There is a growing sentiment in the Business World that now is the time to put a halt to the rapid interest rate increases introduced by the Fed to fight rampant inflation which began in 2021. So far the rate increases haven’t had a great effect on inflation, but they have sparked a number of bank failures. Now the Fed finds itself between a rock and a hard place. Even if it leaves rates flat, inflation will go up. If it raises the rate, it runs the risk of even more banks falling into deep financial trouble, with possible contagion.
What is going on here? The Fed has completely rendered itself ineffectual for this next upheaval in our economic world. Both inflation, and a looming banking crisis are very real things we now have to live with for an extended period of time. With inflation, everything you buy gets more expensive. With higher interest rates, everything you owe gets more expensive. With the bank failures, money will get harder to borrow as the banks tighten up. The icing on the cake here with the failing banks, is if the problem turns out to be too big, and a systemic bank run occurs, there is nothing like ultra low interest rates to fix it. It could be the mother of all banking failures, and just so you know, the central bank has lent $300 billion to the banks in the last week. That’s already half of what it lent during the 2008 financial crisis.
It’s easy enough to figure out how we got here with inflation. We recently suffered short term inflationary pressure due to a bottleneck in the movement of goods and services because of the pandemic. China’s shutdown because of it’s zero COVID policy also created scarcity and inflationary pressure. Both of these issues have largely been resolved, and we have noticed a drop in our inflation rates. Core inflation is now hovering around 6%. The things not included in core inflation such as food, heating, and paying your rent, are still around 10%, month over month. This inflation is here to stay awhile, especially now that the Fed must also be responsive to the looming banking crisis. Just today, the Fed raised interest rates by a quarter percent, but indicated in light of the stress to banks, more increases are pretty much over. Let’s see how this eat your cake and have it too approach works for it.
There’s still an underlying reason why we’re suffering from this extended inflationary period, and holding at 5% interest rate is not going to quash it. In the late 70’s, early 80’s, the Fed had to jack rates up to 19% to fight a similar inflationary period, but that’s just historical fact. Why should it have any bearing on today’s decisions?
The real inflation we are facing today has been building up for a long time. It’s genesis goes back to 2008 with the great recession. As billionaire investor Carl Icahn(5) has pointed out there’s too much money in the system and you get inflation by definition. This huge amount of money sloshing around in the system, around $5 Trillion, was created by the low rate interest policy that has been in effect pretty much for the last 15 years.
Predatory and high risk lending by the banks caused the housing bubble in 2008. It was such a big scandal that it rocked the Western World, and the entire world felt it’s tremors. Not only did the Western World bail out the banks that caused the problem, they then created a rescue policy that continued to allow money to flow to the market. That’s where the $5 Trillion comes in. The simply gave the market money. With near zero interest rates, you got to increase your debt by buying new cars, houses, and really cool things. The rich got to use the money, free of charge, to turn it into more money than they had before. All the money ended up in the market.
So what happens when the interest rates go up and everyone’s caught off guard? For the everyday consumer, debt goes up, and value comes down. The rich just get bailed out, as witnessed by the collapse of Silicon Valley Bank. Everyone who invested money into SVP knew it was a high risk, high reward bank(7). In the old days of capitalism, you took your risks and your loses too. Not any more. As you know, all the people and institutions involved, who stood to lose on their risky bet got paid off. These were investments of over $250,000 that were not insured. $300 Billion dollars was the reward to those brave souls who out of greed knowingly put their money on the long shot and lost. Janet Yellen was out there today saying, ‘Don’t worry. No matter how bad it gets, we’ve got you covered.’ So was Jerome Powell. Once again, the Fed has figured out a way to keep money moving to the rich.