Unintended Consequences

Unintended Consequences

Mark Lazar’s January 2022 Newsletter

Lenin was right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.  John Maynard Keynes


Item YTD Change
Dow Jones Ind Avg 18.73
S&P 500 Index 26.89%
EAFE Foreign Index 2.34%
Emerging Market Index -2.42%
Barclays Agg Bond Index -1.54%
10-Year Inflation Forecast 2.58%
Unemployment Rate 4.2%

*Market index data as of 12/31/2021


In 1791 Alexander Hamilton’s vision of creating a central bank became a reality, and the First Bank of the United States was established and granted a 20-year charter by Congress. In 1811 the Bank’s charter expired and wasn’t renewed again until 1816. The second iteration was, not surprisingly, called The Second Bank of the United States. Suffering the same fate as its predecessor the Second Bank’s 20-year charter expired and due its unpopularity was not renewed. 

After the Second Bank was shuttered, relaxed banking laws fostered an environment where state-chartered and unchartered “free banks, flourished. Absent meaningful oversight the U.S. financial system was literally the Wild West; banks routinely failed, bank notes (bank-issued paper money) commonly traded at discounts relative to the perceived risk of the issuer, and savers were just as likely to keep their savings in the mattress as their local bank. 

The Federal Reserve Act of 1913 created America’s third central bank; the Federal Reserve System, oftentimes referred to as the Fed. The primary purpose of the Fed was to stabilize a mercurial financial landscape. Policymakers recognized the need for a stronger banking system, which would increase confidence in commercial banks, improve the flow of capital and availability of credit, increase savings, promote economic growth, and reduce the risk of future financial crises.

Historically the Fed has relied on traditional policy measures, such as guiding interest rates (via fed funds and the Discount Window rate), bank reserve requirements, and open market operations to manage the monetary system. Over time, however, the Fed’s arsenal expanded to include unconventional monetary tools such as quantitative easing, negative interest rates (NIRP), purchasing/supporting private debt (including junk bonds), access to the Discount Window for non-member institutions, and the Term Auction Facility (TAF), to name a few. 

Prior to the Great Depression, policymakers understood that the economy would ebb and flow with the business cycle and thus took a laissez-faire approach to economic policy. That changed in 1936 after John Maynard Keynes, a Cambridge academic, published The General Theory of Employment, Interest, and Money. Keynes’ postulated that free markets, while generally efficient, at times required government intervention (via monetary and/or fiscal stimulus) to smooth out economic cycles. Keynes’ words were a welcome dog whistle to policymakers’ ears; central bankers, who had abandoned the gold standard three years earlier, could proceed to manipulate interest rates, credit, foreign exchange rates, and the like. Similarly, politicians, no longer constrained by tax revenue receipts, had permission to run large deficits for the good of the economy.

Years later, Keynes lamented some of his previous beliefs admitting, “I find myself more and more relying for a solution—on the Invisible Hand which I tried to eject from economic thinking twenty years ago.” But the genie was out of the bottle, and policymakers were unwilling to give back the power Keynes had unwittingly bestowed upon them. 

For all of the Fed’s pomp and circumstance, monetary policy is one part science, one part alchemy. Policymakers would have us believe they know what the future holds. They don’t. Virtually every recession/depression was the byproduct of misguided monetary policy; too much gas, almost invariably followed by too much brake. Paradoxically, policymakers attempt to formulate future monetary policy based on past (lagging) economic data. However, unlike math or chemistry, economics is a soft science and models are constantly adjusted to account for human behavior.


Year 2006 2007 2008 2013 2014 2015 2016 2017 2018 2019 2020 2021
GDP in Trillions 14.04 14.72 14.61 17.13 17.85 18.33 18.97 19.88 20.81 21.69 21.48 23.2
Money Supply 6.88 7.3 7.79 10.72 11.39 12.04 12.86 13.59 14.12 14.84 17.68 21.44
Money Supply % 49.00% 49.59% 53.32% 62.58% 63.81% 65.68% 67.79% 68.36% 67.85% 68.42% 82.31% 92.41%
Fed Assets 0.87 0.89 2.24 4.03 4.50 4.49 4.45 4.45 4.08 4.17 7.36 8.76
Fed Assets % 6.20% 6.05% 15.33% 23.53% 25.21% 24.50% 23.46% 22.38% 19.61% 19.23% 34.26% 37.76%

Source: FRED. Federal Reserve assets and M2 money supply values are in trillions.


The table above illustrates the growth of both the money supply (M2) and Federal Reserve assets relative to GDP. Since 2006 M2 has increased from 49% of GDP to over 92%. For the same period the Fed’s balance sheet jumped from 6.2% of GDP to nearly 38%—a 609% increase. In an effort to manage or control every aspect of the US monetary system, the Fed has turned the volume up to eleven. 

Due to a misguided belief in demand-side policies, the central bank increased M2 by 40% since 2020. This is the very definition of inflation—inflating the money supply. For the wealthy, Fed money printing made them even richer, pushing stock and real estate prices to record highs. But monetary stimulus doesn’t create wealth. Rather, inflation makes us feel richer as opposed to being richer, and is a Faustian bargain at best. To illustrate, industrial production is lower today than it was two years ago. Furthermore, real wages—wages adjusted for inflationdeclined by 2.4% in 2021; in other words, the standard of living for the middle and lower class actually fell last year. Washington policymakers would be wise to remember Milton Friedman’s famous quip, there’s no such thing as a free lunch. Rather, there are always unintended consequences.


Mark Lazar, MBA
Senior Vice President–Investments
Certified Financial Planner™

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