LETTER #28: Bringing Water Gun In A Nuclear War.
The Fed raised rates by 25 basis points to fight 4 decades high inflation.
LOL.
This was my initial reaction when I saw this move by the Fed.
During the past two years, the Fed printed almost 40% of the entire US dollars in existence and collapsed interest rates to zero.
If you have read Taleb’s ‘Antifragile’ you might be familiar with the fact that when you try to manage or manipulate a complex system from one side, it produces unintended consequences on the other side.
The economy is a complex system.
When the Fed manipulates money supply and interest rates, it devalues the dollar and the average person suffers by paying higher prices at the checkout.
Today, the inflation in America is unlike anything we have seen since the early 1980s. It’s a direct unintended consequence of the Fed’s intervention in the markets.
Back in the 1980s when America experienced this high inflation, it had the privilege of a low debt/GDP ratio. The ratio was less than 40% during those times. Therefore, then-Fed Chairman, Alan Greenspan, easily raised Fed Fund rates from 9% to 19% without the risk of recession.
If you look at the chart above, you might have noticed that the rate is trending downwards since then and hit zero in 2020.
America is again in an inflationary environment, but the problem is that the Fed can’t even think of raising rates up to 19%. It’s impossible without pushing America into the debt default scenario. Why?
Because, unlike the 80s, the debt/GDP ratio is sitting above 130% and if the interest rates are increased up to the 80s level, America won’t be able to make the interest payments, let alone the debt payments, and the country will default on its debt.
Raising interest rates by 25 basis points is not going to do a thing to stop the inflation that’s at a 40-years high. It’s like showing up with the water gun in a nuclear war.
The Fed can delay the inevitable for so long. You can’t override reality forever.
As I said in my previous letters, “This is the End Game.”
A Question for you to ponder :)
What would you do in this scenario? You can’t raise the rates aggressively, and can’t let the inflation run high at the same time.
Take care. Can’t wait to talk to you tomorrow again :)