Federal Reserve of the US has been struggling and juggling things around for the past 13 years by using techniques such as quantitative easing (QE), quantitative tightening (QT), alongside reducing Fed’s Fund Rate to zero and incrementally increasing Fed’s Fund Rate by nearly as much as 75 basis points as recently as last time around and come November 2nd, 2022 again. According to an erudite and well respected Hedge Fund Manager, whatever the Fed can do right now is limited to that which results in the least problem there is.
What is going on is explained in the following typical scenario.
Let us say the administration wants $4T (Trump’s $1T, Biden’s $1.9T, $1.1T and another $3T on the table) to spend on covid relief, infrastructure, student loan forgiveness, subsidizing green technology, free childcare, free community college, expanded medicare and medicaid, end hunger, reduce inequality, free healthcare and save the planet from global warming programs and so on.
To put things in to perspective, $6T adjusted for inflation, is about the money spent on the revolutionary war, the civil war, world war 1, world war 2, the Louisiana purchase, the transcontinental railroad, the interstate highway system and the moon landing combined.
The bill passes through Congress and the President signs it in to law. Now, where do we find the money that we do not have? We can sell governmental bonds to the public, but in order for the people to part with their hard earned money the interest rate has to be higher than the bond yield at least. We already owe $30T ($2T to China alone) in other treasury notes we have borrowed money with. In the year 2019, the national debt was $22T and the interest payment was $300B per year. Within a decade it is expected to go to $1T at which point it will be one fifth of all the taxes received. If we keep borrowing at this rate, we will not have enough money in the federal treasury to do anything except pay interest. There will be riots in the street. The whole financial system will come to a grinding halt. We just cannot do that. Let us go to the federal reserve, which by the way, is neither federal in nature nor does it have any reserves. But they have a big printing press. Fed simply puts $4T, which are just digital dollars on their balance sheet; just created out of thin air. Lend this $4T to the government in exchange for treasury notes (IOUs) from the government. Suddenly, the Feds’s balance sheet is balanced. Fed is owed $4T by the government. The government spends it right away, the money that did not exist before. That sets off a roaring inflation. So, first thing they cannot do anymore is print money like that.
That means they have to get $4T from raising taxes. Do you think that is going to happen? No. The administration has zero interest in balancing the budget by raising taxes. They are simply not going to do that. Congress for ever has not done that either. Therefore inflation saga will continue and the US Government will continue to owe money to the Federal Reserve.
When the Fed’s fund rate was zero, the default inflation was about 2% and the mortgage rate was also about 2% and so the lenders did not get anything back. This 0% Fed’s fund rate also made the real estate and the stock market soar and every thing became unaffordable. Every thing has to stop sometime. So they have to stop the low interest rates. Fed has to increase the borrowing cost above the inflation rate in order for the people to lend. If the inflation is at 8%, the treasury yield has to be raised to 9% and we are right back to the same old problem of dealing with unbearable interest payments on government’s outstanding massive amount of loans which we cannot afford. That is a goodbye to Federal government because we do not have enough money to pay the interest.
So what does the Feds do? Walk a tight rope. Slowly ratchet the interest rate up so that we are not having enough inflation to cause massive recession / depression, interest rates making businesses used to borrow free money to fold up and 20% unemployment. Or else, inflation keeps going up. We do not want to end up like Zimbabwe, Venezuela or Argentina with hyper inflation.
The whole world is based on the US dollars. The US dollar became the world’d reserve currency which means it is in every bank in the world where they have to exchange goods and services over the border into the other country and they do that in dollars. They trusted the dollar and the US to keep a strong dollar. The US has devalued the dollar massively forcing the EU, Japan, China and the third world countries to further devalue their currencies in order to be able to sell US anything. US has driven the world little bit crazy. US has done it on its own.
US has become very bad with respect to its own fiscal responsibility. We have borrowed a generation worth of money and spent it. It is going to be a rough landing. That is where we are right now.
The hedge fund manager thinks we will end up with 5% inflation with 6% bond yield; dim and foggy situation becoming clearer all the time. That is where we are going.