Debt and Deficits

The Credit Strategist - November 2024

Markets aren’t trading as though they think the Federal Reserve should have cut interest rates by 50 basis points in September.  As I argued then, the September 18^th cut was unjustified in terms of both sides of the Fed’s twin mandate, inflation and unemployment.  With stock, housing, and other asset prices at record highs and the government reporting strong GDP numbers, the economic data didn’t justify any rate cut and certainly not one of a magnitude previously seen only in periods of financial stress.

The disconnect between the data and the Fed’s action confirmed long-held concerns about the competence and credibility of the Fed.  The gnomes in the Eccles Building imposed a crisis-era cut based on stated reasons that didn’t conform to the data, a serious problem for an institution that consistently claims to be “data dependent.”  In my view, the only defensible reason for cutting rates was the rising cost of servicing the exploding federal deficit which is rising at an exponential rate with the annual run-rate hitting $1.3 billion. Some suggested the rate cut was prompted by a desire to help the candidacy of Kamala Harris but the cut came too late to help anybody’s candidacy. I do believe the Fed succumbed to pressure from DC insiders and the financial establishment and their praetorian guard, the mainstream media, to lower rates for a variety of reasons that may or may not be related to the election but I don’t think the cut will have any effect on the outcome on November 5^th. 

The Federal Reserve sees the current run-rate on servicing the federal deficit hitting ~$1.3 trillion and rising.  Cutting rates when stock, housing and other financial asset prices are at (or near) record highs reflects the embedded procyclical, pro-inflation bias of all central banks whose real job is to manage the slow decline in the value of their fiat currencies. This requires them to nominally keep inflation under control while conducting a long-term, slow motion project to devalue their currencies.  This is why investors need to earn a rate of return greater than the real-world rate of inflation (not the understated rate of inflation reported by the government).  While the government reported that inflation was low for years, financial asset prices were rising at double-digit rates and many consumer products and services became financialized through financial engineering (securitization, tokenization, etc.). 

Lowering interest rates is inflationary; doing so based on patently bogus reasons exposes the failure of policymakers to honestly explain how fiat currency stems work or to address our debt problems. And that in turn weakens confidence in the system and financial stability.  From an investment standpoint, it made sense to sell bonds and buy stocks (for a short-term trade) after the September rate cut as well as to buy commodities, gold, and Bitcoin.  The price of gold rose ~6% since the Fed raised rates in mid-September.  Bitcoin hit a new all-time high of $73,816 (it’s a bit lower now) and will likely trade higher.  Gold has long been seen as an alternative to fiat currencies and Bitcoin is increasingly seen that way regardless of those who think it’s fairy dust. The fairy dust crowd, however, is ignoring an awful lot of institutional adoption of the cryptocurrency.  In any event, the Fed blew more inflationary air into the “everything bubble” with its rate cut and promises of more to come.

Listening to Wall Street and government officials justifying lower rates confirms that there is virtually no serious interest in addressing our debt problems among our so-called business leaders.  On October 31^st, The Wall Street Journal’s Grep Ip published a one-sided article entitled “The Next President Inherits a Remarkable Economy” buying into all of the government statistics on GDP, employment and inflation that the Fed ignored in cutting rates.  Mr. Ip is certainly correct that the next president will not enter office in the midst of an economic crisis as did Presidents Obama and Biden (the crisis will come later, on his or her watch or on somebody else’s, but come it will).  But the economy is being kept afloat by massive deficit spending, AI spending that may or may not bear fruit, consumer borrowing, and spending by the wealthy of their inflation-driven stock market and housing gains. Organic, productive growth remains disappointing and increasingly hobbled by debt that diverts untold amounts of financial and intellectual capital to speculative and unproductive uses.