The Fed’s ‘Debt Monster’ Is Calling the Shots

The funny money gets funnier in the US, too…

Yesterday, as expected, the Fed raised its key short-term lending rate by 25 basis points, to 0.75%.

Stocks fell. Bloomberg Markets:

Federal Reserve officials raised interest rates for the first time this year and forecast a steeper path for borrowing costs in 2017, saying inflation expectations have increased “considerably” and suggesting the labor market is tightening.

The Federal Open Market Committee cited “realized and expected labor market conditions and inflation” in increasing its benchmark rate a quarter percentage point, according to a statement Wednesday following a two-day meeting in Washington. New projections show central bankers expect three quarter-point rate increases in 2017, up from the two seen in the previous forecasts in September, based on median estimates.

Debt monster

You know our prediction: The Fed will never willingly lead interest rates to a neutral position.

It can’t. It has created a debt monster. It must feed this Frankenstein with easy credit.

This time last year, the Fed began its ‘rate-tightening cycle’. That is, it began raising short-term interest rates.

It pledged to continue to do so in 2016. But then it diddled and dawdled, fiddled and fawdled…claiming to be on top of the situation…watching its ‘data’ come in like a fisherman’s wife waiting for the return of the fleet…and not wanting to admit she was already a widow.

What it was really waiting for was a place to hide.

The Fed can raise short-term rates. But it will have to follow, not lead. It will have to hide in the shadow of rising consumer prices, staying ‘behind the curve’ of inflation expectations.

That way, the expected real interest rate — the rate of return on your money above the rate of consumer price inflation — never really returns to neutral.

Already, the price of a barrel of crude oil — a key input into prices across the economy — is twice what it was 10 months ago. A leading business-cycle research firm, the Economic Cycle Research Institute, says that the inflation cycle has turned positive.

And, already, foreign nations are talking about retaliating against Team Trump by cancelling orders and imposing new tariffs in their own versions of ‘better trade deals’.

This, too, is bound to raise prices.

Funny money antics

But if consumer price inflation were really a concern, the bond market would race ahead of the Fed, imposing its own regimen of rising yields.

The Fed’s increases would be too little, and too late, to have any real effect on the outcome.

Bondholders don’t care much about nominal rates. If consumer price inflation were to rise to the Fed’s 2% target, for example, bondholders might clamour for a 4% yield to give them a positive 2%.

That is a big increase over the 52-week low of 1.32% the yield on the 10-year Treasury note hit on 4 July.

But you don’t get that kind of seismic shift without cracking some flower pots.

Much of the world’s $225 trillion in debt is calibrated to borrowers who will have a hard time surviving a 3% interest rate world, let alone a 4% one.

This is an economy that can stand a lot of grotesque and absurd ‘funny money’ antics. It can survive a bizarre financial world; it can’t survive a normal one.

As inflation expectations increase, investors do not sit still and watch their retirements, their savings, and their fortunes get broken by inflation.

They don’t wait for the Fed’s policy-setting committee to meet. They don’t reflect calmly as the Fed’s wonks collect their ‘data’ and create their ‘dot plots’.

Instead, they act out. The monster gets mad and starts throwing things.

First through the window are the bonds. They get chucked out before inflation manifests itself fully…and long before the Fed increases its key short-term rate.

Then, the ‘boom’ turns quickly into stagflation…as higher borrowing costs pinch off growth, even as consumer prices continue to rise.

But, more likely, inflation is not really surging…not yet.

And, most likely, it will be the painfully apparent when the US economy goes into recession next year.

Then, it will be stocks’ turn to get tossed out, while bonds sneak back in through the side door.

It will also be apparent that the Fed has taken another false step…that the recovery was a sham…and that it’s the debt monster calling the shots, not Janet Yellen.


Bill Bonner,
For Markets and Money


From the Archives…

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If China’s Economy Is So Strong, Why Is Capital Fleeing?
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Welcome to the World of Stagnating Wages and Rising Unemployment
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Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.

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