I have been writing a lot lately about the economy and the market. I know it’s a bit of a departure from what I usually write about here, but I write about things that I believe are important. I am only one person running this website, and it’s impossible for me to write about everything like the other sites that have teams of bloggers. I have to sift through the news and determine which stories I believe are the most important–meaning the most likely to impact our everyday lives.
The whole Joe Rogan-Spotify controversy right now–I’m well-aware of it. I’m 100% on team Joe Rogan and support him all the way. I love Joe Rogan. But that is a Twitter story, in my view. That is not really a story that directly impacts your daily life.
Again, while I’m a huge Joe Rogan fan, if I were to write about that story here and expend a ton of time and effort on it, to me that’s just providing you with empty calories. It’s just outrage porn–“THOSE ASSHOLES! HOW DARE THEY COME AFTER JOE ROGAN!?!”
I really do try my best to avoid writing posts whose sole purpose is to simply piss you off and get you all worked up over something that ultimately does not impact your life in any way. I think modern media runs way too many stories like this, and I do my best not to contribute.
As much as possible, I try to write about things that are relevant to you and me. This is why lately I have primarily been writing about the economy, the markets, the situation in Russia/Ukraine, the Canadian Truckers, and Covid-19. To me, those are the most important and relevant stories right now.
In my view, inflation is the most important of them all.
It is not just some side story that pops up for a day and then is quickly overshadowed and forgotten in the course of the 24-Hour News Cycle.
Certainly, a lot of people treat it that way. The latest CPI print is released, and then people on social media go, “INFLATION AGAIN? WOW! WORST PRESIDENT OF ALL TIME! LET’S GO BRANDON!” And then they move on to the next outrage.
People have a hard time differentiating the signal from the noise. The signal is the important stuff, the noise is what distracts you from the important stuff.
Inflation is the signal. It’s the important stuff. As far as I’m concerned, if inflation continues and gets out of hand, the noise will no longer matter. Inflation will be the only thing anyone talks about at all.
For one thing, it’s making everything more expensive–gas and food primarily. Most people have noticed it. A dollar does not go as far as it used to even as recently as a year ago.
But that’s not even close to the whole story. The real story is how the Federal Reserve will respond to inflation. That’s what really matters here.
From November 1976 to March 1980, the US inflation rate rose from 5% to 14.8%. During that same time period, the Federal Reserve hiked interest rates from 4.75% all the way up to 20%.
The Fed kept interest rates high for the next few years: after bringing rates down to 9% in mid-1980, they hiked rates back to 20%, where they remained until about mid-1981. By April 1982, interest rates were still over 13%, but inflation was coming down from its peak. By May 1983, inflation was tamed and sat at 2.5%, and interest rates were able to come down to about 9%.
During that time, when interest rates and inflation were both sky-high, the US suffered through its worst recession since the 1930s. What made this recession so bad was the inflation: people were losing their jobs and prices were rising like crazy. The nationwide unemployment rate peaked at 10.8% in November 1982, and two states–West Virginia and Michigan–had statewide official unemployment rates of over 16%. In fact, West Virginia’s unemployment rate at one point was over 23%.
Again, it was the worst recession since the 1930s, and outside of the Great Depression, the only economic recession of the past 100 years that rivaled the early 1980s recession was the 2008 Great Recession. But the early 1980s recession was arguably worse because of the inflation, and because it lasted a bit longer.
The reason the early 1980s recession was so bad was because of inflation–or, rather, the Fed’s response to inflation. Fed Chairman Paul Volcker was determined to “break the back” of inflation, and to do so he raised interest rates until the inflation subsided. That was the policy: if the inflation rate was still rising, it just meant interest rates weren’t high enough yet, and so interest rates were raised even more. Volcker didn’t stop hiking interest rates until they were over 20%, which of course leads to a severe slowdown of economic activity.
With high interest rates, people are encouraged to save money–if you can make 20% a year parking your money in a savings account, you’ll probably do it. But if you’re saving, that means you’re not spending and stimulating the economy. High interest rates mean people aren’t buying homes, businesses aren’t taking out loans and expanding–it’s essentially like slamming the brakes on the economy.
But that’s the only way to stop inflation, because inflation is exacerbated by spending and economic activity.
