Galbraith: The Fed Is Like The Little Dutch Boy With The Finger In The Dike

There hasn’t been inflation in the economy since the early 1980s. It collapsed with the end of the Soviet Union and with the rise of China as a supplier for consumer goods. So the Fed has been patting itself on its back for decades [of] holding back a phenomenon that doesn’t exist. [The Fed is like] the little Dutch boy with the finger in the dike who never troubles himself to look over the levy to see that the lake is dry. Economists have fed into that with this completely made-up view that it is the central bank that drives the inflation process — it is not.

-James Galbraith, MarketWatch interview

I highly recommend you read the interview with James Galbraith linked below. The big takeaway, as MarketWatch’s senior economics reporter Greg Robb points out is that Galbraith believes mainstream economists – including the Fed – hold a fictitious view of how the economy operates and who pulls the economic levers.

On inflation, Galbraith says it was the fall of the Iron Curtain and the addition of China into the global trading system that brought price level growth down. The Fed had nothing to do with it. 

Galbraith’s view is that inflation is not the pressing issue that the Fed thinks it is. The Fed is now making a pre-emptive strike against inflation by raising rates despite headline inflation below target. And all that will do in Galbraith’s opinion is make the dollar more expensive and hurt the “internal competitiveness of the economy, diminish internal employment.”

My take: If Galbraith is right that inflation is not the key factor here, then we should expect the Fed’s rate hikes to continue to flatten the yield curve. Moreover, Galbraith’s view suggests the bond bull market has legs – that is, at least until macro policy changes, allowing wages to rise and employment markets to tighten more substantially before policy rates rise.

There’s a lot more at the link below. The most ominous point is that the mainstream model of the economy has household debt as the main driver (see yesterday’s post). Galbraith says eventually the consumer will be tappe out and the economy will run aground.