Talk continues about both inflation and recession. The arguments that are made come from a monetary-policy perspective which ignores–or worse, misrepresents–fiscal-policy. The latter, is almost unanimously confused for being like a household budget where the spender must have an income and must borrow if that income falls short of the spending. While the former, in an almost cultist fashion, believes that ‘too much money’ causes inflation. In this piece we will outline how misguided raising rates and lowering spending is.
Monetary Policy
Raising rates to ostensibly lower inflation is a ruse that allows the already-rich to increase their UBI (risk-free income for no work); higher FFR forces higher Treasury spending on interest-payments which go to the already-rich in proportion to how much money they have. Although this is a regressive form of spending, it does transfer money into the economy and facilitates growth in GDP.Interest expense:
Interest expense (FRED)
I call raising rates to fight inflation a ‘ruse’ because even Volcker himself realized (after the fact) that raising rates works against inflation-reduction through the interest-income channel–just look at Argentina.Interest rate for Argentina:
Interest Rate for Argentina (Tradingeconomics)
Inflation rate for Argentina:
Inflation Rate for Argentina (Tradingeconomics)
If raising rates lowers inflation, then Argentina should have the lowest inflation on the Planet.Inflation came down in the US, but not as quickly as it would have if rates had not been raised–look at Japan.Japanese interest rate:
Japanese inflation rate:
The reason is that inflation is always caused by shortages of real-resources, not the existence of ‘too much money’. Shortages themselves have various causes: natural disasters, war, corruption, and monopolies to name a few. Fix the shortages, and you fix the inflation. Raising rates do not fix supply issues.High rates can fix inflation only by causing a recession; when they get so high that private debt can no longer be maintained and assets have to be sold (like in Volcker’s time).Raising rates to kill the demand side instead of spending to increase supply, is like amputating your toes to fit your shoes instead of buying bigger shoes; the shoes will fit, but it is a painful, bloody mess.The FFR has risen above the down-sloping trend of maximum FFR, and the 10y-2y has inverted, but as long as the FFR stays below 6% and the 10y-2y does not invert for a second time, a recession is not likely in the next 6-9 months.
ANG Traders, stockcharts.comThe Fed always does what Wall Street tells it to do, and Wall Street is telling it to hold rates steady into the new year…
Interest Rate Probability (CME)…and start reducing rates in the Spring.
Interest Rate Probabiity (CME)Rates are not going to 6%, and inflation is getting out of control.
Fiscal Policy
The Federal government is the currency-creator and, therefore, has no need for an income like a currency-using household does. The laws of Congress allow the creation of US dollars by spending them into existence, and the cancellation of US dollars by taxing them out of existence. The matching of deficits with bond sales, and the regarding of those sales as “borrowing”, are choices left over from the old gold-standard days, not a necessity under the current floating-exchange system. What the herd considers as public “debt”, is simply the depositing of ‘already-created’ dollars into risk-free savings accounts called “Treasuries” that pay interest. The fear-mongering around the ticking “debt bomb” has been around for 80-years, and still it persists; It is not a bomb, it is not ticking, and it isn’t debt. It is simply the accounting of the dollars that have been spent into existence (deposited in private bank accounts) and that have not been taxed back and cancelled. How is having dollars in private hands (the economy) a problem?You cannot grow the economy by cutting. You can only grow by spending. The economy “follows” the fund-flows, and so does the stock market.The Treasury creates US dollars when it directs the Federal Reserve Bank to deposit money into private bank accounts (to pay for the real-resources it buys), and it cancels US $ when it collects taxes from the private bank accounts. The aggregated result is a net-transfer into or out of the private sector (the economy)–depending on whether spending is greater than taxation, or taxation is greater than spending, respectively.If spending is greater than tax-collection, then there is a budget deficit for the Treasury, but a budget surplus for the private sector, with the reverse situation producing a private-sector deficit.
Government Deficit = Private sector surplus
A balanced budget means that every dollar spent by the government into the economy gets taxed back and canceled, thereby, leaving nothing in private hands.The chart below shows how the average slope of the SPX depends on the net transfer rate: Blue is when the government was spending (transferring to the private sector) $1T more than it taxed back in the fiscal year: Green is $2T/year: and Black is $3T/year. In fiscal 2023 (ended September 30, 2023), the government spent $1.7T (green line). So far, in the 2024 fiscal year, the rate of net transfer is $1.8T/year. If this rate is maintained, then one can expect the stock market to rally along the green line.
Net-transfer rate (ANG Traders, stockcharts.com)In conclusion, rates are not going higher, inflation is not going to get materially worse, and for the next 6-9 months the economy will not collapse into recession as long as the current fund-flow net-transfer rate is maintained.More By This Author:Ignore The Herd’s Fear Of The Fed And Of Recession. Focus On The Fund-Flows
Fear And Loathing Of The Deficit
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