Inflation is a vicious cycle: prices for producers rise, so consumers have to pay higher prices. Consumers–who are also the labor force–demand higher wages to offset the increased cost of living, and then the businesses, in order to pay those higher wages, have to raise prices even more, which in turn leads to further wage hikes, and on and on. If the cycle isn’t broken, it will eventually lead to runaway hyperinflation, where prices rise so rapidly that between the time you sit down at a restaurant to the time you get the bill for your meal, the price of that meal has gone up. The ultimate endgame of inflation is a situation where it costs a trillion dollars to buy a loaf of bread, and people are burning paper money to stay warm because it’s cheaper than firewood. In other words, it is complete and total economic collapse. The currency becomes worthless, there are mass defaults on debt, and, best of all, there’s widespread starvation and famine.
It’s essentially an economic apocalypse. That’s what happens when inflation gets out of control. It happened to Germany in the early 1920s, and not long after the German hyperinflationary period, Adolf Hitler and the Nazis rose to power. Certainly, there was more to the rise of Hitler than just the hyperinflation (losing World War I in 1918 contributed, as did the worldwide Great Depression starting in 1929), but in the wake of the German hyperinflation, governments all around the world took notice of just what could happen if inflation were allowed to get out of control.
Central bank monetary policy over the past 100 years has been heavily influenced by the lessons of 1920s Germany. Central banks know that above all else, inflation must be kept in check. And no central bank in the world is more acutely aware of that than the US central bank, the Federal Reserve, because of America’s role as the global hegemonic superpower.
Weimar Germany in the 1920s was not the economic powerhouse of the world. Its currency, the mark, was not the global reserve currency. And the world economy was not as interconnected and “globalized” back then as it is today. And so when Weimar Germany underwent hyperinflation, the rest of the world was able to largely sidestep the economic carnage–Germany’s economic problems were largely contained back then. The worldwide Great Depression that began in 1929 had nothing to do with the German hyperinflation.
But today, if America descends into an inflationary crisis, it will wreck the world economy. And a collapse of the dollar will be end of the American world empire.
And this is why Paul Volcker raised interest rates so aggressively in the early 1980s even though the economy was in shambles: because as bad as the recession was, hyperinflation would be many times worse–for both the American people and the American ruling class.
This is the point I keep stressing: the US Federal Reserve will not tolerate runaway inflation. When faced with inflation, they will do everything in their power to get it under control, no matter how badly it harms the US economy. They will break the back of inflation at all costs.
In 1974, the inflationary spike that preceded the inflation of a few years later, the inflation rate was over 12%, and the Fed hiked interest rates to 13% in response. This also caused a very painful recession and stock market collapse.
In 1980, when inflation was over 14%, the Fed hiked interest rates to over 20% in response.
That’s the kind of effort it takes on the part of the Federal Reserve to get inflation under control. You have to raise interest rates to above the rate of inflation in order to get inflation under control.
Today, the official figures show 7% inflation. Putting aside for a second the fact that if inflation were still calculated the way it was back in 1980, the rate today would be 15%–if inflation does not subside naturally and on its own (which many are predicting/hoping), then that means the Fed may have to increase interest rates from the current 0% to over 7%. And that’s if inflation stays stable at 7% and doesn’t go any higher.
Now, it may be the case that it’s not necessary to hike interest rates up over 7% to get inflation under control. Just because that was what worked in the early 1980s does not mean it is the only thing that will work today. Inflation may start to come down at something like 2% interest rates, or 3% interest rates.
But if the Fed hikes rates to 1.25%–which is what Goldman Sachs’ economists expect by the end of the year–do we really believe that will be sufficient to get inflation under control?
Prior to 2008, when 0% interest rates became the norm, an interest rate of 1.25% used to be considered accommodative monetary policy. That’s what the Fed would cut interest rates down to in order to spur economic activity in the midst of a recession. As you can see from the chart, following the 2001 recession and the Dot Com crash, the Fed cut interest rates from 6.5% down to 1% by June 2003, and that was what jumpstarted the economy again.
Yet now, we are talking about 1.25% interest rates as if that’s going to induce enough of an economic slowdown to tame a 7%+ inflation rate.
I just don’t see it.
There really is no hard and fast rule that tells you, definitively, “If inflation is x%, you must increase interest rates to y% to get it under control.” We can only look at the past as a guide. And if we look at the early 1980s, what it shows us is that inflation doesn’t start going down until interest rates are higher than the inflation rate.
But things are also different today. and the first major difference is that we have a massive amount of debt–government, corporate, consumer–that will be highly sensitive to any rate hikes at all. I mean, we’ve had 0% interest rates for the better part of the last 12 years–people have essentially “adapted” to operating in a low-rate environment.
What that means is that all entities–government, corporations, consumers–have gotten used to low interest rates and have accumulated a lot of debt as a result. When debt is cheap, you can afford more of it. Everybody levers up because interest payments are low.
