If there is one thing you need to understand about what is happening in the political economy today, it is the fundamentals of debt. You don’t have to be a bean sprout counter or dig too deep to understand what is going on.
What you need to understand is this: The debt (public and private) has become so enormous that it can never be repaid.
But it will be resolved one way or another. Either through default, inflation, or some combination of the two. And the imminent debt restructuring will be legendary.
As debt has increased, prices have become distorted. That’s why house prices and stock prices have become meaningless. And that’s why consumer prices continue to rise.
The federal debt recently surpassed $35 trillion. In fact, the Treasury is responsible for the excessive amount of debt issued. But the Treasury is merely funding the deficits dictated by politicians in Washington, who in turn are indebted to a vast cadre of special interest groups.
Defense spending. Green energy bills. Farm subsidies. Pork projects. Social welfare programs. Foreign intervention. Endless agency and agency jobs with employees showing up every day to do fake work. Nothing is too big or too stupid for Washington to fund.
The Treasury’s ability to finance deficits would have ceased long ago if it had not been for the debt-based paper money system that allows for the infinite printing of dollars. Of course, for every new debt issued, there must be a lender. In the United States, the lender of last resort is the Federal Reserve.
What’s happening at the Federal Reserve?
It might be, it might not be
The Federal Open Market Committee (FOMC) met this week to set monetary policy and fix interest rates. Wall Street’s focus was almost entirely on interest rates: Will the Fed cut the federal funds rate now or in September?
After the meeting on Wednesday, the Fed left the federal funds rate unchanged at 5.5%, which was expected, but there were hints that a rate cut would come in September. Next FOMC StatementHere’s what hasn’t changed since the June meeting:
“In considering adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the changing outlook, and the balance of risks. The Committee anticipates that it would not be appropriate to reduce the target range until it has greater confidence that inflation is moving on a sustainable basis toward 2 percent.”
Will the Fed become more confident that inflation will go away before its September meeting?
Probably not, so Wall Street will likely have to wait until November for its long-awaited rate cut.
If the Fed does finally cut rates, it would be the first time since March 16, 2020, when it cut the federal funds rate to near zero in the early days of the coronavirus crisis.
Still, the slight prospect of a rate cut in September was enough for Wall Street. Traders celebrated the news by pushing up the indexes. On Wednesday, the S&P 500 rose 85 points and the NASDAQ rose 451 points. On Thursday, almost all of those gains were reversed.
In our view, rate cut optimism is misplaced. Consumer price inflation remains well above the Fed’s arbitrary 2% target.
The balance sheet is strange.
The latest PCE price index is 2.5% and the latest CPI is 3.0%. So the Fed still has work to do to lower inflation. Keeping the federal funds rate at 5.5% for a long time may ultimately work. If it cuts too early, inflation risks rising again.
Still, a rate cut is needed to bail out the banks from all the underwater bonds they purchased in 2020 and 2021. It is also needed to help the Treasury finance the remaining bonds. $1.3 trillion We estimate that the loan will be repaid by the end of the year.
But while everyone was almost entirely focused on the Fed’s intentions to cut rates this week, they were ignoring a more important story: the Fed’s balance sheetAnd how absurd that is.
As you may recall, before the Great Recession and quantitative easing (QE) in 2008, the Federal Reserve’s balance sheet was about $800 billion, or about 6% of GDP.
Then, between 2008 and 2014, the Fed grew its balance sheet to $4.5 trillion. Then, during the coronavirus panic, it grew its balance sheet to $8.9 trillion by 2022.
The assets held on the Fed’s balance sheet are generally comprised of Treasury securities, mortgage-backed securities, and some corporate bonds. It is a bit of an illusion where the Fed gets the credit to buy these debt securities. In short, it creates credit out of thin air.
Since early 2022, the Fed has reduced its balance sheet by $1.6 trillion, to just under $7.3 trillion. But that’s still 26% of GDP. Add to that runaway deficit spending, and consumer prices will never return to pre-pandemic levels.
The infinite depreciation of the dollar
This week’s FOMC statement included the usual content: Implementation Notes. This implementation note is largely ignored.
According to the memo, monthly reductions in Treasury securities will be limited to $25 billion and monthly reductions in mortgage-backed securities will be limited to $35 billion. Prior to May 2, Treasury holdings were being reduced by $60 billion per month.
This decline in the rate of decline in the balance sheet means that the Fed’s total assets will never return to their 2019 levels. Simply put, the money supply inflation that occurred between 2020 and 2022 is permanent.
Former Federal Reserve Board member Kevin Warsh recently shared his thoughts: The Wall Street Journal In the article he said:
“The Fed has been shrinking its balance sheet over the past few quarters, taking it down 7 percentage points from its peak as a share of GDP. M2 is down about 3%. Look: less money printing, less inflation.
“If the Fed were to continue to reduce its balance sheet, it would be easier to achieve price stability. But Fed leadership has been sending strong signals to the contrary, that its balance sheet is approaching stability. They argue that the decline in inflation is due to lower wage growth in a softer jobs market. I think irresponsible government spending and excessive money printing are the primary causes of inflation in the first place.
“If the Fed had recognized the inflation problem sooner, it would not have raised interest rates so high. If the Fed’s asset holdings had been smaller or had been reduced more quickly, inflation would not have risen so high. Hard-working Americans would not now be suffering the double humiliation of higher prices and higher credit costs.”
Mr. Wash’s comments should not be open to revelation or controversy. It is unusual to hear such criticism coming from someone who came from the Federal Reserve.
Finally, the Fed continues to act in the interests of the private banks it serves at the expense of American workers, savers, and retirees. So whether or not the Fed cuts rates in September, the Fed has already started to reduce the rate of decline in its balance sheet months ago, and it is done fighting inflation.
The continued policy of devaluing the dollar has resulted in permanently distorted and higher prices for goods and services. Infinitely.
[Editor’s note: It really is amazing how just a few simple contrary decisions can lead to life-changing wealth. And right now, at this very moment, I’m preparing to make a contrary decision once again. >> And I’d like to show you how you can too.]
thank you,
MN Gordon
For Economic Prism
Returning to the economic prism from the infinite depreciation of the dollar
