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The Federal Reserve’s aggressive approach to corral inflation has not made a significant impact. Given that, it’s no surprise that the central bank reportedly has no plans to cut rates in 2023. The question is, how much higher can rates go? Straight Arrow News contributor Larry Lindsey says it’s too early to know for certain. But he warns that we should not expect to see the Fed stop raising interest rates anytime soon.
It’s important to remember that the Fed is not going to stop because of a recession, or because of inflation. It’s going to stop because markets become disorderly. That’s their phrase. You see, inflation and recession both have financial stability as a prerequisite. If you don’t have functioning markets, you basically don’t have an economy. And so the recession and inflation become secondary motives.
Second, there are a lot of lags involved between when the Fed tightens rates, and when it has an effect on labor markets and on inflation. These lags can be quite long. They used to estimate it at 12 to 18 months. It’s probably a little shorter than that, maybe in the six to 12 range. But given that they started hiking in the spring, we’re about due. So as rates go up after this long period, what you have, as I mentioned, is a lot of people who took on too many loans – we call it leverage – in order to increase their stock and bond portfolios. We never really know who did the leveraging…at least at the national level.
We learned something a few weeks ago, when Britain had a financial crisis. It turned out it was their pension fund, of all people, who increased leverage. Why? Well, pension funds have to make payments in the future. And to do that successfully, they have to earn some money on the money they invest. Britain’s rates, like everybody else, were very, very low. So what the pension funds did was to borrow money and buy even more bonds…they call them gilts in Britain, in order to up their return. Well, as soon as rates started to rise, the bonds started to sell off, and the pension funds had to dump whatever they had in order to pay off the debts they had.
It’s a global problem. The Bank of America, for example, has a credit index that they now call borderline critical. So something is going to have to be done. And you can see it even in the math. We’re running a budget deficit of about a trillion dollars. Net savings in America is about $500 billion. And in addition, the Fed is taking out $95 billion a month from the market by selling its bonds. Fed sales, new issuance by the government, overwhelms the amount of private savings. The only way to make it work is for interest rates to go up and ration the available funds.
So the question is, when will the Fed stop?
