Chief Investment Strategist, The Freeport Society
President Trump really wants a rate cut.
He wants one badly enough to push for the immediate resignation of Fed governor Lisa Cook on the grounds that she might have fudged a mortgage application to get a better rate.
Whether or not Trump nudges Cook out the door, he’s likely to get his cuts. The Fed funds futures market is pricing in two cuts this year.
I’ll spare you another rant on why it’s a terrible idea to lower rates while inflation still refuses to die and the stock market looks more and more bubbly by the day.
Instead, let’s look at the bigger picture.
Why do we have a Fed?
What does it do?
And could we just abolish it (or at least some of its current responsibilities)?
You know the quote attributed to Einstein…
“The definition of insanity is doing the same thing again and again and expecting a different result.”
Well, we keep expecting the Fed to do its job without inflating or destabilizing financial bubbles. But that never quite seems to work out.
So, let’s go back to the source.
Not Even Morgan Was Immortal
This is hard to imagine today, but when we had a major, 2008-style financial panic in 1907, Wall Street didn’t run to the Fed for help.There was no Fed to run to.
Instead, they ran to John Pierpont Morgan.
Mr. Morgan used his clout and connections to cobble together a pool of funds to stabilize the system.
Obviously, that’s a problem.
You can’t have the livelihoods of millions of people dependent on one man… even a banking legend like Morgan. It worked in 1907… but there’s no guarantee it would work the next time or ever again.
The core motivation to create the Fed was to serve as a lender of last resort. In plain English, this means the central bank could play the role Morgan did, stepping in to provide emergency loans to banks to avoid a string of bank failures.
There were other reasons
Before the creation of the Fed, every individual bank could issue its own dollar banknotes. There wasn’t much of a central clearing system in place. A central bank could improve these functions.
But the key role – the major selling point – was that the Fed could provide a backstop so that bank failures would be managed orderly and not result in a cascade.
The Fed didn’t take on the role of managing monetary policy as we think of it today – actively setting and influencing interest rates – until the 1950s.
What Does the Fed Do Today?
Over time, the Fed’s role has grown. It still serves as a lender of last resort, of course. But on a day-to-day basis, its job is mostly focused on setting interest rates, regulating and supervising banks, and maintaining the payments system.
It’s proven to be wildly ineffective in most of these roles.
For the last four years, we’ve had persistent inflation thanks to the excessive stimulus the Fed pumped into the financial system in 2020 and 2021
Its regulation of the banks didn’t prevent them from taking absurd risks in mortgage securities in the run-up to the 2008 crisis.
And the prospect of additional interest rate cuts now is inflating yet another bubble, this time in AI stocks.
So, how do you fix this mess?
I don’t know if we can.
Going back to a gold standard, while appealing, isn’t a magic bullet. And it would be political suicide to implement.
Scrapping the Fed entirely would return us to a day when Wall Street’s biggest banks served as a de facto central bank. We really don’t want to give Wall Street more power than it already has.
So, what’s the solution?
As a start, strip the Fed of its ability to set discretionary monetary policy. It’s clearly not very good at it. Take that power away and let the free market set interest rates.
Next, eliminate quantitative easing. No more multi-trillion-dollar bond buying schemes.
But the lender-of-last-resort role probably needs to stick around. I hate it on principle. It creates a moral hazard. Banks will take more risk if they know they can run to the Fed in an emergency. But it’s still better than a cascade of bank failures taking the entire system down.
I’m not delusional. I know none of this will ever happen.
That’s why I hold on to my gold and Bitcoin. You should too. The Fed can’t run those two assets into the ground.
To life, liberty, and the pursuit of wealth.