THE FED VS. THE ECONOMY - The idea that the Fed can squash inflation without squashing the economy is false.

There are two major sources of inflation. There's the supply side and there's the demand side. Either one of them can drive inflation, but they're very, very different in terms of how they work. Raising interest rates has no impact on the supply side shortages we're seeing. And that's where the inflation's coming from. Since the Fed has misdiagnosed the disease, they are applying the wrong medicine. Tight money won't solve a supply shock. Until the supply shortages are fixed, higher prices will continue, says Jim Rickards.

- Jim Rickards.

Right now, it’s basically a case of the Fed versus the economy. You might say, “Wait a second. Isn’t the Fed supposed to help the economy?”

Well, not exactly. They may want to help the economy, but helping the economy actually isn’t job one. Job one is helping the banks. The Fed was essentially created to prop up the banking system and prevent bank runs. Everything else it tries to accomplish, such as price stability and maximum employment, comes second. So it’s not clear that the Fed’s always aligned with the best interests of the economy. People don’t realize that, but it’s important to keep in mind.

Everyone knows the Fed’s raising interest rates right now. But which rates? The rate that the Fed actually raises is called the fed funds target rate. And what is that?

That’s the rate at which banks lend to each other to meet their reserve requirements on an overnight basis. Fed funds are amounts that banks lend to each other to meet overnight reserve requirements.

It’s an extremely short-term rate. The Fed targets that rate as a way to control the money supply and perhaps tweak inflation or achieve other economic goals.

THE FED IS TARGETING A RATE THAT NO LONGER EXISTS

I don’t want to get into the mechanics of the banking system, but here’s the essential point I want to make: There hasn’t been a real fed funds market for about 12 or 13 years, ever since the Fed began flooding the system with money during the Great Financial Crisis. Today, reserves are close to an all-time high. In other words, the banks have excess reserves. Their actual reserves are multiple trillions of dollars in excess of the requirement. So there is no shortage of reserves.