Several times recently I’ve referred to the dilemma facing the Fed: inflation or recession. And, of course, it’s likely that the inflation horn of that dilemma won’t be just a little bit—as we’re realizing across the country already. I’ve wondered whether Jay Powell’s Fed will have the gumption to make a tough choice to try to get America back on track. Lately, however, I’ve noticed more commentators suggesting the the Fed may actually be serious—this time may be different. Maybe.
Of course none of these things are simple, and getting America back on track isn’t so simple as fighting inflation, complex as that is. It’s not simple because our current crisis is the end result of generations of bad decisions made by human beings. And we don’t exactly have our best and brightest with their hands at the levers of power these days.
I’ve cited Karl Denninger in this regard a number of times, and today he talks about the prospect of Fed anti-inflation action, but in his usual colorful way. Some excerpts:
What’s in motion, he says, is a train—and it’s heading down the tracks toward our vehicle that’s stuck on the tracks.
Joe Biden's administration killed Keystone. This action, like Jimmy Carter's shutdown of nuclear fuel reprocessing, was entirely intentional. Its purpose was to cripple oil and gas production and even if reversed by a subsequent administration will do so because no private enterprise in its right mind will ever spend a nickel where it can be destroyed without compensation by executive fiat in the future.
Carter's order was voided by Ronald Reagan on his first day in office. It didn't matter. There is still, forty years later, no commercial nuclear fuel reprocessing industry in the United States.
This is a serious matter folks because now, without strong legislative or even Constitutional protection we are facing a price spike problem on the input side of everything. You can dream of "green energy" all you want, but the fact of the matter is that we use hydrocarbons simply because they are more cost-efficient and reliably available; the so-called "green" alternatives are neither.
You might have noticed that going out to eat has gotten hideously expensive. It's not up by 10% or so in most places; in many it has now close to doubled. The reasons are quite-complex but all of them devolve down into energy in one form or another. Fertilizer, which is largely made from hydrocarbon inputs, has also wildly escalated in cost and that needs to go on the ground in the coming weeks for this spring planting season. You can't fix this in a week or a month, just like you didn't break it in a week or a month.
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None of this was from natural forces; it was all man-made by our governments.
We’ll skip a bit, to where KD starts talking about societal breakdown:
The ivory-tower and "walled commune" folks in DC and many "Blue" cities, many of whom have never made an honest dollar through hard work in their life, are nuts. While you can paper over stupidity for quite a long time, and in the process make your buddies very rich at some point the ordinary person has to be able to not just live with rats in the subway tunnel and survive but produce -- or civil society fails.
At its core "law and order" only exists because more than 99% of the people go along with whatever the laws and rules are. It's simple math: You can't throw more than about 1% of the adult population in jail as every person in jail winds up costing you two more people's worth of economic output plus the one you incarcerated. If you try to lock up 3% of the population you lose 10%+ of your productive output and society collapses. Once it collapses it's open season on everyone, including both those who caused it and those who did not.
Many think The Fed will not do what has to be done in this situation. I believe they're wrong. The FOMC is always inclined to try to salvage a soft landing out of an incipient crash, but if push comes to shove, and it has at this point, they will force the bad policy actions of the government back onto them because they have to, lest they risk being what's for dinner just like everyone else.
Is this the reason for the Fed’s continued delaying? KD doesn’t speculate on that, but from his standpoint it would make sense that the Fed is trying to goad the government into—don’t laugh—responsible policy decisions.
The truly ugly [thing] is that remedial action will take as long to fix it as the original bad actions took to break it. There's only one place in the federal budget to get the bulk of the money that has to be redirected to interest along with direct spending cuts to stop running the deficits in the first place, and that's Medicare and Medicaid.
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I don't believe The Fed will allow the United States to go down the toilet. I believe they will do what needs to be done. They'll be late, as they have been thus far, and they will make lots of noise, but in the end they'll do it because they know full well that if they don't they're likely to be what's for dinner just like everyone else.
As usual, much has been left out.
I would welcome increased interest rates, 0.2% interest on deposits is criminal, in comparison to what is being charged to borrowers. I believe the US government will default on bond obligations. This has been done in the past, the holders of WWI liberty bonds got screwed in 1934. Liberty bonds were supposed to be paid with dollars that were worth $20.67 per ounce of gold, instead of $34.00, around 70% lower real buying power.
The bond market seems to indicate that raising rates will, in fact, result in a recession. What has happened is that rates between 1 month and 7 years duration have come up under the jawboning of the Fed, but the 10Y+ rates haven't moved nearly as much- in short the entire duration curve has gotten flatter, not steeper, and a flatter curve indicates no growth expected 7 years and out.
Will the Fed start raising short term rates? I don't know. I do know the math shows interest costs to the US government will get much worse if they do anything more than they did during the last raising rates cycle from late 2015 to 2019. The difference now, though, is the effect of the COVID policies are added on top of the load.
Like I wrote last week- I have made my bets- my bet is basically that Denninger is correct- the Fed will raise rates to choke inflation in its crib, and this will cause a recession.