Right now, the Federal Government’s debt is 122% of GDP. That’s the highest in US history:
Back in the late 1970s and early 1980s, Federal debt was only about 31% of GDP, meaning the government was much better able to handle extreme rises in interest rates and still make its interest payments.
Corporate sector debt is currently over 49% of GDP, which is higher than it has ever been before:
Back in the stagflation era, it was around 30% of GDP.
Household debt is currently 75% of GDP, which is not the highest it has ever been (2008 was the peak at over 98%), but still higher than it has ever been for most of US history:
In the stagflation era, household debt was only about 49% of GDP.
So debt levels are way higher today, and what this means is that it will not take much of a hike in interest rates before we start seeing defaults and declining economic activity.
In other words, there is simply no chance the economy can handle interest rates of 5% or higher–definitely not the 7% it might require to get inflation under control.
But–and this is the point I stressed above–the Federal Reserve may not care if the economy can “handle” sharp interest rate hikes. They may not care how many corporations and households high rates bankrupt, because inflation is their #1 priority.
We know from the Volcker rate hikes that the Fed will stop at nothing to get inflation under control, even if it means sending the economy into a brutally devastating recession. Inflation must be tamed at all costs. The US dollar must be stabilized no matter what. The Fed is chiefly concerned with maintaining the integrity of the dollar; the economy comes second.
If the Fed is aggressive today in fighting inflation as it was in the early 1980s, the resulting recession will be even worse than the recession of the early 1980s–and it may be even worse than 2008 was. Because in 2008, there was no inflation to worry about. The Fed was free to cut rates down to 0% and begin Quantitative Easing (money printing) because there was no inflation to worry about. In fact, in 2008, inflation had fallen so hard the economy was in a state of deflation.
The only thing that, in my view, would cause the Fed to ease up on the rate hikes would be if it became clear the Federal Government was at risk of defaulting on its debt.
But what if we get to the point where the Fed’s rate hikes are risking a federal debt default, and inflation is still not under control? That’s the nightmare scenario, and I don’t know what the Fed would do. I really don’t. They’re basically fucked at that point.
At that point they would probably ease off the rate hikes and have the government impose wage and price controls and hope to get inflation under control that way.
Plus, if and when the rate hikes send the economy into recession, federal tax revenues will plummet due to the fact that both corporations and people aren’t making any money. Government revenues fell sharply during the Great Recession: from $2.6 trillion in 2007 down to $2.1 trillion in 2009. Tax revenues didn’t get back up above 2007 levels until 2014. So, a recession only further exacerbates the government’s debt problem.
Now, there’s always the possibility that the federal government cuts its spending, but we all know this is never going to happen. The federal government hasn’t cut spending since the 1990s–and that’s when the economy was way stronger and could handle a reduction in federal spending. Besides, most of the federal government’s spending isn’t discretionary–it’s mandatory spending that essentially can’t be cut. We’re talking about Social Security, Medicare, Medicaid, CHIP, and of course the ever-increasing interest payments it must make on its debt.
Over 77% of the federal government’s 2021 budget was either mandatory spending or interest payments. Of the remaining 23% of the budget that constitutes discretionary spending, about half of that is the military budget, which of course could be slashed dramatically, but do you really think the military industrial complex is going to allow that to happen?
In other words, federal spending can’t be cut–at least not in any meaningful way.
If interest rates do have to rise, and the Federal debt becomes a serious problem, the Federal government is going to have to take out even more debt just to make its interest payments, and hope to God people keep buying government bonds until the Fed gets to the point where it feels inflation is tamed and interest rates can come back down.
As you can see, this has the potential to unfold into a very nasty situation. I really have no idea how it’s going to play out. The Fed needs to get inflation under control, but in order to do so, it will probably have to tank the whole economy and risk a federal debt default.
When I think of Fed Chairman Jerome Powell, all that comes to mind is this Entourage clip:
“Because you’re fucked. Do you even know how fucked you are? I mean you are so fucking fucked; I mean, I think you’re the most fucked person I know.”
And what if, because they can obviously see what a bad spot the US government is in, the Chinese start dumping the US government bonds they hold, sending interest rates up even higher? Or what if they just threaten to do this and demand massive concessions from the US–like, say, allowing China to invade Taiwan and in the process take control of the vast majority of the world’s semiconductor production?
I really don’t know what’s going to happen. It feels like the US is fucked no matter what: either the US dollar is destroyed by inflation (no rate hikes), or the federal government defaults on its debt (rate hikes).
Now, you might be asking: “How did the government ever let it get to this point? How did they not foresee this day coming?”
