Cats and Dogs

The Credit Strategist - October 2024

“So many people out there, including people in positions of authority, are just willing to say anything, regardless of whether it has any relationship to the truth or not.”

A voting-machine-company executive after the 2020 election to The New York Times

            They may not be eating household pets in the basement of the Eccles Building but the people managing America’s monetary policy have just as tenuous a relationship with reality as our politicians.   

Neither the jobs numbers nor inflation data justified a 50 basis point cut in interest rates. The Federal Reserve cut rates by an amount exclusively seen in periods of serious economic stress for two reasons: first, the upcoming presidential election, and second, the exponentially growing federal deficit. But since these are the types of things they don’t want to admit out loud, they prattled on about jobs and inflation to pretend that their action was principled.  And naturally the bought-and-paid-for-by-Wall-Street financial media was happy to go along for the ride (Jay Powell just feeds stories to Nick Timiraos at The Wall Street Journal). The political establishment, which includes the Fed, desperately fears Donald Trump’s return to the Oval Office, while the few sentient beings left in government realize that leaving the federal deficit unaddressed is an ongoing act of national suicide.  But rather than speak these truths out loud, they obfuscate them with phony statistics and rely on the self-interest of Wall Street and other powerful financial interests like Big Tech to carry forward a phony narrative.  If you dig through all the heavily doctored and manipulated government jobs and inflation data, however, you will find little support for the emergency-sized rate cut that 50 basis points represents.  There is indeed an emergency staring us right in the face, but it is one of failing to seriously address the debt crisis that is going to destroy our economy.

            But that is the world we live in so my criticisms won’t change the fact that we should expect at least two more 25 basis point cuts before year end and another 100 basis points in 2025.  That will drop the Federal Funds rate ~3.25-3.50% which should not only eliminate any margin above inflation but return us to a world of negative real interest rates.  Official inflation statistics understate the real-world costs of goods and services and the costs of financial assets are still rising.  It is extremely hard to swallow the idea that inflation is contained with the Fed’s balance sheet at $7 trillion, the annual deficit at $2 trillion, and financial conditions still loose. Easing when stock and housing prices are at record highs can only be justified by politics and fears about the deficit;  as a matter of monetary policy, it is another in a long series of monetary policy errors that led us to our currently untenable position and will eventually undermine financial stability and trigger a severe financial crisis.

From the standpoint of the Fed and the Treasury, negative interest rates are desirable because negative interest rates help inflate away the deficit.  They are just a milder version of negative nominal interest rates which ate away at the economic fabric of Europe and Japan during the 2010s.  Everyone should understand that negative real interest rates are damaging as well.  Borrowers will welcome lower rates whether they result in negative real rates or not; lenders not so much.  But from the standpoint of economic stability and economic growth, negative real rates are dangerous because they will incentivize speculative financial and economic activity.  They encourage excessive borrowing often for projects that make sense not on their own merits but only because they can be financed with cheap money.  Already stuck in the hangover from more than a decade of QE/ZIRP (policies almost certain to return during the next crisis), the Fed is setting the table for more zombie deals and zombie companies financed by brain-dead institutions who believe they have no choice but to fund the overcrowded, low-return private equity and venture capital industries.  Time ran out before the system was able to clear the detritus from the last cycle and that is already launching a new cycle of monetary easing in response to political and budget pressures.  This is how a system collapses, step-by-step, then all-at-once after it hits a tipping point.  We haven’t hit that tipping point but we are moving closer to it every day with increasing speed because the process is exponential, not linear.

In order to protect yourself, you should reduce leverage as much as possible (don’t be lured in by lower interest rates – they are a trap), be extremely selective in what you buy, and buy gold to save yourself.  Gold is at record highs but we can expect it to go much higher.  As for Bitcoin, which I know some readers think is wampum and others think is digital gold, it appears to be in a rallying mode through year end due to increasing institutional adoption (PayPal, BNY/Mellon, ETFs, etc.). Nobody knows what it’s worth (including me) so the market will set the price until further notice. But there are worse ideas than having exposure to this alternative to fiat currencies.