Who Watches the Fed? The Myth of Independence and the Coming Reckoning - Part 2

If you have not read yesterday's blog post, please read it before continuing here.

Japan: The Cautionary Preview No One Wants to Look At

If you want to see what happens when a central bank gains enormous power with no external guardrails, look at Japan. Japan is 20 years ahead of the U.S. in the central-banking experiment. They made the mistakes first; we're repeating them now.

The Bubble and the Lost Decades

In the 1980s, the BOJ tightened too late into the largest asset bubble in modern history. When the bubble burst, they eased too slowly. The result was 30 years of deflation, stagnant wages, zombie companies, an economy unable to grow, and a bond market with no natural buyers.

Yield Curve Control: The Point of No Return

To keep the system alive, the BOJ began buying government bonds on an unprecedented scale. At one point it owned over 50% of the entire Japanese government bond market. That's not independence; that's nationalization. Real price discovery disappeared as the BOJ became the market. And once a central bank becomes the market, it can never exit. If it tightens -> recession. If it eases -> currency crisis. This is the trap.

The Japanification of America

For a long time, people laughed at the idea the U.S. could follow Japan. But not anymore. The U.S. today looks eerily similar to early-stage Japan: Debt-to-GDP exploding, structural fiscal deficits, fed owning trillions in Treasuries and MBS, aging demographics, politicians are unwilling to cut spending, markets are dependent on easy liquidity, and fragile banking and real estate sectors.

Raise rates too high? Banks fail, commercial real estate collapses, and deficits blow out. Cut rates too low? Inflation reaccelerates, and long-end yields spike anyway. The Fed is stuck in the same trap as the BOJ. Policy isn't about growth; it's about survival.

The Coming Reckoning

The reckoning isn't a crash. It's the moment the market realizes the Fed is not independent - it's cornered. Here's what that could look like:

1. Higher neutral rates: If investors stop believing in Fed independence, long-term rates drift up structurally.
2. Financial repression: Yield caps, forced low rates, stealth taxation through inflation.
3. Permanent intervention: QE becomes a chronic condition, not an emergency tool.
4. Dollar volatility: If politics steer policy, currency markets price the dysfunction.
5. Fed-Treasury convergence: The lines between monetary policy and fiscal policy blur, just like in Japan.

The Fed doesn't need to "lose independence." It simply needs to reveal that it didn't have much to begin with.

What Investors Should Watch Next

A few signals matter more than any Fed speech:

• The long end of the Treasury curve: If the Fed is forced into yield curve control, the Japanification box slams shut.
• Political rhetoric: Both sides are pressuring the Fed on unemployment, housing, and lending. That's the opposite of independence.
• Shadow QE: Look for liquidity programs that aren't labeled QE but act like it.
• Inflation expectations: If the Fed loses credibility, this is where it shows up first.
• Balance sheet policy: Any pivot back to balance-sheet expansion is a red flag.
  

The Fed will keep talking about data dependency. Investors should focus on political dependency.

Conclusion: Who Watches the Fed?

Central banks were built to be independent, yet history shows they rarely are. Yes, the Fed is powerful. But power without oversight is vulnerability, not strength. Japan already lived this movie. A central bank can become the entire market - and still never fix the system. It just traps itself in a cycle of intervention.

The U.S. may now be walking the same path, with bigger markets, bigger politics, and bigger consequences. The myth of independence won't protect them. And sooner or later, markets will stop pretending.