between OPEC and U.S. producers. US production quickly started to decline. The oil price declined to the $30 to $35 range by the end of the following year. Over 200 bankruptcies followed in the US oil and gas industry over the next two years.     

Federal Reserve Chairman Janet Yellen testified to Congress she did not know why the price dropped and that it was unexpected, a complete surprise. This was an appalling admission of incompetence from one of the longest-serving U.S. high economic policy officers. It was her agency’s Quantitative Easing (QE) policies which caused the oil price to rise and to drop and she did not know it.

Quantitative Easing is a process of creating new U.S. dollars and injecting them into the economic system thus diluting the value of dollars. The Saudis increased oil prices in response to the Fed starting QE in 2010. Reducing and then ending QE in 2014 triggered the oil price decline which led to Al-Naimi’s announcement. The Saudis let it fall through their traditional $75 support level to the low $30s to kill the U.S. Shale Revolution which had nearly doubled U.S. production.    

Janet Yellen has been involved with the Federal Reserve since 1977 and in top policy-making positions since appointment to the Fed Board of Governors in 1994. Her testimony exposed the Fed making policy without understanding its consequences, or the role of the dollar in international trade, or the close interrelationship between oil markets and international financial systems. 

Now, in our current state of economic confusion and energy crisis, she is Secretary of the Treasury, dreaming up useless ideas such as an irrelevant price cap on Russian oil. She even admitted in interviews with the Wall Street Journal that, while at the Fed, she did not fully understand what was happening in the subprime mortgage crisis of 2007-8. She also indicated she is pretty vague about anything else that leads to a crisis until it is a crisis. 

She is joined by Jerome Powell at the Fed. Powell started denying inflation was a problem in early 2021 even though the Biden-Schumer-Pelosi team was passing trillions of dollars of new spending for vague purposes.

The Fed did not increase interest rates until March 2022, well after every consumer knew prices were going up at the gas pump and grocery store. Why does it take so long for these people to realize they have a problem? Could it be because they do not include food or energy (gas pump and utility bills) in their inflation calculations? That makes sense for really understanding the economy outside university economics departments, right?    

Inflation and interest rates continue to rise. 

Milton Friedman died in 2006 before the subprime mortgage crisis or the current pandemic/Ukraine/energy crisis. But he understood the current situation exactly:

“There is one and only one basic cause of inflation: too high a rate of growth in the quantity of money. All other alleged causes of inflation – trade union intransigence, greedy business corporations, spend-thrift consumers, bad crops, harsh winters, OPEC, and so on – are either consequences of inflation or excuses by Washington, or sources of temporary blips of inflation.” 

If the price of oil caused inflation why did the rising and high prices from 2004-14 not cause inflation? Inflation during this period, except for a few quick spikes, stayed below 4% and generally trended downward as oil prices surged up from around $30 to over $100 with spikes up and down until 2014 when it dropped to the low $30s again.  

With Bernanke as Chairman and Clueless Janet as Vice Chair, the Fed dropped interest rates to nearly zero in 2014 and Janet maintained them there when she became Chairman until late 2015.  Powell dropped them again in 2020. Books are being written about the economic distortions and damage caused by such prolonged low interest rates.  

Friedman admonished against Fed policy which targeted interest rates “specifically the Federal funds rate, rather than monetary aggregates, and continued to adjust its interest rates targets only slowly and belatedly to changing market pressure.” He further noted the Fed is generally too slow lowering the Fed Funds Rate causing a sharp deceleration of monetary aggregates and a recession.  

Thus, the Fed’s practices are not effective for controlling inflation but run a risk of causing recession. A recent study showed the Fed wrong 71% of the time predicting inflation and wrong 83% predicting GDP growth. How can they determine proper monetary policy? 

Oil is the largest component of international trade. 

In 1974, Petrodollar was created by agreement with the Saudis that all revenues received for their oil in excess of what they need for internal use would be used to purchase U.S. Treasury bonds.  

This ensured the dollar as the international reserve currency and closely intertwined the oil markets in the international finance system.

Oil prices do not cause inflation. They are not established by oil companies. They are manipulated by foreign governments protecting their own interests and responding to Federal Reserve and Treasury Department policies – particularly those they consider inflationary or dilutive of dollar value. Monetary policy causes inflation.

The staff and policy makers of the Fed and Treasury seem to understand little of this and are oblivious to the consequences of what they do.  

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