{"id":1650339,"date":"2022-09-21T06:52:23","date_gmt":"2022-09-21T10:52:23","guid":{"rendered":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/?p=1650339"},"modified":"2022-09-21T09:25:38","modified_gmt":"2022-09-21T13:25:38","slug":"debt-and-why-the-fed-is-trapped","status":"publish","type":"post","link":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/debt-and-why-the-fed-is-trapped\/","title":{"rendered":"Debt\u2014and Why the Fed Is Trapped"},"content":{"rendered":"<aside class=\"mashsb-container mashsb-main mashsb-stretched\"><div class=\"mashsb-box\"><div class=\"mashsb-count mash-medium\" style=\"float:left\"><div class=\"counts mashsbcount\">12<\/div><span class=\"mashsb-sharetext\">SHARES<\/span><\/div><div class=\"mashsb-buttons\"><a class=\"mashicon-facebook mash-medium mash-nomargin mashsb-noshadow\" href=\"https:\/\/www.facebook.com\/sharer.php?u=https%3A%2F%2Fwww.conservativenewsdaily.net%2Fbreaking-news%2Fdebt-and-why-the-fed-is-trapped%2F\" target=\"_top\" rel=\"nofollow\"><span class=\"icon\"><\/span><span class=\"text\">Facebook<\/span><\/a><a class=\"mashicon-twitter mash-medium mash-nomargin mashsb-noshadow\" href=\"https:\/\/twitter.com\/intent\/tweet?text=&amp;url=https:\/\/www.conservativenewsdaily.net\/breaking-news\/?p=1650339&amp;via=ConservNewsDly\" target=\"_top\" rel=\"nofollow\"><span class=\"icon\"><\/span><span class=\"text\">Twitter<\/span><\/a><a class=\"mashicon-subscribe mash-medium mash-nomargin mashsb-noshadow\" href=\"#\" target=\"_top\" rel=\"nofollow\"><span class=\"icon\"><\/span><span class=\"text\">Subscribe<\/span><\/a><div class=\"onoffswitch2 mash-medium mashsb-noshadow\" style=\"display:none\"><\/div><\/div>\n            <\/div>\n                <div style=\"clear:both\"><\/div><\/aside>\n            <!-- Share buttons by mashshare.net - Version: 4.0.47--><p>&nbsp;<\/p>\n<p>The massive <a href=\"https:\/\/www.theepochtimes.com\/t-debt\">debt<\/a> levels provide the single most significant risk and challenge to the <a href=\"https:\/\/www.theepochtimes.com\/t-federal-reserve\">Federal Reserve<\/a>. It is also why the Fed is desperate to return <a href=\"https:\/\/www.theepochtimes.com\/t-inflation\">inflation<\/a> to low levels, even if it means weaker economic growth. Such was a point previously made by Jerome Powell:<\/p>\n<p>\u201cWe need to act now, forthrightly, strongly as we have been doing. It is very important that inflation expectations remain anchored.\u00a0What we hope to achieve is a period of growth below trend.\u201d<\/p>\n<p>That last sentence is the most important.<\/p>\n<p>There are some important financial implications to below-trend economic growth. As we discussed in \u201c<a href=\"https:\/\/realinvestmentadvice.com\/the-coming-reversion-to-the-mean-of-economic-growth\/\">The Coming Reversion to the Mean of Economic Growth<\/a>\u201d:<\/p>\n<p>\u201cAfter the financial crisis [of 2008\u201309], the media buzzword became the\u00a0\u2018new normal\u2019 for what the post-crisis economy would be like. It was a period of slower economic growth, weaker wages, and a decade of monetary interventions to keep the economy from slipping back into a <a href=\"https:\/\/www.theepochtimes.com\/t-recession\">recession<\/a>.<\/p>\n<p>\u201cPost the \u2018COVID crisis,\u2019\u00a0we will begin to discuss the\u00a0\u2018new new normal\u2019\u00a0of continued stagnant wage growth, a weaker economy, and an ever-widening wealth gap. Social unrest is a direct byproduct of this \u2018new new normal,\u2019 as injustices between the rich and poor become increasingly evident.<\/p>\n<p>\u201cIf we are correct in assuming that PCE [Personal Consumption Expenditures price index] will revert to the mean as stimulus fades from the economy, then the\u00a0\u2018new new normal\u2019\u00a0of economic growth will be a new lower trend that fails to create widespread prosperity.\u201d<\/p>\n<p>As shown, economic growth trends are already falling short of both previous long-term growth trends. The Federal Reserve is now talking about slowing economic activity further in its inflation fight.<\/p>\n<figure id=\"attachment_4739116\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739116\" src=\"https:\/\/img.theepochtimes.com\/assets\/uploads\/2022\/09\/19\/image001-600x365.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"389\" \/><\/noscript><\/figcaption>&nbsp;<\/figure>\n<p>The reason that slowing economic growth, and debilitating inflation, is critical for the Fed due to the massive amount of leverage in the economy. If inflation remains high, interest rates will adjust, triggering a debt crisis as servicing requirements increase and defaults rise. Historically, such events led to a recession at best and a financial crisis at worst.<\/p>\n<figure id=\"attachment_4739117\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739117\" src=\"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-content\/uploads\/2022\/09\/image002-600x322-1.