The Fed Will Fix Inflation? Yeah, Sure …

by Gerry Allan | Nov 16, 2022 | Future, Managing | 0 comments

“The government solution to a problem is usually as bad as the problem.”
— Milton Friedman

“I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments.”
— Friedrich August von Hayek

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
— John Maynard Keynes

“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.”
— Alan Greenspan

“Domestic inflation reflects domestic monetary policy.”
— Martin Feldstein

“Inflation is the one form of taxation that can be imposed without legislation.”
— Milton Friedman

“In reality there is no such thing as an inflation of prices, relatively to gold. There is such a thing as a depreciated paper currency.”
— Lysander Spooner

“I have never known the Federal Reserve make a good decision. Indeed, disastrous decisions are the Fed’s hallmark.”
— Paul Craig Roberts

“But firstly the Fed is determined to quash inflation at any cost. Remember that all the Fed’s actions have always damaged the economy since their timing is always wrong and that is without exception.”
— Egon von Greyerz, Managing Partner at Matterhorn Asset Management

The U.S. Federal Reserve Bank is hiking interest rates to reduce the currently high inflation rate. They also – sort of, maybe – stopped the money printing that causes inflation. Will it work? Will the Fed give up and reverse its direction? Economic crash, or hyperinflation, or both? Nobody, including the Fed, really knows. Huge impact on us normal folks. What if anything, can we do?

Probably good to start with a comment on inflation as currently measured and mis-measured. Official inflation rate (consumer price index, aka CPI) is over 8% annually. Not so bad. However, the government in its infinite wisdom has decided to mess a whole bunch, technically speaking, with how they measure inflation.

John Williams of ShadowStats has been computing alternative inflation rates for decades based on how inflation used to be computed (in 1980, and in 1990). The differences are truly amazing and telling:

“Alternate Inflation Charts. The CPI chart on the home page reflects our estimate of inflation for today as if it were calculated the same way it was in 1990. The CPI on the Alternate Data Series tab here reflects the CPI as if it were calculated using the methodologies in place in 1980. In general terms, methodological shifts in government reporting have depressed reported inflation, moving the concept of the CPI away from being a measure of the cost of living needed to maintain a constant standard of living.”

Inflation rate as calculated using 1980 methodology (blue) is roughly double the official inflation rate (red) today.

The ShadowStats inflation measure is roughly double the official measure today. Personally, as a very minor but real live consumer, the ShadowStats figures seem much closer to reality.

A recent report on layoffs and consumer concerns concluded with this note:

“Inflation and the economy more broadly will likely continue to be at the forefront of the American people’s minds moving forward. Polling over the last several months, including exit polls taken after people voted on Election Day, has shown almost uniformly that voters ranked the economy, particularly inflation, as their most important issue. That same polling has also shown a majority of Americans disapprove of Biden’s handling of inflation and the economy.”

Why are inflation rates being understated?

Inflation is at the top of most folks’ concerns today, as the above quote suggests. If it isn’t, it should be. Inflation – true inflation – is killing the average consumer. Reasons for inflation generally gather around COVID, supply chain disruptions, business closures, labor force problems (such as a livable wage), and quite a few others. Mostly credible reasons, but far from the whole story …

U.S. government debt recently topped $30 trillion, or about double the 2017 debt of about $15 trillion. Debt levels are now greater (123%) than this country’s gross domestic product (GDP) of around $25 trillion. But such figures are effectively meaningless. Why?

Debt once upon a time included a credible means of its repayment. The U.S. government debt (as well as that of many of the largest countries) will not and cannot be repaid. Ever. To believe otherwise is pure fantasy. So, what will happen?

The U.S. has pretty much reached its limit of borrowing, although Japan seems to have limped along for decades in at least as bad (or worse) shape. Since the U.S. government runs on huge deficits (spends more than taxes bring in) each year, it has to borrow continuously. It also has to service its enormous and growing debt load – interest plus rolling over massive debts due – to avoid default. The current workaround here is to have the government “buy” whatever debt is required – by printing more pretend-money. This works, until it doesn’t.