Well, the answer is that politicians deliberately kicked the can down the road for the past 20 years, putting the problem off for what they believed to be future generations to deal with.
Politicians never want to cut spending. Doing so is unpopular with the voters, and politicians like being in power, so they never cut spending. They’ll never make the needed reforms to Medicare and Social Security to keep those programs solvent. And they’ll never increase taxes to the point where the federal government no longer has to go into debt, because tax hikes are just as unpopular as spending cuts–arguably more unpopular.
The federal government over the past 20 years or so has lived beyond its means–it has spent money at a level it could not afford to spend at. We have a government we cannot afford. It has been financed by debt, and we have come to believe that we really could afford it all simply because we were able to keep making our interest payments.
Most Americans really do believe the Federal government can afford to do anything we want it to do simply because it can always just borrow more money to pay the bill. And in a low interest rate environment, this really did seem to be true–the federal debt literally didn’t matter at all because all the federal government had to do was keep making its interest payments.
But now we’ve reached the point where, due to rising inflation, low interest rates are no longer feasible.
Inflation must be tamed, and interest rates must go up.
The only real hope we have is that the magic number for interest rates–that is, the point at which increased interest rates cause inflation to subside–is lower than the federal government’s breaking point in terms of making its interest payments on its debt.
For example, if the federal government can only handle, say 5% interest rates maximum, but we see inflation start to subside at 3% interest rates, then we’re in the clear. Sure, we’ll probably be in a recession–perhaps a serious recession–but at least the federal government won’t have to default on its debt.
I don’t know where the Federal government’s breaking point is in terms of interest rates it can handle. I’ve looked for answers (on Google) and I couldn’t find anything.
And there are steps the federal government could take to avoid a default, such as selling off federal lands and assets. Mainly we’re talking about oil-and natural resource-rich (coal, natural gas, minerals, etc.) areas that could be sold to corporations or even other countries. A 2017 article estimated that the federal government could net over $20 trillion, and possibly as high as $35 trillion, for all of its assets were it to decide to liquidate them all at once.
Now I don’t think this would be necessary, as all the government would really have to do is sell off enough assets to make its interest payments until interest rates are able to come down. The point is, though, there are measures the government would be able to take before it has to announce the Social Security checks are no longer being sent out.
(Although even this measure could be carried out more efficiently and without causing as much harm: simply don’t send the checks to the people that don’t need them (this is known as “means-testing”). In fact, we should stop doing this as it is. Just stop sending Social Security checks to rich people! It’s idiotic and we can’t afford it.)
But these would still be no more than desperate emergency measures–and immediately afterward, the government would go right back to its reckless spending.
What really has to happen is the federal government is going to have to institute some massive reforms to its big-ticket mandatory spending programs so it can stop racking up so much debt. I’m not saying we need to get rid of Social Security, Medicare and Medicaid–only reform them so that they are, you know, actually solvent. We can’t afford them presently. I know it would be unpopular, but the simple fact is we cannot afford the government we have. We’re not as rich as we think we are, and so this is all completely unsustainable. A federal government that is in massive amounts of debt is a tremendous liability.
The World Bank in 2013 found that federal debt levels that exceed 77% of GDP are increasingly a drag on the economy. Ours is over 130%. We are now in a situation where our debt is a burden to economic growth, and that slower economic growth also causes the debt to increase more rapidly–we are already in a vicious cycle.
And we need to get birthrates trending upward again because an aging and declining population means lower and lower economic output, which ultimately means the federal government will default on its debt some day in the future.
But as I went over in a prior post, low interest rates are a big part of the reason America’s population growth is slowing: lower interest rates mean greater demand for housing, which means housing becomes more and more unaffordable, which ultimately means it’s harder for young people to settle down and start families. It also makes it harder for existing families to have more kids if they can’t move up to a bigger house.
The problem is that interest rates, as we’ve just gone over, can’t go up until the federal government gets its finances in order. And do you have any faith that that will ever happen? I certainly don’t. Our politicians have shown a consistent determination to kick the can down the road and let some future generation deal with the consequences.
When our politicians have a choice between setting the government on a path to long-term fiscal solvency or kicking the can down the road, they will choose to kick the can down the road every time.
This is why we need to get rid of all the Old Boomers that are currently in control of government: they don’t care about the future. They have very little skin in the game. They’re perfectly content kicking the can down the road and letting some future generation deal with the meltdown when it eventually happens.
Can you imagine if past generations had run the country this way? We wouldn’t have lasted 50 years. Previous generations always managed to get government debt under control–plus, they only ran up high debt levels to fight major wars.
