The FED decided to hike rates up 50 basis points and all signs point to more hikes. The interviews FED figures provide the public point to this being their priority. Problem is inflation has a runway now and will continue despite their rates hikes.
The double whammy is that America continues to run up huge deficits (despite Biden touting his cut to the deficit), and the FED let ZIRP last too long. Biden reducing the deficit from the covid induced spike is nothing. Dollars are being pushed out in immense quantities. The FED let ZIRP last a decade and kept worse than marginal borrowers in the spending game. The FED cannot slow down the spending in DC and can only affect marginal borrowing.
The last financial crash was the product of the housing bubble, but that’s not the whole story. Starting in January of 2001, the FED held an emergency meeting to begin a two and a half year cut to rates from 6% to 1%. All lending was boosted as the FED cleaned up the stock bubble bursting. With federal government guidance, this became a housing bubble. Paul Krugman himself requested such a bubble. It was the most visible expression of the ‘00s bubble as it created homes and the HELOC binge fueled consumer spending.
The FED began raising rates in 25 basis points steps starting mid-2004. They stopped in June of ‘06 at 5.25%. The damage was done though as the effects on all debt instruments increased costs, and eventually, the nation ran out of new borrowers. This was shown by the anecdote of a tomato picker making $14,000 receiving a $700,000 mortgage. As rates rose, that speculatively marginal borrower was the last in line. The big bust finally caught up with everything and everyone by ‘08, a full two years after the end of rate hikes.
How does this provide insight to our predicament? The FED hiked rates as oil was climbing, and oil climbed despite all of those hikes. Oil was not alone. While some focused on Peak Oil, others noticed the rise in all agricultural and mineral costs. The world was not running out of everything all at once. This carried on for the full two years of rate hikes and two years after. This was in the face of rate hikes. It only ended once raw costs destroyed the economics of the productive economy and the too big to fail banks had a liquidity crisis. It was a year before the crash but Jim Cramer’s CNBC meltdown begging for rate relief signaled time was up. Some suspect the move to prevent that 2008 blow off top to commodities was a rate hike, but the show carried on for one more year.
The FED can push rates up, but will likely not raise them fast enough to reach positive real rates. They can’t raise them too high due to the mountain of debt Bernanke-Yellen allowed to form for a decade. Their hope is to have a rate around 3% when inflation hits year over year comparisons as the rate of inflation will be 1-2%. We won’t see a drop in prices but the FED and our compliant media will trumpet the victory of disinflation as an end of it. You will not enjoy any relief from a deflation; disinflation will be a new plateau. With a slip in employment numbers so 95% of us will be fine.
That is if they are lucky. That is the best case scenario. Hard layoffs lurk in the future. What if inflation doesn’t stabilize? How can the FED do it anyway? Demand destruction so a true blue recession. Even then, that would take more than is politically tenable. The problem we face is oil and other raw inputs are now elevated and look to stay that way. Finished goods now likely had cost inputs at the lower fall ‘21 levels. Once the economic cycles prices these in as the new normal, final consumer prices will jump further. The only non-monetary fix for this would be a dose of austerity. That won’t happen in a midterm election year, and it would be cold soup to serve up for the Biden administration as ‘24 looms. No one wants to run as a belt tightener in a ‘70s environment. If any politician should remember, it should be Biden. If he can remember.