The good news is that there is another way to get rid of this colossal debt load: deflate it to near-zero. Inflation, as you surely know, simply makes current money worth less in the future. Your $2.50 gallon of gas not so long ago now costs upwards of $5.00 a gallon. It will likely go much higher this winter.

So, is inflation an essential part of the debt reduction game plan?

The Fed has been increasing interest rates lately in order to reduce inflation. Or so they say. This is a very tricky game plan. Increasing rates increases government debt servicing costs, which could easily consume 100% or more of the current tax base at the current rate of interest increases. Not so good, right?

But the inflation rate has to be contained if not reduced (by a recession or depression) because it can quite quickly escalate into runaway inflation. Think Zimbabwe and Venezuela. Hyperinflation is defined as an inflation rate exceeding 50% a month! Both countries managed to achieve this rate. Also not good, right?

The U.S. government (the Fed in practice) is stuck today between a rock and a hard place. It has a very delicate balancing act to carry out. Inflation plus a recession or worse is called stagflation. Looks like that’s where we are today.

David Haggith, publisher/editor-in-chief of The Great Recession Blog, has this to say about the Fed’s interest rate hikes: “Powell Feinted Full Dovetard, and Stocks Still Plummeted. Why?”:

“The statement is clear that they would like to slow the pace of hikes. In addition to looking at the data and looking at markets, they are also now considering the cumulative impact of what they have already done. And the lag with that will hit the economy. Most estimates are that it takes 9-12 months for rate hikes to be felt, and 12-18 months for the maximum effect. We are only just now eight months past the first rate hike [in March 2022], so it makes sense to slow down.”

Will the Fed actually pause or reduce rate hikes in this case – waiting until they can see the impact of the recent hikes? Pretty unlikely, in my view. But why?

Inflation is vital to reduce the national debt. This reduces the value of money. The value of the U.S. dollar chart below by Statista is fascinating but painful. Up to about 1900, the dollar gained in value via the Industrial Revolution, with a couple of bursts due to the Revolutionary War and the Civil war. Then, in 1913, the year the Federal Reserve Bank was founded, the dollar began its major decline in purchasing power from around $20 to $1 today. That’s a 95% drop in what a dollar buys over a little more than a century.

Purchasing power of one US dollar (USD) in every year from 1635 to 2020.

About half of this decline occurred post-WWII. No doubt helping offset the enormous costs and debt increases resulting from the war.

Keep in mind that a drop in the dollar’s “price” is just another way of stating that its purchasing power falls—i.e., more dollars are required to buy the same set of basic (or reference) goods and services.

With this background, you can see why rate hikes may not be reduced, or even paused, near-term. The Fed, I think, doesn’t want inflation to drop too quickly or too far until its impact on the dollar, and our associated national debt, has done what is needed. Besides, huge borrowings seem almost certain going forward (or backward, more accurately) and inflation is vital to offset such machinations.

Good news here is that inflation could “pay off” much of the national debt

Good news for government only, of course. Bad news for savers, bondholders, and other assorted folk who use U.S. dollars as money for living. What’s not to like about a gallon of gas jumping from $2.50 in 2020 to over $5.00 in 2022? Food and a whole bunch of other living essentials are behaving similarly.

The government that caused this situation cannot possibly fix it. This is one of the most fundamental laws of human existence. And you can’t vote the bums out because the voting process simply generates a new set of bums (or reelected old ones). Government is the problem, but you can’t really get rid of government. It is an especially nasty weed of civilized life.

This situation will get fixed the hard way, as always. The people, aka you and I, will experience the pain. There is no other way, as history shows so abundantly.

Fed Chair Powell on Nov 2, 2022, via C-SPAN:

“’Today, the FOMC raised our policy interest rate by 75 basis points and we continue to anticipate that ongoing increases will be appropriate…Restoring price stability will likely require maintaining a restrictive stance of policy for some time.’ He added that the U.S. economy has slowed significantly from last year’s rapid pace and ‘at some point…it will become appropriate to slow the pace of increases…We still have some ways to go and incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected [emphasis added].’”

What is most likely to happen in our present situation is that the Fed will maintain a “clever balance” between a healthy dollar depreciation through continuing, significant inflation rates (and thus depreciating the dollar debt) and a manageable, sort-of, period of recession/depression. We get the short end of high interest rates and relatively high living costs.

