A simple analogy to grasp Jerome Powell's achievement

Photo by Caleb Fisher on Unsplash

Imagine that you’re the most productive, wealthiest member of your family.

Your siblings are also productive and wealthy, but again, just not as much as you.

Let’s also imagine that you have dozens of cousins who are capital destroyers.

Several decades ago, your grandparents mandated that as long as they’re alive, then you must offer near 0% interest rate loans to these cousins. Sure, your cousins can borrow from your siblings as well, but they want to maximize their loans. So, your cousins usually borrow from you.

With your hands tied and balance sheet getting more unstable, what do you do?

Again, you can’t raise the interest rates on the loans you offer. But without raising interest rates — at least not yet — you can at least divert some of the capital that’s going to your deadbeat cousins.

Your temporary solution: Allow your responsible, productive siblings to park money at your “bank.” You’ll pay them a slightly higher interest rate than the prevailing market rate.

And remember, since your cousins can also borrow from your siblings, you’re sterilizing some of those funds that would otherwise go to unproductive purposes and would likely never get paid back.

Your move works out well and as you planned. Meanwhile, your cousins are screaming at the top of their lungs.

And then your grandparents die.

Now, it’s on. You can finally raise interest rates on the loans to your cousins. You can’t jack them up from near 0% to 5% immediately or your balance sheet would be in jeopardy. The deadbeat cousins would all go broke.

You run this play for several years, gradually raising the interest rates on the family’s most important bank — the one you control.

Although many of your cousins go bankrupt, a few of them start to reform their finances. And you’ll be happy to work with them in the future.

Of course, you’re Federal Reserve Chairman Jerome Powell.

Your siblings are the U.S. investment banks who have been on board with your plan.

And your deadbeat cousins are the countries — mostly in Europe — who are long due for bankruptcy.

(And, for you savvy readers, to complete the analogy: Your grandparents’ mandate is the London Interbank Offer Rate (LIBOR) — the rate that, from 1986 to 2023, determined the price of dollars on the offshore dollar (“Eurodollar”) market. LIBOR meant that for decades, the U.S. was never fully in control of its own monetary policy. Credit revolvers, auto loans, and other short-term loans for American individuals and companies depended on LIBOR. But thankfully, that all stopped when the Federal Reserve stood up the Secured Overnight Financing Rate (SOFR) — a domestic dollar indexing and market rate that, unlike LIBOR, is collateralized with U.S. Treasury holdings.)