March 27th 2023
Christian Laggard raised interest rates by 50 bps last week, and Mr. Powell decided to raise the Fed Funds Rate by 25bps today and to keep the Quantitative Tightening Program at its current pace. It is hysterically funny that the Fed and ECB both contend that they can fight inflation while also ensuring financial stability. Such a contention reeks of manure so much that only a dung beetle could endure it.
It was once possible to have both—financial stability and low inflation–but not when interest rates have been raised from a nominal negative level to 3.5% in a nine-month timeframe, as is the case in Europe. And when those negative nominal rates were set in place for six years in duration. It is a similar dynamic with the Fed, which raised rates from 0%, to around 5% within one year. In fact, the Fed has maintained a zero-interest policy for 10 out of the last 14 years.
When you get paid to borrow money, it naturally causes a massive accrual of new debt. Years’ worth of free money always leads to financial instability because it engenders an overleveraged economy. The global economy has become so debt disabled that it can only be adequately serviced while money remains virtually free. But central bankers can only provide a ridiculously negative real interest rate for borrowing new money into existence as long as inflation remained quiescent, which is absolutely no longer the case.
In my 2012 book, The Coming Bond Market Collapse, I predicted that the then-current environment of perpetual disinflation would eventually end; and intractable inflation would result from years’ worth of reckless fiscal and monetary policies. After all, inflation results when the market loses confidence in the purchasing power of a fiat currency. And, sometimes, that confidence just takes a long time to break–especially when that fiat paper is the world’s reserve currency.
Inflation always breeds chaos. And there is no better way to produce inflation than to deploy helicopter money. The Pandemic-related money drops used by the government were sufficient to destroy confidence in the purchasing power of the USD. Therefore, the Fed needed to (and still needs to) fight inflation by aggressively raising rates and reducing the base money supply. However, because we have so much debt in the system and asset bubbles have become so large and integral to GDP growth, the level of interest rates and destruction of money supply that is needed to beat inflation will also lead to a substantial economic crash. Hence, the fiscal and monetary authorities will be choosing between inflation and depression and producing both at different times. And, maybe eventually ending up with both conditions existing simultaneously…what I call an Inflapression. That is what happens when inflation becomes intractable, and real GDP growth plunges.
If anyone ever doubted that the US and its central bank would soon have to give up its flaccid fight against inflation, just look at what has transpired in the past two weeks. On the one-year anniversary of the first rate hike off the zero-interest rate bound, the viability of the US financial system has been impugned. Three domestic banks went belly-up, and several major European banks were moved to death row. Right on cue, the Fed’s balance sheet rose $300 last week thanks to the Bank Term Funding Program, which is a 1-year lending program at a 4.6% rate. Banks can now take their troubled assets and dump them on the Fed at full value–regardless of their condition. The Fed and FDIC have also virtually guaranteed $9 trillion of uninsured deposits in a blink of an eye. In fact, the Fed is really guaranteeing all deposits, including the ones supposedly FDIC insured, because the government doesn’t have the tax base or fiscal means to stand behind the FDIC–so the Fed would end up printing that money as well.
But the actions taken to date have not stopped banks from swirling down the bowl. First Republic Bank (FRB) will now receive a $30 billion lifeline from a group of America’s largest banks, including JPMorgan, Bank of America, Wells Fargo, Citigroup, and Truist. FRB is a commercial bank that is not concentrated in crypto and technology lending like that of the defunct SVB, but the bank does tend to cater to businesses and wealthy individuals who have large uninsured deposits.
Wall Street wants you to believe that the banking crisis has been completely ringfenced. While, the Fed’s Bank Term Funding Program may be able to temporarily stabilize the financial system, it has merely created a bunch of Zombie lending institutions. The already-strained financial system can’t extend credit anything close to what they were doing even a couple of weeks ago. And we haven’t even seen the recession hit yet. In fact, the Atlanta Fed has Q1 GDP growth at over 3%! I’ll take the under on that one.
As a reminder of what is killing the banking sector: The removal of liquidity and reserves as a result of the QT program—that is continuing. A deposit flight that was caused when banks decided to pay next to nothing on short-term money, while Treasury bills paid 5%–nothing has changed here. And, Banks’ assets (loans) have been under pressure–and we are just seeing the tip of the iceberg on this catastrophe.
The fed raised rates so high and so fast, that when it naturally caused Treasury prices to plunge and yields to soar, it also caused financial institutions to become insolvent. But these same rate hikes that caused the world’s “safest” asset to crater in price must also have negatively affected CLOs, CMBS, RMBS, Junk bonds, derivatives, and other loans to consumers and businesses. These other assets should be the next to falter. Then the shadow banking system (pension funds, hedge funds, private equity funds, investment banks) will get into trouble. Finally, the credit markets will freeze. It will only be at that point in which we get a genuine Fed pivot back towards ZIRP and QE.
Remember, banks were already tightening lending standards aggressively before Silicon Valley, Silvergate, and Signature banks failed. Now that recession fears abound, banks will be taking much less risk. In fact, the regulators will see to it that they do. Just imagine what will happen to the economy when the profitless 2/3rds of the companies in the Russell 3,000 cannot raise cheap credit any longer and must close their doors and lay off their employees.
Sadly, our great country has allowed its foundation of freedom to be eroded. First, the government removed God from its schools. Now it is seeking to completely dismantle the American family. We are losing any semblance of personal responsibility, are ceding individual freedom to bureaucratic sycophants, and have completely abrogated the free operation of markets. What to do about it? We have no choice but to continue to dynamically invest around the machinations of these freedom-hating power mongers, as they cause the economy to repeatedly swing between the macroeconomic cycles of destabilizing inflation and depression.