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December 15, 2021 | Why the Fed Can’t Raise Interest Rates

Is an American author of books and articles on economic and financial subjects. He is the founder and president of Agora Publishing, and author of the daily financial column, Diary of a Rogue Economist.

YOUGHAL, IRELAND – What a wacky world!

The stock market is more overvalued than at any time since 2000. Any sane person would think twice before buying more stocks.

And then, along comes the worst possible news – that inflation is running at a near-40 year high. What kind of dope doesn’t know what that portends?

The Federal Reserve will be forced, like it or not, to tighten credit. Businesses that are heavily in debt will have to roll over their debts at higher interest rates.

We look up. And there’s our Crash Alert flag flying sheepishly… the ol’ black ‘n blue… warning investors to watch out.

Stocks Forge Ahead

If the stock market were an army, it would be knee-deep in mud… overextended… and far from its supply lines. And now, its scouts are staggering back to camp, wounded and hungry.

Cathie Wood’s Ark Innovations exchange-traded fund (ARKK) is down 40% from its peak last February.

Bitcoin is 30% off its peak.

Goldman Sachs’ index of unprofitable tech companies is off 25% over the last month.

And yet, there is still no sign of a broad retreat. Stocks rose on the latest inflation news.

And now, commentators are calling for more victories ahead. Here’s Barrons’ headline:

Stocks’ Rough Patch Could End Soon. The Fed’s Next Move May Be Priced In.

Daredevils and Dimwits

What to make of it?

There are two possible interpretations. First, investors are very stupid. Second, they are very smart.

You have to be pretty dumb not to see that asset prices are way out of line with economic reality. By all measures, stocks are at the top of their range.

Despite all the loose talk about “disruptive technology” and the “metaverse,” real output is still produced by people who do real work, either physical or mental. And it’s still measured by GDP.

So the simplest way of keeping track of stock prices is to add all the stocks together and compare them to GDP. This is sometimes called the “Buffett Indicator,” after legendary value investor Warren Buffett, who popularized it.

This measure shows you that stocks are usually worth about 80% of GDP. And between 1950 and today, they only crossed the 150%-of-GDP line twice – in 1999 and again in 2017.

After January 2000, the dotcoms crashed and stocks quickly fell back. But recently, they just keep going up. And now, the ratio stands at 213% – an all-time high.

How much upside is left, we don’t know… But whatever it is, it is only suited to daredevils and dimwits.

Everyone’s Doing It

Stocks are only where they are because the Fed has been pumping them up for more than 10 years. And now… it is still lending money at an inflation-adjusted interest rate of about MINUS 6%.

But with inflation on the rise, the only sensible thing for the Fed to do is to raise interest rates – which would bring stock prices crashing down.

And this is where the very smart investors may be outsmarting themselves.

They realize that the Fed faces an “Inflate or Die” choice. It encouraged everyone to borrow. A recent Bloomberg article, for example, told readers that they should emulate the Argentines – borrow as much as possible… and get rid of their cash as quickly as possible.

On the pampas, as well as the Great Plains – everyone does it. Households are once again “taking out equity” by borrowing against the inflated value of their homes.

Corporations do it – almost doubling their debt since 2007.

And who does it most of all? The government! The feds have tripled their debt load since 2007.

And now, so many people have borrowed so much money that the Fed can’t normalize rates – at least, that’s our “Inflate or Die” hypothesis.

Why the Fed Can’t Raise Interest Rates

Inflation hurts savers (and thus, hurts the entire economy, which relies on savings to fund expansion).

But it helps debtors. Their debts evaporate as the value of the U.S. dollar goes down.

Who’s the biggest debtor in the whole world?

Right again. The U.S. government.

And with inflation running at almost 7% (it is actually much more, if you calculate it honestly), and the federales paying only about 2% on their loans, it means they are gaining about 5% on their outstanding debt.

With a total debt of more than $28 trillion, that means they are reducing their obligations by about $1.4 trillion each year, grosso modo.

The very smart money is betting that this is too sweet a racket to give up.

The Fed suppresses interest rates by buying bonds. As long as the asset-buying goes on, presumably, stocks and bonds get a bid, even as inflation rates go up.

The value of the debt goes down.

The value of the elite’s stocks and bonds goes up.

Everybody’s happy.

Well, everybody except the 90% of the population that pays higher consumer prices.

What could go wrong? Tune in tomorrow…

Regards,

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Bill

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December 15th, 2021

Posted In: Bill Bonner's Diary

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