Tinkering with Interest Rates - Again.
“Blessed are the young for they shall inherit the national debt”
Herbert Hoover
I write this as I read the Fed reduced rates by 50bps earlier today. While to some this may be a cause for relief and hopes of good things ahead (lower mortgage and car loan rates) it also comes with risks. The last couple newsletters I wrote on interest rates were very critical of the Fed’s being slow to acknowledge that excess inflation was in the system. They were slow to respond and as a result we got hit very hard with a healthy dose of inflation not seen since the 1980’s. Whether you eat out or grocery shop and eat at home – inflation over the last 3 years has been extensive and painful, especially for those on the lowest economic rungs. The Fed’s dual mandate (or job) is to promote maximum employment and stable prices. Easy you say?... To be fair the Fed has an incredibly difficult task – they must anticipate the future direction of the economy using imperfect and sometimes conflicting data. Then, add to the complexity the fact their only tool (changing interest rates) is exceptionally blunt. Hence – it doesn’t always produce the intended results in the time and manner intended AND sometimes Fed policy produces collateral damage. The current narrative is this: prices are becoming more stable, but it appears that economic activity is slowing. The Fed’s answer is to reduce interest rates to spur hiring and cross their fingers that inflation does not come back with a vengeance. And here’s the reality: policy change impacts have a lag. We will probably not see the full impact of this policy change for months. In addition, if the Fed underestimated the latent inflation in the system then they have just added fuel to the inflation fire.. Stay tuned. On another but closely related note – my largest concern is not interest rates or even current stock prices but rather deficits and debt. The difference between the two is “deficit” is what we overspend annually whereas “debt” is the accumulation of all previous deficits. It’s not that the national debt was not a big deal previously – but it has exploded since 2020! While the government’s efforts to combat Covid 19 were perhaps an understandable reason for deficit spending that year – it has not gotten much better since. Consider:
The problem with debt was somewhat benign when we spent only about 1% interest to finance that debt – but now when the treasury issues new debt it being priced at 4%+ in some cases the average cost of debt has more than doubled in a little over two years! Why? Ever more debt and higher and higher rates on the debt. The family level equivalent would be a family who consistently spends more than they make, have done so for 20+ years by using credit cards and is now paying higher interest rates on the card balances. As a result, 2024 will mark the first year where interest (not principal) payments on the national debt will be greater than US defense spending... Some data points:
This also illustrates the Fed’s desire to crush inflation in the near term as opposed to having it become endemic. Higher interest rates are painful for a country which carries a lot of debt. Can you imagine what would happen if the average rate on debt was 6%? However, there are significant risk associated with lowering interest rates too soon – with the consequences being higher rates down the road. To me, this is the existential problem that we don’t seem to have a solution for. Neither presidential candidate seems to be serious about government spending. Eventually, the national debt and deficit spending will be a problem that explodes either for us or for our kids unless it is addressed. We must quit spending so much as a country or risk a U.S debt explosion which would make the great recession look tame by comparison.
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