Janet Yellen caused a mini-meltdown in stock markets recently when she said ‘interest rates will have to rise somewhat’ to keep the economy from overheating and to keep a lid on inflation. The NASDAQ Composite promptly fell over 350 points before recovering.
Doubling down on monetary ignorance
Yellen then walked back her comments, and stock markets continued their way higher. The damage was quickly undone. Still, Yellen’s comments were more revealing than she realised, as described in this technical but insightful article.
Investors need to begin their analysis with the realisation that Yellen knows nothing about monetary economics. She proved that in her time as Fed chair, and she’s doubling down on monetary ignorance in her new role as US Treasury Secretary.
Yellen’s first mistake is the belief that higher interest rates are the way to cool inflation. Interest rates are not a leading indicator; they are a lagging indicator. Higher interest rates do not signal coming inflation. They signal that inflation is already here.
Inflation is bad for savers and investors, but higher rates are not generally bad. Higher rates are usually associated with stronger growth. They mean that growing businesses are competing for funds and willing to pay more to get them. Banks can pick and choose from among borrowers and charge higher rates as a result.
Higher rates won’t nip inflation in the bud
In short, higher rates can signal a strong economy, or that inflation is here, or both. They are not a tool to nip inflation in the bud, especially when there are no signs of inflation. (I know fuel prices are higher, but that’s just one item in the basket. Clothing, electronics, tuition, healthcare, and many other price index components are flat to down.)
If you raise rates to nip inflation in the bud, you will more likely nip the recovery in the bud and possibly cause a recession. If you actually have to use high rates to stop inflation (as Paul Volcker did in 1980), it means inflation is out of control and you’re willing to cause a recession to stop it. In fact, Volcker caused back-to-back recessions in 1980 and 1982 in his anti-inflation crusade. Yellen raised rates too early in 2015–18, which contributed to a stock market crash in October–December of 2018. Now she’s at it again.
Yellen is a labour market economist and statistics geek. She’s not an adept monetary economist. Her understanding of international economics and exchange rates is even weaker. Jay Powell at the Fed has his own problems, but let’s hope he can keep Yellen in her box at the Treasury. If not, we may be on our way to premature rate hikes and the return of the back-to-back recession.
Meanwhile…
Time’s up for tenants and borrowers — pandemic bills are coming due
We’re all familiar with the great lengths the Federal Reserve and the US government went to in order to prop up the economy in response to the COVID-19 pandemic. The Fed printed over US$4 trillion of new base money and trillions of dollars more were created by the banking system.
Congress approved US$3 trillion of new deficit spending under President Trump and US$1.9 trillion under President Biden, with another US$4 trillion of deficit spending on the way later this year. This money went to public health facilities, payroll protection plan loans, higher unemployment benefits, and bailouts for airlines, cruise ship operators, resorts, and other industries most directly affected by the pandemic lockdowns. Even more will be spent on social welfare programs for childcare, teachers’ unions, school lunches, free tuition, and a grab bag of Democratic spending favourites, along with some physical infrastructure spending for bridges, tunnels, and roads.
The invisible part of the bailout
Still, this massive monetary and fiscal response to the pandemic was what might be called the visible part of the bailout. There was also an invisible part. This did not consist of direct handouts or cheques but consisted of forbearance and grace periods on loan and lease obligations.
Student loan borrowers were told they did not have to pay interest on their loans. Tenants were told they did not have to pay rent. The rent moratorium was backed up by an eviction moratorium. If tenants did not pay rent, landlords were powerless to evict the tenants. Meanwhile, the landlords had to keep paying mortgages and property taxes, which put 100% of the economic burden of the pandemic adjustment on the landlords’ shoulders.
A new wave of defaults
What was the statutory or legal authority for these orders? Some were justified by explicit statutes, but many economic relief orders were issued by the Center for Disease Control (CDC) under a broad interpretation of its powers during a public health crisis. Now, litigation challenging these orders is making its way through the courts. As reported in this article, a judge in the US District Court has recently ruled that the CDC eviction moratorium is an illegal use of CDC’s public health powers.
This is the first of many moratoria and grace periods that are set to expire. The full economic impact of the pandemic has never been felt, in part because so much debt and rent was held in abeyance. As those back payments become due, a new wave of defaults will ensue. The pandemic is still playing out, as is the economic meltdown.
All the best,
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Jim Rickards,
Strategist, The Daily Reckoning Australia
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