Capital follows a broad life cycle. First it is imagined. Then it is produced. Later it is consumed. Ultimately it is destroyed. How exactly all this happens involves many and infinite waves over decades and centuries.
One generation can produce wealth. The next generation consumes it. Likewise, the doomed generation can inherit an insurmountable debt burden. In the form of enormous government debt, that debt will haunt them until they die. Ingenuity and determination will be considerably stifled.
As we understand it, the value of money is in what it represents. Every dollar of real money must come from a dollar of wealth produced, and every dollar of credit multiplied by that money must mean interest added to the dollar of wealth in the process of being created.
This is how wealth creation should work in a world where money is sound, budgets are balanced, and bankers back up loans. But today’s world rarely works as expected. Through state-sponsored wealth destruction policies, wealth is extracted from those who created it and then burned with systematic efficiency.
This is achieved through fake money, deficit spending, and central bank credit market manipulation. It is also achieved through transfer payments, belligerent behavior, tax credit policies, and public spending programs.
The result is endless, massive distortions, misallocations, debt piles and losses. Plus, the average wage earner (the one who works hard, saves money and pays for his own living expenses) doesn’t get the chance of an honest person.
Drawn dots
Within a system of fake money, large deficits, and central bank intervention, money is continually degraded. Its relationship to the basic wealth it represents is degraded. The purchasing power of money is impaired. The labor that earns money is diminished. The time spent accumulating money is stolen.
When a government launches a massive state-sponsored counterfeiting operation… when it issues fake money – money that has no clear link to any form of wealth produced – what happens next is well known: consumer and/or asset prices gradually inflate, and this can only be stopped by a central bank-manipulated financial disaster.
This week saw the release of the latest monetary policy statement following a two-day FOMC meeting. Released. Simply put, the Fed is maintaining its target range for the federal funds rate at 5.25% to 5.5%. Dot plotBut it does provide some new signals.
In 2024, the Fed is expected to cut rates three times, totaling 75 basis points, with a median rate of 4.6%. This is consistent with previous forecasts. However, in 2025 and 2026, the Fed is expected to reduce the number of rate cuts.
Specifically, the FOMC mid-rate rate forecast for 2025 has now been raised to 3.9% from the previous forecast of 3.6%, and the FOMC mid-rate rate forecast for 2026 has now been raised to 3.1% from the previous forecast of 2.9%.
After the meeting press conferencePowell commented on QT: “It would be appropriate to slow down the outflow soon.”
Is it significant that the Fed expects to reduce the pace of rate cuts in 2025 and 2026?
In fact, the Fed’s projections for 2025 and 2026 are useless. By the time the calendar reaches those marks, the economic situation will look very different than it does today.
Very accommodating
More importantly, in the face of a 3.2% CPI, cutting rates in 2024 is reckless in our view. We believe that the massive deficit spending coming out of Washington will continue to drive higher inflation. The Fed’s forecast of three rate cuts in 2024 further supports this view.
The federal funds rate within the target range of 5.25% to 5.5% generally does not signal restraint, not when prices are rising at a rate of 3.2% per year.
Using the 5.5 percent cap for the federal funds rate target, the real inflation-adjusted rate would be 2.3 percent. And using the 4.6 percent median rate after three rate cuts expected later this year and assuming inflation remains the same, the real inflation-adjusted rate would be 1.4 percent.
These interest rates are very favorable.
The perception of restraint implied by current interest rates is the result of a decade or more of crazy monetary policy that has left society dependent on money that is virtually free. Like going off a 3,000 calorie a day diet, going off a 0% interest rate policy may cause some pain. But that doesn’t mean it’s unhealthy.
Real labor is needed to acquire real capital. Therefore, capital must be used wisely. The cost of funds (interest rate) is the mechanism for managing the wise use of capital.
The extended free money episode following the Great Recession of 2008-09 made capital readily available. But this was not real capital that required real effort to obtain. It was fake capital that was given away for free.
Fake capital may have acted like real capital. It can be borrowed and used to acquire real goods. But without the natural limit of the interest rate premium, fake capital was used indiscriminately.
Why the FOMC Wants to Cut Rates
Simply put, fake capital has led to countless price distortions: marginally valuable business ventures, over-construction of commercial real estate towers, electric cars that don’t get you where you need to go, over-priced stocks, and so on.
Governments (federal, state, local) have also borrowed cheap money and spent it with little accountability. Since 2008, the national debt has ballooned from $11.3 trillion to over $34.5 trillion.
Likewise, companies borrowed money at extremely low prices and used it to finance things that did not generate future growth, such as debt-financed stock purchases and dividend payments. Without the fake capital of the Federal Reserve, such financial engineering schemes would not have been possible.
Higher interest rates will make capital more expensive due to rising consumer prices. In addition, higher interest rates will force borrowers to use their capital wisely.
But with consumer prices still rising at a rate of 3.2% per year, and the cost of funds at 5.5% (soon to be 4.6%), this does little to encourage prudent and efficient use of capital. Rather, it amplifies the price distortions, debt accumulation, and speculative fever that have caused the current chaos, and pushes it further into a crisis.
Given these fundamentals, why would the FOMC want to cut rates?
Here at Economic Prism, we don’t pretend to know what interest rates should be. Still, we would prefer that interest rates be determined by lenders and borrowers (i.e., the free market) rather than by an unelected bureaucracy.
These bureaucrats have no more idea what interest rates should be than the dog next door. But they do know what they ‘want’ to be.
Remember, these unelected bureaucrats work for the big banks, and the big banks want lower interest rates to bail out all those terrible loans.
So the FOMC also wants to lower interest rates.
[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
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