Not this generation. Debt has been skyrocketing since the early 1980s outside of a brief period in the late 1990s where a bipartisan government was committed to balancing the budget. But that didn’t last long.
At the end of the day, low interest rates really are to blame for all of this.
Low interest rates encouraged all of us–the government, the corporate sector, households–to live beyond our means. Because debt is cheap, and it’s easy to live beyond our means.
Low rates have also caused both a stock bubble and a housing bubble.
And the most dangerous part of this is that the massive amount of debt accumulated at low rates has made it almost impossible for the Fed to hike interest rates to any meaningful degree.
We have inflation now, but the Fed may not even be able to hike rates to the extent needed to get inflation under control because doing so could risk a government debt default, which might then trigger a massive liquidation of federal assets (or even a pause in Social Security payments).
And many of the lesser borrowers–corporations, individuals–will be taken under when rates go up because they have racked up so much debt during the period of low interest rates.
We need to go back to an era of normalized interest rates. No more of this 0% rates bullshit. It encourages financial irresponsibility at every level of society, and it is completely unsustainable long-term.
We need to go back to an era where the stock market rises because of increasing corporate profits and business activity, not because the Fed has cut rates and is printing money.
We never actually allow our economy to go through the full business cycle of expansion and contraction. Policymakers have decided that they will not tolerate recessions anymore, and so interest rates must be cut until the economy starts growing again.
We never allow the economy to fully deleverage and get back to a healthy and unburdened state.
Look at the number of “zombie firms” in the US today: according to Deutsche Bank, 20% of US firms have higher debt-servicing costs than profits, meaning they’re making just enough money to pay their interest but not enough to ever actually pay off their debt:
This is what happens when you never allow the economy to self-correct. Unproductive businesses are rewarded, and never purged. Most of our economy now is simply debt.
Perhaps the best analogy is that of wildfires: when dead leaves and branches fall to the forest floor, they become kindling become a fire risk. The more dead leaves and branches that fall to the forest floor, the greater the risk of wildfire, and the worse the wildfire will be when it eventually does happen.
But you can mitigate the risk of a massive, out-of-control blaze by periodically allowing smaller burns to clear out the dead leaves and branches.
What we have is an economy where the “dead leaves and branches” (i.e., debt-supported zombie firms and unproductive investment ventures) are never allowed to be burned off, and so they just pile up until one day, a great conflagration breaks out and incinerates everything.
We not only inflate asset bubbles with cheap debt enabled by low interest rates, we also do not allow those asset bubbles to fully deflate because as soon as a recession begins, policymakers frantically spring into action to artificially halt the recessionary process. Thus, we just get deeper and deeper into debt, and asset prices get more and more inflated.
Stock markets have been overvalued for over 20 years now despite two major crashes:
Stock prices have never in the past 30 years been allowed to fall down to the point where they are at fair value, meaning an average P/E ratio of 15.
We are now in the midst of the third major bubble cycle of the past 30 years, and it has all been enabled by low interest rates and Fed policy to bailout the markets anytime things get rough.
Markets crash and economy goes into recession? Just cut interest rates–and, nowadays, turn on the money printer.
Even if the economy doesn’t crash, the mere hint of a coming recession compels the Fed to begin easing and cutting rates.
We were heading into a recession back in 2018-2019 as the Fed was in the midst of a rate-hiking cycle, but the Fed staved off the crash by ceasing its interest rate hikes in early 2019, and then the Fed began cutting rates in mid-2019, soon following it up with another round of QE.
The Pandemic was, in many ways, a stealth economic bailout as it served as an excuse for the Fed to drop interest rates down to 0% again and begin the biggest round of QE since 2008.
We were also probably going to go into recession in late 2015/early 2016, but the Fed also headed that off by pausing its rate-hiking cycle until the end of 2016.
You can clearly see the trend over the past 40 years: declining interest rates the whole time:
Since the early 1980s, when rates have been hiked, they never go back up as high as they were previously, and when rates are cut, they have gone lower and lower each time, until 2008 when they finally hit 0%.
We haven’t had a genuine deleveraging in a long time. We no longer allow the economy to do so. The Fed steps in and stops every recession before the economy can actually bring itself back to an equilibrium state.
When things get out of whack, they stay that way.
Economies are not supposed to work this way. Economies are not supposed to continually alternate between extravagant bubbles and devastating collapses.
But this is what we have as a result of the Federal Reserve slamming interest rates to the floor to encourage economic activity, and then hurriedly racing to hike rates in response to rising inflation.
This cycle has got to end at some point.
It may be in the process of ending right now due to inflation. But never underestimate the government’s ability to kick the can down the road.