Larry Summers, ex US Secretary of the Treasury, went way out on a limb on Wednesday, Fox News was there: ‘Former Treasury Secretary Larry Summers predicts there will “almost certainly” be a “downturn in the economy”’:
‘Larry Summers, who served as U.S. Treasury Secretary under President Bill Clinton and was a White House economic adviser to President Barack Obama, predicted Wednesday that the economy will experience a “downturn” in the coming months as the Federal Reserve raises interest rates to combat inflation.’
Note to Larry: that’s the idea.
Three times so far this century, Mr Market tried to correct the nonsense and distortions caused by the Fed. In 2000 — with the Nasdaq crash. In 2008 — when the mortgage finance collapse caused a crisis on Wall Street. And then again, in 2020, when the feds panicked and shut down the economy to keep people from getting sick.
Each time, Mr Fed rebuffed the attempt with more money and debt. The Fed refused to allow a correction. Zombie businesses that should have gone broke were kept on low-interest life support. Zombie investments that should have been wiped out were allowed to refinance at even lower rates. And the zombie feds themselves, their pockets as empty as their heads, were given trillions more dollars to spend as they saw fit.
Then, in the beginning of 2022, the party was over. A ‘downturn in the economy’ was for real. For the first time in 40 years, it was open season on zombies.
90 trillion reasons
It’s either inflate or…the zombies must die. Right now, the Fed’s campaign of raising the cost of borrowing is death to zombies. But it’s life to the dollar; it has made the dollar the world’s strongest currency. And it’s why the best thing you could have done with your money so far this year was simply to leave it in dollar cash.
But in protecting the dollar, the Fed is also protecting the value of US$90 trillion worth of US debt. US$30 trillion of that is the debt of the US Government, which the feds desperately want to get rid of. And the question we left off with yesterday was how they were going to do it.
They can’t pay it — especially not at higher interest rates. And the higher rates greatly reduce their room to manoeuvre. They used to be able to spend as much as they wanted…confident that the Fed would ‘print’ enough to keep up with them. They simply issued a bond; the Fed bought it with cash it created especially for that purpose. And since interest rates were going down, their carrying costs actually went down as their debt went up.
But now…all that has changed. Now it is time for Mr Fed to be a hero again.
The Fed claimed to have saved the economy in 2008. It aims to do it again…this time, not by reflating the economy, but by deflating it.
But the Fed-as-hero story ignores important flaws.
Forgotten is the long period in which the villainous Fed transferred trillions of dollars to the richest and most powerful people in the country, favouring the country’s deciders with its unnaturally low interest rates. Forgotten too are the many years when the incompetent Fed failed to notice the nation’s debt reaching up to US$90 trillion…and inflation creeping up on its flank.
We will also draw a veil over the Fed’s ignorance, in which it thought inflation would be ending before it had even started…and the monumental conceit of former Fed head Ben Bernanke who tried to portray his own cowardly money-printing as ‘The Courage to Act’…and the preternatural imbecility of its former chief — now directing the US Treasury — Ms Janet Yellen:
‘Would I say there will never, ever be another financial crisis?’ she asked herself in 2017.
‘…I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be’, she concluded.
Since then, there have been two financial crises. And she’s still alive.
But we put all of that behind us…let bygones be bygones. Now, if we can believe it, this band of brothers and sisters is all that stands between us and the apocalypse. Either the Fed squashes inflation…or it squashes us.
The Fed’s leading man has been reborn as Paul Volcker; he will stomp on inflation with both feet.
What remains to be seen is how our hero will resolve the apparent contradiction in the plot. He serves at the pleasure of the US Government…which is controlled by the elite.
If he follows through on his program, and ‘normalises’ asset prices, the top 10% of the country — the elite — will lose as much as US$50 trillion in stock, bond, and real estate values. Congress, too, will be in a helluva jam, with US$30 trillion in debt and — at much higher interest rates — no way to refinance it. It will be unable to continue borrowing and spending at today’s pace. Horrors…it might even be forced to balance the budget.
Inflation destroys the economy…punishes consumers…and unsettles government and civil society. Runaway inflation is always a terrible thing for a nation to suffer. It should be stopped as quickly as possible.
But if you owe US$30 trillion…and you can’t pay it back…
…you might see things differently. You might see, for example, that inflation is not such a bad thing after all.
More to come…
For The Daily Reckoning Australia