There is far too much shorthand in the study of the economy and markets. We take so many things for granted, we never really stop to ask if its appropriate that we should. The desire for quick rules of thumb is understandable enough given a complex world. There is probably nothing more in it than the economy and markets.

It starts often with ceteris paribus. For academics, the concept is crucial. In the real world, hardly ever is all else equal.

If you are a business that produces widgets, as a stylized example, and the input costs of manufacturing them goes up, all else equal it seems you’re going to have a hard time making money making widgets. It may, in fact, lead you to produce less of them as noted a few days ago in what economists call cost-push inflation.

But in a real economy there are a bevy of choices available even to the most restrictive of scenarios; all else is never equal. Faced with rising input costs, a business could respond to lower profit margins by producing more volume at the same price. This assumes that it can find a way to sell more widgets, but that’s not as unrealistic as it sounds in certain industries.

One of those that immediately springs to mind is the banking industry. There aren’t as many tangible factors preventing volume from being so scalable. When the output, or widget, is loans and lending, achieving such efficiency might even be quite easy.

We are told by every Economics textbook that when the Federal Reserve or whatever other central bank raises interest rates it amounts to economic tightening. Not only that, we are supposed to believe that it is tightening because it restricts, somehow, the money supply. This is the shorthand version rarely ever examined. In practice, there are a whole bunch of things that have to happen before that’s true.

For one, banks might respond to what is nothing more than an increase in their input costs (funding) by increasing volume. You can grow profits via price (steep yield curve, in theory) or volume. If the Fed pushed up funding costs even to a substantial degree, you could overcome them by selling your brains out at relatively the same price (loan interest rate). The yield curve could flatten but you still make out handsomely and the monetary policy is left perplexed.

That is, in very general terms, what happened in the middle 2000’s. Stunned by a flattening curve because of rising short rates, Economists declared it “tightening” in the real economy even as the housing bubble raged on in the US and the EM debt explosion was taken to another level overseas. Global banks saw right through the rise in funding costs and made up for any lost profit via exponential volume growth. Greenspan intended on tightening but that’s not what really happened.

All that was required was sufficient demand (subprime, being one form).

So, it’s not so easy and straightforward that what happens in monetary policy works out as the shorthand rule of thumb might have it. This is why I refer to monetary policy as a “frame of reference.” The Federal Reserve, seeing through all the layers of PR and scientism applied often afterward, does not control money in the economy. It doesn’t even know how to define it, let alone attempt any consistent influence over it.

Economists under Positive Economics assert they don’t have to know these things. When you break it down, it is just that preposterous.

That’s what we are really talking about, after all, the amount of effective and usable money inside the real economy. Raising or lowering the federal funds rate, or now band, does not necessarily change how much money there might be available, nor how it might be used or not used. There are feedbacks upon feedbacks upon feedbacks, one in the manner described above.

Rather than skip all the steps in between, it useful to work backward. That’s inflation. Inflation is the end result if money is, for whatever reasons including potentially monetary policy, leaking out the back end. If you are printing it in the front, then it doesn’t really matter if it gets lost in the middle. Unless it comes out in the real economy your efforts amount to interesting but ultimately useless theater.

It’s also the same in reverse. If whichever central bank is raising rates and attempting to tighten, if banks respond in a manner inconsistent with that intention the central bank is fooling only itself and those who blindly follow it (like the 2005-06 conundrum).

The quantity of bank reserves which have built up as a byproduct of QE in all these jurisdictions don’t tell us a thing about monetary conditions in the real economy; not one thing. They tell us merely, like the interest rate, what the central bank intends to happen. Whether it does or not depends on those middle steps, and that means banking.

Banks have their own factors to consider, and in the modern monetary age (eurodollar) the central bank is only one among many – and, as I often argue, not much of an important one. In those middle 2000’s years, the Fed was really only good for one thing and one thing only – the Greenspan put. While that is a term applied most often to stocks, in the vastly more important FICC arena it simply meant Bagehot’s dictum.

The financial system required, and expected, nothing more than a full liquidity backstop against crisis. Somehow, that became a full-fledged mainstream belief in the wake of the Asian flu and LTCM. In the banking system, it never completely translated, however, thus, the bond market’s polite disagreements over the reasons behind monetary policy.

As the bubbles blew in dot-coms and housing, there was this nagging sense that perhaps the Fed didn’t know as much as people thought, maybe little to nothing at all about monetary reality. After all, they sat around and every six weeks raised or lowered a largely irrelevant money market rate by 25 bps this way or that. It was, and still is, as ridiculous as it sounds – controlling the whole global economy and markets with what was essentially a toy.

UST’s are the most liquid instrument available in the dollar system, or any other for that matter. Even those denominated in other currencies still require them for that connection with the global economy – eurodollars. The more UST’s you have, the bigger the potential dollar problem. Economists see these forex reserves as insurance; they should see them instead as a target.

What that means is there are often conflicting regimes traded in a single marketplace. The Fed may intend on tightening and expect markets to price on the belief for why they might (inflation), but the banking system may intend on something else, including the unacknowledged, nontrivial liquidity risks of a global system where there is no backstop at all. That’s the one thing the Federal Reserve so thoroughly proved in 2008, and then just to make sure reproved it in 2011.

Where that leaves us is outside of the shorthand. The Fed is altering the federal funds band, therefore the front-end price of monetary substitutes (things like T-bills, though we know well even those don’t always behave in the straightforward, theoretical manner, either). It is attempting to change the frame of reference for the whole market, therefore the economy at large. Whether it is successful or not depends on a lot more than the word of the incredulous Economists who run the place.

As this is being done, the market is pricing out what that eventually might mean. As noted repeatedly, it is so far resistant to it meaning what everyone including Jay Powell wishes it would. The flat yield curve proposes that what’s in the middle between money and inflation still isn’t going the right way. Liquidity risk hasn’t disappeared, it remains very distortive.

What Ben Bernanke once tried to classify as a “global savings glut” was really just his ignorance about the rule of thumb. For him, it was always just that easy, the Federal Reserve being the center of everything. The Fed lowered the federal funds rate, the economy was stimulated; forget how. The Fed raised the federal funds rate, the economy was slowed; it just was.

In practice, nothing has gone in that way. Whenever I hear “global savings glut” I immediately think “how can we sound like we know what we are doing when we really don’t.” If we want to operate in shorthand, it should be something like this instead: it doesn’t matter what central banks do, only banks.