Opinion – Helio Beltrão: The Fed’s odyssey between Scylla and Charybdis

The world’s central banks, especially the Fed and the ECB, are in a relentless dilemma like the sailors of ancient Greece.

Homer tells us how Odysseus navigated the corridor between two terrible sea monsters, Scylla and Charybdis. The irresistible monsters of Greek mythology inhabited the Strait of Medina, which separates the coast of Calabria (the toe of Italy’s “boot”) from the island of Sicily by a mere two miles.

Scylla, on the Italian coast, with four meters and six terrifying heads, devoured everything that passed in front of her cave. Charybdis, off Sicily, spewed huge amounts of water into whirlpools that sank all boats.

The current dilemma is to cross the narrow space between Scylla, the monster of inflation, and Charybdis, the recession that sinks everyone, unharmed. The goal is to avoid both. However, it doesn’t seem like a possible task in the real world. The alternative became to choose the lesser of evils.

The navigation error started much earlier, between 2008 and the 2020 pandemic. The Fed had been exaggeratingly deviating from Charybdis, the recession, and, consequently, approaching Scylla.

At the sign of trouble —in the economy, banks or the stock market—, he always pressed the magic button to create money, with quantitative easing (QE). In 2020, Charybdis suddenly appeared, and the helmsman pointed the bow towards Scylla. “Full steam!”

The Fed’s balance sheet jumped from $4 trillion to $9 trillion, an unprecedented monetary injection in history. Not even during the reckless administration of the Fed in the 1970s was there such boldness.

The speech repeated over and over in 2021 that inflation was temporary was changed when the huge heads of Scylla were seen. Dollar inflation has reached 8.6% in the last 12 months, and the Fed surprised last week by raising interest rates by 0.75 percentage point, more than our central bank’s 0.50 point. “Helmsman! All helm to port, heading… Charybdis?” oops

Last week, the US stock market entered the dreaded bear market territory, falling more than 20% from its January high. There is a flurry of economic growth revisions, always downwards.

Many investors recognize that, in the past, whenever dollar rates rose, something collapsed somewhere in the economy. Thus, they protect themselves by selling some positions. But they may still be overly optimistic.

There is a misguided belief that inflation has to do with supply chain disruptions, with war, and with the greed of oil and energy companies. As soon as these factors are mitigated, they believe, inflation will recede. Wrong.

Inflation has a monetary origin. In the 1970s, the Fed believed the flawed thesis of cost inflation, blamed the Arabs, and generated unprecedented inflation. Upon taking office, Paul Volcker had to shock interest rates by more than ten percentage points for inflation to subside.

Therefore, as long as the interest rate (today at 1.75%) remains well below the inflation projected for the next 12 months (6.5%), there is not much hope for the inflationary process to stop. The announced monetary contraction, the QT (quantitative tightening), although positive, will take more than two years to cancel part of the extraordinary injections of 2020.

The Fed has been roaring thickly, but in stocks it is still a sly kitten. It must first recognize its responsibility in producing inflation so that it resolves to act vigorously to contain it.

Its greatest difficulty is that the truth can be revealed: in the obscurity of the cave, the Fed has always fed the monster. “Scylla, I’m your father.”