I'm here to report to you with near certainty that inflation is not going away anytime soon. Last week the headline CPI number came in at 3.5% year over year. That's up from 3.2% last month. The trend is moving in the wrong direction. And away from the Fed's 2% inflation goal. And to expect otherwise would be a fool's errand...or a Wall Street sales pitch.
The Fed can decrease inflation in only two ways. It can raise interest rates, usually short term interest rates. Raising rates usually leads to less borrowing on the part of consumers and businesses which causes less final demand for consumer goods. Notice I did not say that raising interest rates causes less government borrowing. I'll get back to that interesting dichotomy later. Less demand for the same amount of production leads to lower prices all else equal.
Or the Fed can lower the amount of direct lending it does. By selling bonds, usually Federal treasury bonds, but in recent years mortgage-backed securities and other lower quality securities. By making bond sales the Fed is effectively increasing the amount of debt held by the private sector and thereby decreasing ultimate consumer demand and easing inflationary pressures.
The Wall Street sales pitch is that inflation is coming down so the Fed can start to cut interest rates. The problem is, inflation stopped coming down well before it reached the Fed's 2% target. Cutting rates now would almost certainly cause future inflation rates to increase. The Fed has already stopped mopping up credit by selling bonds.It's buying again.
And the well-telegraphed Fed intention to cut interest rates three times this year is now being questioned by Wall Street. That's why the stock market has been crashing the last few days. You see, the stock market thrives on loose money. Low interest rates make it lucrative for speculators to borrow at low rates to buy stocks betting that they will continue to go up, making profits for speculators and long-term investors alike. High interest rates choke off that demand to buy stocks and all else equal lead to lower stock prices.
So the Fed has caught itself inside its own trap. Through ulta-loose money, near zero interest rates and quantitative easing or the Fed purchase of debt from private bond holders, the Fed facilitated the 9%+ inflation of recent memory. They raised interest rates and engaged in quantitative tightening or Fed sale of debt to private bond holders facilitating the drop in inflation to February's 3.2%. Just as they started patting themselves on the back and said we've done our job of taming inflation here, the market said, not so fast. There's still a huge ocean of newly created Fed funny money floating around the market and it's being spent. Causing inflation to trend up once again. Fed, you're a long way from done. We're selling our stocks and bonds in anticipation of interest rates going up rather than down. Hence stocks crashing and ten year treasuries going up nearly 1% in the last three months.
The Fed is between a rock and a hard place. If they go through with their telegraphed intentions to cut rates, inflation will continue to rebound, possibly to hyperinflation territory. And, remember, the only sector of the economy that has not reduced spending due to higher interest rates is the Federal government. They, instead, are increasing spending. Increasing treasury borrowing. And at higher interest expense. Plus, maturing treasuries cannot be repaid. They have to be replaced at higher interest rates.In fact, interest expense is now on a par with military spending. If the Fed raises rates, the financial markets will go down and unemployment will go up. In an election year.
The Congress and both Trump and Biden are clueless or don't care about the country's growing debt problem. Total debt is now approaching 130% of GDP. That has happened in 52 countries in history. 51 of those countries went bankrupt in one way or another. Either through outright default on their treasuries or through hyperinflation which is effectively a regressive tax increase.
Which way do you think the wind is blowing? My guess is that the Fed will hold rates steady, hoping for the elusive soft landing. I say, good luck with that. And I will further predict that in a year or two, a 3 or even 4% inflation rate will become the new normal. After all, remember inflation is just a regressive tax that politicians don't have to leave fingerprints on. This is Richard Fields with this week's Report From the Fields. See you again next week.