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"343\" \/><\/noscript><\/figcaption>&nbsp;<\/figure>\n<p>The problem for the Fed is trying to \u201cavoid\u201d a recession while trying to kill inflation.<\/p>\n<h2>Recessions Are an Important Part of the Cycle<\/h2>\n<p>Recessions are not a bad thing. They are a\u00a0necessary part of the economic cycle\u00a0and arguably a crucial one.\u00a0Recessions remove the\u00a0\u201cexcesses\u201d\u00a0built up during the expansion and\u00a0\u201creset\u201d\u00a0the table for the next leg of economic growth. Without\u00a0\u201crecessions,\u201d\u00a0the build-up of excesses continues until something breaks.<\/p>\n<p>In the current cycle, the Fed\u2019s interventions and maintenance of low rates for more than a decade allowed fundamentally weak companies to stay in business by taking on cheap debt for unproductive purposes, such as stock buybacks and dividends. Consumers have used low rates to expand consumption by taking on debt. The federal government increased debts and deficits to record levels.<\/p>\n<p>The assumption is that increased debt is not problematic as long as interest rates remain low. But therein lies the trap the Fed faces.<\/p>\n<p>The Fed\u2019s mentality of constant growth, with no tolerance for recession, has allowed this situation to inflate rather than allowing the natural order of the economy to perform its Darwinian function of\u00a0\u201cweeding out the weak.\u201d<\/p>\n<p>The chart below shows total economic system leverage versus gross domestic product (GDP). It currently requires $4.82 of debt for each dollar of inflation-adjusted economic growth.<\/p>\n<figure id=\"attachment_4739118\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739118\" src=\"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-content\/uploads\/2022\/09\/image003-600x345-1.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"368\" \/><\/noscript><\/figcaption>&nbsp;<\/figure>\n<p>Over the past few decades, the system has not been allowed to reset. That has led to a resultant increase in debt to the point that it impaired the economy\u2019s growth.\u00a0It is more than a coincidence that the Fed\u2019s\u00a0\u201cnot-so invisible hand\u201d\u00a0has left fingerprints on previous financial unravellings. Given that credit-related events tend to manifest from corporate debt, we can see the evidence below.<\/p>\n<figure id=\"attachment_4739119\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739119\" src=\"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-content\/uploads\/2022\/09\/image004-600x319-1.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"340\" \/><\/noscript><\/figcaption>&nbsp;<\/figure>\n<p>Given the years of ultra-accommodative policies following the financial crisis of 2008\u201309, most of the ability to\u00a0\u201cpull forward\u201d\u00a0consumption appears to have run its course. This is an issue that can\u2019t, and won\u2019t be, fixed by simply issuing more debt, which, for\u00a0the last 40 years, has been the preferred remedy of each administration. In reality, most of the aggregate growth in the economy was financed by deficit spending, credit creation, and a reduction in savings.<\/p>\n<figure id=\"attachment_4739120\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739120\" src=\"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-content\/uploads\/2022\/09\/image005-600x350-1.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"373\" \/><\/noscript><\/figcaption>&nbsp;<\/figure>\n<p>In turn, this surge in debt reduced both productive investments and the output from the economy. As the economy slowed and wages fell, the consumer took on more leverage, decreasing the savings rate. As a result of the increased leverage, more of consumers\u2019 income was needed to service the debt.<\/p>\n<figure id=\"attachment_4739121\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739121\" src=\"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-content\/uploads\/2022\/09\/image006-600x345-1.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"369\" \/><\/noscript><\/figcaption>&nbsp;<\/figure>\n<h2>A Long History of Terrible Outcomes<\/h2>\n<p>After three decades of surging debt against falling inflation and interest rates, the Fed now faces its most difficult position since the late 1970s.<\/p>\n<p>The U.S. economy is more heavily levered today than at any other point in our history. Since 1980, debt levels have continued to increase to fill the income gap. Bigger houses, televisions, computers, etc., all required cheaper debt to finance it.<\/p>\n<p>The chart below shows the inflation-adjusted median living standard and the difference between real disposable incomes (DPI) and the required debt to support it. Beginning in 1990, the gap between DPI and the cost of living went negative, leading to a surge in debt usage. In 2009, DPI alone could no longer support living standards without using debt. Today, it requires almost $7,000 a year in debt to maintain the current standard of living.