From Wikipedia, Federal debt as a percentage of GDP by year (now nearly 125%):

Federal debt held by the public, 1900 to 2050.

You see the problem we are facing, yes? Well, there is yet another solution …

Another popular solution to such nasty economic problems: War

The Fed is presently juggling several major economic factors: interest rates, economic activity (GDP growth), unemployment, and preserving dollar hegemony. Very difficult to succeed here, especially with the Fed’s virtually unblemished record of failures. So, what to do? Well, starting a big war works …

Benefits of big-war:

Economic stimulus (producing war materials)
Puts many unemployed people to work
Distraction from internal problems
Development of technology and medicine
Suppression or elimination of dissent
Bringing people together against a common enemy
Allows raising of huge sums that could not be raised in peacetime
Allows taking on huge debts that could not be justified otherwise
Allows repudiation of debts owed to enemies
Allows imposition of dictatorial measures
Population culling
Enriches a small population of profiteers
…

You may be able to add to this impressive list of big-war benefits in helping solve difficult government problems. As Mandar Nimkar & Saikat Das argue writing in The Economic Times (India) “Is war a solution to global recession? [2008]”:

“History shows that war always follows slowdown or recession. And given the somber geo-political situation across the globe, some economists and analysts feels that the world may well be headed in this direction.”

“After the 1797’s economic deflation, there was war between US and France from 1798 to 1800. The war between US and Great Britain in 1812 followed the depression in 1807-1808. The long depression of 1873-1879 paved the way for war between US and Spain and the First World War which lasted for 3 years from 1918-1921.”

“In the Great Depression, Herbert Hoover–then US president–attempted to maintain labor rates at 1929 levels, causing massive unemployment. The economy stagnated, with labor rates failing to adjust to levels where production could be refurbished.”

“The world was only rescued by the advent of World War II, with increased war production and mobilization– solving the unemployment problem. The prevailing conditions are no different from that in 1920-1930’s. The credit crunch after the sub-prime problem has literally put the global economy on the verge of depression which is on the lines of 1930’s.”

Hard to believe that the geniuses in our massive government and corporate oligarchy haven’t figured out something along these lines. Well, what about the non-war mess in the Ukraine – wouldn’t that work just as well here?

Maybe these folks in corporate-government are smarter than we think

Today we have huge public debt, serious and growing price inflation, a non-war that seems to refuse to become a nuclear WWIII, another sketchy election mess of some kind, a crypto implosion with non-war Ukraine connections, cost of deflating money (aka interest rates) still going up, and an increasing level of unease among the people (aka you and I). Other than these (and perhaps a few others), things seem pretty much on track. Life is mostly good.

The world has always been in some kind of nasty mess. Klaus Schwab and his buddy Yuval Noah Harari figure that this is largely due to an excess of people, aka you and I. So, war that solves a whole bunch of economic and political problems might also be effective in reducing the excess of people.

Don’t know about you, but my take at the moment is that war – big war – has so many benefits to the-powers-that-be (TPTB) that it is destined to happen. Has to happen.

When? Well, my crystal ball is seriously busted but my gut says “soon”. Soon as in six months. This winter is going to be a beast for billions of people. Assuming that the majority survive the winter, it seems likely that many of these will be very angry come spring. A few billion seriously angry people is not going to help the-powers-that-be (TPTB) do its thing. A big-war distraction is just the thing that TPTB need. So, it will happen.

Any bets on a peaceful 2022-23 winter-spring outcome?

Inflation is not likely to be “fixed” but instead “used” as a tool

Where does all of this lead us? My sense right now is that inflation is being used purposefully, as a tool, by the Fed. Money printing, the primary driver of inflation, must continue because the Federal government cannot operate with taxes alone. To offset this source of inflation, the economy must be slowed through higher interest rates. If successful, the “slowdown” should reduce the prices of goods and services – i.e., deflation.

This means an almost certain recession, or more likely a depression, in the very near future. We are in fact in a mild recession right now, as historically defined by two successive quarters of negative GDP growth.

