The Fed Chairman was flush with praise yesterday over the stupendous state of the US economy.
The economy is in a “good place”, he told reporters at a press conference after announcing a 50-basis point (0.5%) interest rate cut. The labor market is “strong”. Inflation is “coming down”. They’re “confident” about the future outlook. Basically, everything is awesome.
But at least a handful of reporters noticed the obvious paradox: if the economy is doing so great, then why are you slashing interest rates?
Typically, central bankers only cut interest rates when the economy is weakening… which certainly doesn’t conform to the Chairman’s effervescent outlook.
So, which is it? Is the economy strong? Or is it weak? Apparently, we’re supposed to believe that it is simultaneously both.
A handful of reporters in attendance at yesterday’s press conference were courageous enough to push him on the issue.
One reporter noted, for example, that Fed officials were anticipating several more rate cuts in the near future… simply to prevent the unemployment rate from rising any further. That certainly doesn’t sound like a super-healthy economy.
But the Fed Chairman continued to insist that the economy is solid, with the same conviction that Kamala Harris has when she declares that her “values haven’t changed”.
What I found most remarkable about yesterday’s meeting was that almost all the questions were about the labor market and unemployment; there was very limited discussion about inflation.
It was as if the Fed had cast a spell over the crowd and made people forget about all the insufferable inflation over the past few years… or at least convinced them that inflation was in the rear-view mirror.
But candidly, the Fed has to know that the inflation problem isn’t over.
Last month’s CPI inflation report, for example, showed a 2.5% annual increase in consumer prices— though excluding the volatile food and fuel prices, so-called ‘core’ inflation was 3.2%.
But remember, the overall inflation number is really just an average of various categories, like apparel, medical care, and transportation services.
It turns out that one key category— used cars— has been dragging down the average over the past few months. You probably remember that used car prices shot up to outrageous levels in the early days of the pandemic. They’re finally starting to fall. And over the last year, used car prices fell around 10%.
This 10% drop in used car prices dragged down the inflation average.
But here’s the problem: the fall in used car prices is a temporary phenomenon, i.e. used car prices can’t and won’t fall forever. Most likely this will only last a few more months, after which the overall inflation average will shoot back up.
And that’s just over the short term.
Longer term, endless multi-trillion-dollar federal deficits will keep driving inflation higher.
Right now, the national debt is a whopping $35.3 trillion. And the government’s own forecasts indicate that it will rise by an additional $22 trillion over the next 10 years. In reality the rise will be far greater.
The interest bill on this massive pile of debt is debilitating; already, this fiscal year, the total gross interest bill will exceed $1.1 trillion— far more than the government spends on national defense.
And this interest bill is rising at an alarming pace.
Consider that, just before the pandemic in 2019, the annual interest bill was around $400 billion. So, it’s surged nearly 3x in five years.
Government tax revenue has increased as well. But interest expense is surging at a far more rapid pace. And this is dangerous.
The more money the government has to pay in interest, the less money is left over to pay for other things, including Social Security, the military, etc. This will force the government to borrow even more money just to make ends meet, making its interest problem even worse.
This is really the reason why the Fed cut rates. They know that the US government cannot afford to pay even 5% on its debt… which is totally ridiculous.
Some of our readers may remember the late 1990s. Back then, the government actually ran a budget surplus, at least on paper. The national debt was low and shrinking. The US economy was booming. Inflation was just 1.5%. And there was no other country on the planet that could come close to rivaling America’s dominance.
And yet the US government 10-year Treasury Note still yielded over 6%.
In other words, despite everything being so great and the government balance sheet looking so favorable, investors still demanded a 6%+ return from the government.
Today, the US is $35 trillion in debt— about 125% of GDP— with a weak, highly dysfunctional government that embraces socialism and cannot compromise on the most basic priorities. And yet the 10-year yield today is less than 4%.
But now the Fed says even 4% is too high, therefore interest rates must fall!
And they’re right. Think about it: the national debt is expanding at an exponential pace, and it will likely pass $50 trillion within the next 5-7 years. If interest rates average 4%, that means the government will spend over $2 trillion per year just to pay interest. And that’s potentially just five years away.
The Fed knows this is totally unsustainable. They know the only way that the US government can function anymore is if interest rates are essentially 0%.
And that’s why they cut rates yesterday: because the US government can’t afford to pay 4%.
They talk about the awesome US economy and shrinking inflation rate, but these are just excuses to justify the rate cut. The real reason is that they have to bail out Uncle Sam.
Ultimately this combination of low interest rates and extreme deficits will create a lot more inflation. But if the Fed has to choose the lesser of two evils, i.e. higher inflation versus a bankrupt US government, they will easily choose the path of inflation.
That’s why it makes so much sense to own real assets.
