The latest book on Paul Volcker is a must read for those interested in Fed policy making as practiced by someone with an actual backbone as well as no particular political bent. What I found most interesting about Volckers policy choices was that not once was there any mention made of utilizing the Fed balance sheet to affect policy. This adherence to tried and true policies in the face of 12% inflation and long bond rates exceeding 14% is a testimony to a Fed unmoved by the vagrancies of capital markets or political pressures. While it is true that the Volcker Fed changed tack mid-stream from targeting interest rates to targeting the money supply, their strategy was based on legitimate historical evidence of cause and affect. Compare this with what we see under the guise of central banking today. I think everyone can forgive the Bernanke Fed for their actions in the fall of 2008, however the various QE’s since then have been ever more questionable.
The take away for investors looking at the Volcker Fed in the historical context of the time was that Central Bank policy was utilized purely for a single, well defined purpose: the elimination of heightened inflationary expectations. More importantly, the policy tools that were used were fairly standard and proven. If there ever was a time when Fed policy might have strayed from its mandate, this was the time. Why the Bernanke Fed felt, and continues to feel, that an extended cyclical credit-driven downturn is evidence enough for a complete abandonment of traditional Central Bank tools is a mystery to us. We continue to maintain that these highly unconventional methods will produce highly unintended consequences;most notably higher levels of inflation. Thus, efforts to stimulate growth and employment via Central Bank balance sheet management may end up exacerbating their weakness as inflation takes hold. Holding hard assets as the antidote to unconventionality would therefore seem to be a prudent strategy.