The benchmark Federal Funds Rate, which determines borrowing costs of all kinds, is currently set at just under 4%. Projections are for a roughly 5% rate in 2023, and a 4.5% rate in 2024. The long term average rate is 4.6%. Recall that Fed Chairman Paul Volker raised the Fed rate to around 20% to quickly kill a particularly nasty bout of inflation in the early 1980’s. Today – just baby steps.

But consider what Brazil is doing in high-inflation rate South America (Argentina: 71% currently). Levi Borba in Medium.com describes Brazil’s successful (so far) alternative: “How This Country Is Crushing Inflation in the World’s Most Inflationary Region.”:

“Even the USA is right now suffering from inflation, and at least part of it can be attributed to the baby steps the FED is taking to increase interest rates. The Brazilian central bank, however, decided to not take baby steps and obliterated any chance of negative real interest rates by increasing the SELIC (the national interest benchmark) to a whopping 13.75%”

Paul Volker would approve.

So, why the U.S. Fed’s baby steps? The only reason I can see is that the Fed doesn’t really want inflation to go down. It will instead be limited to the maximum rate that we-the-people can live with. This is roughly the 8%-9% official rate we have now. There is some indication that inflation may be pausing, or even peaking, as a result of the non-recession downturn we are presently experiencing.

This still-significant inflation rate will help devalue the currency at roughly the same rate, helping deal with the huge government debt burden appreciably. Keep in mind here that the real inflation rate – the rate we-the-people experience – will probably remain in the 15%-20% annual range.

The trick here will be to keep the non-recession downturn from escalating into a non-depression downturn. Changing downturn definitions again may help a bit.

If successful, the government will be mostly happy while us non-government people continue to carry a pretty heavy cost and pain burden. Definitely a non-fix for us, as usual.

So, where is all this leading us?

Apart from the big-non-war raging around us as part of this non-fix, things seem to be looking maybe okay? Or maybe not.

This can’t be the real story about where we are headed today. After a whole bunch of reading, all I can find are many diverse guesses and opinions pointing in almost all directions. This tells me only that nobody truly knows. Each of us has to develop our own guesses and opinions and hope for the best.

Of course, this doesn’t work when you are trying to manage a business or organization where bad guesses can be very costly or even fatal. To help you develop your very own bad guesses and opinions, I can at least offer a strawman crystal ball view of where I see things headed at the moment:

My busted crystal ball is currently showing a break-up of major nations and various supra-regional monoliths. Including the Fed, and probably the U.S. as a whole. The parts will of course reassemble into some more-localized, probably tribal, forms – The Untied States of America perhaps?

The-powers-that-be (TPTB) and many TPTB-wannabe’s, will scramble to direct the reassembly back to a very few, or even just one, New World Order. Crystal ball says that this won’t happen despite enormous efforts and endless money-printing. We could be headed for a hugely multi-polar political and economic world where individual states pretty much do their own thing, cooperating only where there is a strong and clear mutual benefit. Maybe call this a New Tribal World?

Money will get back to being real money, which is what I explained in this post. Federal debt will implode and vanish as huge federal structures themselves vanish. Unemployment due to a recession/depression will also vanish as people who may well be unemployed vanish as well. Schwab and Harari will be happy since their major depopulation goals are realized. Assuming that they are among the survivors.

That’s what a busted crystal ball says – very big picture-wise, so far as I can see. You may not place a whole lot of credence on what a busted crystal ball says, but the time frame it reflects is short enough to wait and see. And to do something about surviving long enough to find out what actually happens.

“I, however, place economy among the first and most important of republican virtues, and public debt as the greatest of the dangers to be feared.” — Thomas Jefferson, 1816

Bottom line:

The U.S. Federal Reserve Bank is hiking interest rates to reduce the currently high inflation rate. They also – kind of, maybe, unlikely – stopped the money printing that causes inflation. Will it work? Not so far as I can see. Inflation will persist at a rate far above the Fed’s longstanding 2% annual target, and the true inflation rate is roughly double what the official rate of 8% or so claims. Big-war is a popular fix for recessions and depressions that are often driven by inflation.

What we seem to have here is a really major mess that keeps getting worse. Where it is leading nobody knows, including myself. This is all unfolding against a background of the most important global reorganization in history, possibly complicated and confused even further by a non-war World War.