The US election cycle is focusing on all the usual issues: personalities, inflation, identity, the environment, foreign relations and geopolitics. Yet the one subject that could affect the global economy and the finances of everyone on the planet has completely escaped discussion: will the Fed remain independent? Or will it be shanghaied into lowering rates to absorb the massive debt build-up?
Monetarism is a system whose core values may befuddle a mortal’s understanding of a national economy. The way a country works is very different to that of households and businesses. There the rule is simple: earn more than you spend. One may borrow to acquire an asset or stay afloat, but within strict limits.
None of that applies to countries. Since 1971, countries can legitimately create money out of thin air, allowing them to operate in the red for a very long time. So where economists often talk about recessions and debt defaults as an inevitable result of certain policies, policymakers grinningly remind themselves that in the modern world these ugly notions are simply… choices.
“The Buck Stops Here” Harry S. Truman used to say. Governing means making choices. A government often chooses to avoid a recession by borrowing more. When the debt becomes too onerous, it is again faced with a choice. Will it incur the consequences of defaulting? Or will it print more money and devalue its currency?
In the past two decades, debt rose precipitously. Governments borrowed heavily, to absorb enormous quantities of bank debt and avoid crashing capitalism in the wake of Lehman’s collapse. And borrowed again after the pandemic lockdowns. From 1999 to 2023, global total debt-to-GDP rose from 220% to 331%. However, debt is different pre-2008 and after. Pre-2008, developed market debt was mainly incurred by banks, who lent out the money mostly to finance businesses and real estate. After 2008, banks were forced to delever and governments picked up the tab to stabilize the financial system. That debt was used to plug holes and reinforce social security. As such, it was less productive. With the world still reeling from the Global Financial Crisis, Developed economies saw GDP growth fall from 2.8% in prior years to 1.6%.
So we have more debt and less growth to pay for it. According to US Congress, interest payments could reach 4% of GDP. If the country grows at 2%, that debt becomes unsustainable.
The government controls the amount of debt and will often incur as much as it can. But it is the central bank who controls the interest on the payments. An independent central bank will prevent inflationary money and act as a counterbalance to a government’s choice to grow at all costs. Hiking rates curbs growth and increases budgetary expenditure.
But what if the central bank wasn’t independent? Not many governments dare to consider that. Turkey, who did, faced 80% inflation. Central banks are the sacred cows of our economic system, beyond scrutiny. Yet, the norm-breaking former US President Donald Trump attacked the Fed’s rate hikes and questioned whether he could replace Chairman Powell. What’s to say that, re-elected, he would not seek high growth, even at the expense of the central bank’s independence? And what’s to say that other nationalistic governments in Europe might not seek to follow that example? Why should they allow central bankers to regulate growth, instead of elected officials?
This would have a profound impact on inflation and yields. A non-independent central bank could be forced to keep rates low, even as inflation rose significantly. Just like when Richard Nixon broke the Bretton Woods system in 1971, there’s an argument to try everything.
The world saw 20% inflation thereafter. Will history repeat itself?
