Our double-minded central bank

The Fed recently has begun to signal that it might slow down on hiking interest rates. Investors reacted by driving up the price of gold, driving down the exchange value of the dollar and purchasing inflation hedges such as commodities and inflation-protected bonds. Markets generally rise on the perception of easier money, this time reversing a volatile, mostly down year for markets. But behind those fluctuating price movements is a flawed understanding of human nature.

The Biblical worldview presents a God who creates a world, then works to shape and develop it, crowning his labors with the creation of image-bearers who themselves also shape and develop the world. Humanity is designed to be productive under the Providence of God. That is God’s own plan. 

Modern economics is based on the idea that there is no God, that economic activity is the result of human passions that John Maynard Keynes called “animal spirits,” and that the government should play the role formerly reserved for divine providence as either the stimulator or the suppressor of those instincts. Lately, monetary policy has been the chief lever of economic planning. Starting with the Great Recession and then again in the COVID shutdowns the central bank sought to stimulate the country’s animal spirits through extreme interest rate suppression and money creation. But, creating money is not the same thing as creating wealth, and so these monetary interventions created not wealth but inflation. 

The inflation became undeniable and then it became intolerable, so the Fed was forced to fight it (though reluctantly). But the only way to fight inflation is to tighten money, and cease from the unprecedented experiment in interest rate suppression, which triggered a bear market and recession. This is how the Fed complies with its mandate to keep inflation low. But the Fed had a “dual mandate,” the second part of which is to keep unemployment low.

That’s where the volatility is coming from. Each new piece of news is now evaluated by markets, not for what it says about the inherent value of a stock or about the current state of the economy, but rather for how it might influence Fed policy. Data is not read for what it tells us about the state of the economy, but rather for what it tells us about the state of mind of the central policy planners. Markets on a daily basis ask, “Which mandate will the Fed follow today?”

That explains the paradox of how good economic news becomes bad market news. A recovering economy gives the Fed the confidence that the economy is strong enough to weather a shift to its inflation fighting mandate. Interest rate expectations shift upwards, stocks then fall. Soon thereafter, inflation and growth expectations fall. Cyclical stocks underperform recession hedges such as consumer staples and utilities. Growth stocks underperform value stocks. That’s what happens when markets think the Fed will focus on its inflation-fighting mandate.

But when there is a sign that the economy is weakening, those trades go in the opposite direction as markets conclude (at least for the moment) that the Fed probably thinks the economy is not strong enough to handle the tough love of monetary contraction. Then markets think the Fed will switch to its unemployment-fighting mandate.

Sometimes the clues come directly out of the Fed itself. Official announcements about policy changes, minutes from the meetings where the policies are decided, speeches from members, interviews with members, leaks to the press, are all pored over and exegeted like sacred text to determine which mandate is likely to rule the minds of the people who rule our markets. This volatility isn’t an inherent characteristic of our markets. Rather it’s a current characteristic of markets trying to guess what government will do next.

In the New Testament, James tells us that a double-minded man is unstable in all that he does. Our most important monetary authority is structurally and institutionally double-minded, subject to two competing commands—stoke inflation to fight unemployment or stoke unemployment to fight inflation. Double-mindedness creates conditions where men are “driven by the wind.” Economists call this “volatility.”

The answer lies in the rejection of Keynes’ “new economics” and the re-adoption of the system he rejected. Money should be a constant, not a variable. It should be made back into a medium of exchange, not a cudgel to push the herd’s animal spirits in whatever direction on any given day the central planners choose to lead. If the central bank goes back to its single mandate, stability of currency, then the markets can safely ignore it, and focus on their single mandate of wealth creation. That’s the right path, but the Fed seems unlikely to take it.