Before discussing Andolfatto and Powell, it is perhaps important for people to understand that labor power, unions, shortages, demands for wage increases, are weak following a major credit incident like the Great Recession. 

However, it does not seem like that behavior is at all imminent. That behavior has existed in the past. But as labor had power in the 50's and 60's, that power is now gone. In fact, labor is very, very weak. That plays against the Fed's desire to keep the Phillips curve in play as discussed below. Following the discussion of Andolfatto, we can take a look at Ellen Brown's recent article, because it explains much, but not all of Fed behavior. Lastly, we can take a look at the status of counterparties to the banks by looking at Chairman Jerome Powell's important understanding of the matter.

David Andolfatto and the Phillips Curve

David Andolfatto is Fed Vice President at the St Louis Federal Reserve Bank.

Dr. Andolfatto has a personal blog representing his own views. It is titled Macromania. He is clearly a dove, meaning he is not for aggressive interest rate tightening in the New Normal, and does not see the value in ratcheting up rates when there is little inflation. Dr. Andolfatto quotes WSJ author Greg Ip:

Massive tax cuts, robust federal spending and a synchronized global upswing are expected to push annual growth in economic output to 2.7% this year and 2.5% next—past what Fed officials consider its long-run sustainable rate of 1.8%—according to projections Fed officials released after their meeting Wednesday. 

To sustain such growth, the Fed projects employers will have to dig deep into a diminishing supply of workers. That will cause unemployment, already at a 17-year low of 4.1%, to sink to 3.6% by the fourth quarter of 2019, a level last seen in the 1960s. That’s well below the “natural rate” of 4.5%, which is the rate Fed officials and many economists think the economy can sustain without eventually producing inflation. 

But it faces a problem: In theory, unemployment will eventually have to go back to 4.5%, or inflation will head even higher. Yet since records begin in 1948, unemployment has never risen by 0.9 points, except in a recession.

Dr. Andolfatto goes on to say that the Fed would say rising unemployment is simply collateral damage of Fed policy, not the goal of Fed policy:

I think it's time for economists to stop relying so heavily on the Phillips curve as their theory of inflation.There are two good reasons to do so. First, it's bad PR to (unintentionally) suggest that workers are somehow responsible for inflation. Second, and more importantly, it would help avoid policy mistakes like raising the federal funds rate too aggressively against low unemployment rate data.

But it is clear to many that the Fed has been deliberately pruning wages as labor has weakened over the years. The Fed is clearly pounding labor in favor of capitalism.

But the Fed behavior is certainly more than just bad PR. The Fed is clearly prisoner to the Phillips Curve, and the truth is that it wants to be a prisoner. Irrational fear of wages is creeping into Fed policy. Dr. Andolfatto writes a second post regarding inflation and unemployment where he quotes Paul Krugman. There is a sensible point made in this post. Krugman asks a series of questions:

1. Does the Fed know how low the unemployment rate can go?2. Should the Fed begin tightening now, even though inflation is still low?3. Is there any relationship between inflation and unemployment? 

Nobody knows what the natural rate of unemployment is, that rate that is sustainable. It can change with economic reality. The natural rate may be lower now than what the Fed thinks. Andolfatto points out that Switzerland had virtually zero unemployment with no inflation in the 1960's. To assume 4 percent, or as Ellen Brown has said, 4.7 percent, is the natural rate is just mean-spirited capitalism in my opinion.

The Fed is engaged, because of the prison of its own making, in mean-spirited capitalism. The Fed, if it doesn't know what the natural rate of inflation is, is experimenting.

Jeff Gundlach recently said it best. The Fed raises rates until something breaks. That does not sound like a Fed that can set a correct natural rate. It sounds like a Fed that is applying a central plan to clip growth by forcing Warren Buffett's tide to recede. We have to look at Fed motives here.

Ellen Brown and Fed Protection of Banks

Ellen Brown wrote a scathing criticism of the Fed, and the desire of the Fed to protect and increase profit for the banks off the backs off of main street USA. But what most people don't realize is that the Fed does all the things Ellen Brown mentions so eloquently, and yet does much more. 

Yes, the Fed is in it for the banks and for creating demand for its bonds. It is in it for banks making money on interest on reserves, and all the rest. But part of being in it for the banks is something that Ellen does not mention and most do not grasp. That is, the Fed also squeezes counterparties to get its way, and to enhance demand for bonds. 

The Fed is willing to push rates up on the low end, which could result in a slowdown, as Gundlach said. The Fed is willing to push rates up to force many into bonds and away from stocks, as rates can replace stock growth and dividends for conservative investors. And most importantly, the Fed knows a lot of bonds are coming through the Trump massive tax and spend plan. 

In order to create demand for those bonds, the Fed forces counterparties, who have put long bonds up as collateral, to buy more bonds to cover the decline in prices of the bonds they already have put up. As I have written before, collateral is marked to market daily. Therefore, there are constant margin calls for collateral to be covered in the clearinghouses. 

Jerome Powell and Counterparty Risk Management

The question remains, why would the Fed seek to weaken the bank counterparties which have put up all this collateral? We get an insight from Jerome Powell, current Fed chairman, in a 2013 speech. It is clear from the speech that Powell believes central clearinghouses are the way to go. And raising rates almost guarantees that banks must know where their counterparties stand and raising rates forces banks to work through that middleman, the clearinghouse. It forces banks to monitor variation margin as well.

Obviously, Powell thought then and thinks now, that in the clearinghouse environment, the surviving counterparties have the means to pay for defaults. Squeezing the counterparties to buy a few more bonds to cover collateral shortages is then not seen by the Fed is being high risk. Powell said in 2013:

Of course, the other side of this coin is that concentrating risk in a central counterparty could create a single point of failure for the entire system. Given their heightened prominence in the financial infrastructure, if CCPs are to mitigate systemic risks they must hold themselves to--and be held to--the highest standards of risk management. In many respects, CCPs are the collective reflection of the financial institutions that are their members and the markets that they support. The credit and liquidity risks borne by a CCP arise from the clearing activities of its members. Those risks materialize when a clearing member defaults. Most of the financial resources to cover risk exposures will come from a CCP's members. And a member's default will require the CCP to work with surviving members in the context of prevailing market conditions. CCPs play a critical role in ensuring a robust risk management regime that fully takes account of this interplay among markets, institutions, and infrastructure.

In order for a default to be orderly, the CCP (clearinghouse), must be able to convert assets to cash within hours. Powell says:

To measure and manage its liquidity risks, the PFMIs require a CCP to have effective methodologies to estimate its funding exposures under a variety of stressed conditions, to identify available cash resources, and to establish mechanisms for converting its noncash collateral to cash. The need to assure adequate liquidity presents a number of challenges. CCPs will need to mobilize cash within a matter of hours on the day of a large clearing member's default.

With regard to margin requirements, Powell reveals that this is indeed experimentation. It is a secret only in that few pay attention to it. The public does not view this as being very important, and certainly, mainstream media says nothing about it. Yet this experimentation reveals the goal of the Fed, to create a foolproof, risk-free financial system for the insiders. Powell's final comments reveal just that:

It should also be noted that these margin requirements are new to the market and their effects cannot be fully understood before they become effective. There is simply no substitute for experience.

and:

The financial crisis revealed significant flaws in the structure of the OTC derivatives markets that are now being addressed as part of a worldwide reform effort. Increased central clearing and margins for noncleared derivatives are foundational elements of the program. Together, these reforms can help create a system in which the OTC derivatives market infrastructure acts as a pillar of strength in the next crisis...More broadly, international cooperation will be needed to ensure that the new framework works in practice.