<\/p>\n<figure id=\"attachment_4739122\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739122\" src=\"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-content\/uploads\/2022\/09\/image007-600x306-1.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"327\" \/><\/noscript><\/figcaption>&nbsp;<\/p>\n<p>(Source: St. Louis Federal Reserve, Refinitv; Chart: RealInvestmentAdvice.com)<\/figure>\n<p>The rise and fall of stock prices have little to do with the average American and their participation in the domestic economy.\u00a0Interest rates are an entirely different matter. Since interest rates affect\u00a0\u201cpayments,\u201d\u00a0increases in rates quickly negatively affect consumption, housing, and investment, which ultimately deters economic growth.<\/p>\n<figure id=\"attachment_4739123\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739123\" src=\"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-content\/uploads\/2022\/09\/image008-600x343-1.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"366\" \/><\/noscript><\/figcaption>&nbsp;<\/figure>\n<p>Since 1980, every time the Fed tightened monetary policy by hiking rates, inflation remained\u00a0\u201cwell contained.\u201d\u00a0The chart below shows the federal funds rate compared to the Consumer Price Index (CPI) as a proxy for inflation. The current bout of inflation is entirely different, and as the Fed hikes interest rates to slow economic demand, it is highly probable that it will over-tighten. History is replete with previous failed attempts that created economic shocks.<\/p>\n<figure id=\"attachment_4739124\" class=\"wp-caption aligncenter\"><figcaption class=\"wp-caption-text\"><noscript><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-4739124\" src=\"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-content\/uploads\/2022\/09\/image009-600x352-1.jpg\" alt=\"Epoch Times Photo\" width=\"640\" height=\"376\" \/><\/noscript><\/figcaption>&nbsp;<\/figure>\n<p>The Fed has a tough challenge ahead of it, with very few options. While increasing interest rates may not\u00a0\u201cinitially\u201d affect asset prices or the economy, it is a far different story to suggest that they won\u2019t.\u00a0There have been absolutely <em>zero<\/em> times in history the Federal Reserve began an interest rate-hiking campaign that did not eventually lead to a negative outcome.<\/p>\n<p>The Fed is now beginning to reduce accommodation at precisely the wrong time. To the point:<\/p>\n<ul>\n<li>There are growing economic ambiguities in the United States and abroad: peak autos, peak housing, peak GDP.<\/li>\n<li>Excessive valuations exceed earnings growth expectations.<\/li>\n<li>There is a failure of fiscal policy to \u201ctrickle down.\u201d<\/li>\n<li>Geopolitical risks abound.<\/li>\n<li>Yield curves are declining amid slowing economic growth.<\/li>\n<li>There are record levels of private and public debt.<\/li>\n<li>Junk bond yields are exceptionally low.<\/li>\n<\/ul>\n<p>Such are the essential ingredients required for the\u00a0next\u00a0\u201cfinancial event.\u201d<\/p>\n<p>When will that be? We don\u2019t know.<\/p>\n<p>We do think, however, that the Fed will make a policy mistake as\u00a0\u201cthis time is different.\u201d<\/p>\n<p>Unfortunately, the outcome likely won\u2019t be.<\/p>\n<p><i>Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.<\/i><\/p>\n<div class=\"author_wrapper\">\n<div class=\"one_author_block round\">\n<div class=\"top_row\"><\/div>\n<div class=\"bio\"><\/div>\n<\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>Commentary\u00a0The massive debt levels provide the single most significant risk and challenge to the Federal Reserve. It is also why the Fed is desperate to return inflation to low levels,<\/p>\n","protected":false},"author":1,"featured_media":1650342,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_mo_disable_npp":"","fifu_image_url":"","fifu_image_alt":"","footnotes":""},"categories":[],"tags":[],"class_list":["post-1650339","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry"],"_links":{"self":[{"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/posts\/1650339","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/comments?post=1650339"}],"version-history":[{"count":0,"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/posts\/1650339\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/media\/1650342"}],"wp:attachment":[{"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/media?parent=1650339"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/categories?post=1650339"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.conservativenewsdaily.net\/breaking-news\/wp-json\/wp\/v2\/tags?post=1650339"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}