After the most recent Federal Open Market Committee meeting, Chairman Powell issued an official statement
explaining the decision to raise interest rates another quarter-point.
That brings the Federal target funding rate to 5.25-5.5%, the highest rate in over two decades. (Granted, those were two decades of perpetual emergency, the lowest-for-longest rates in U.S. history.)
Powell summarized the FOMC decision as follows:
Recent indicators suggest that economic activity has been expanding at a moderate pace. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated.
The Fed’s continuing battle against inflation was started way too late under the mistaken idea it was “transitory.” Towards that end, the recent rate increase was justified by Powell in another statement:
We understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down to our 2% goal. Price stability is the responsibility of the Federal Reserve. Without price stability, the economy doesn't work for anyone.
He’s right that price stability is a crucial part of a functioning economy.
However, the Fed’s efforts to rein in inflation add stress to another part of the economy that’s already cracking under the strain…
Higher interest rates are good for creditors, but terrible for debtors
The truly wealthy, who have no debts at all – people like Warren Buffett and Bill Gates – don’t need to worry much about interest rates.
Institutions and individuals who require credit, though, including the U.S. government, banks, many businesses and most American households, are running into trouble. Higher interest rates are pushing them to the brink of survival.
Let’s take a look at how the world’s largest debtor, the U.S. government, is doing. This graph compares the growth rate for four major economic indicators: GDP and tax revenue (“income”) on the one hand, total federal debt and debt service payments (interest expense) on the other.
Deficit spending increases government debt.
Old debts aren’t paid off – instead, they’re rolled over into new loans. And when interest rates are higher, those new loans become more expensive.
When interest rates were low (for those 20 prior years), the government borrowed massive amounts of money – cheaply.
As though historically low interest rates would last forever.
The borrowing continued – now surpassing $32 trillion. But now, thanks to 5% in rate increases the Fed has initiated since February 2022, the interest expense the government pays has skyrocketed.
This is because, instead of paying off its debts, the government is simply writing new IOUs and paying higher interest rates, rolling over old debts into new:
Since interest rates started rising rapidly in early 2022, the effective federal interest rate has risen by a full percent. Debt over the same period increased by $1.8 trillion, and the interest expense rose by $328 billion. Of the $328 billion, only about $50 billion was due to new debt issuance. The remainder is a function of the Treasury having to fund maturing debt by issuing new debt at higher interest rates than the old debt.
In just the first half of the year, SIFMA calculates the Treasury has issued $9.9 trillion in new debt. At the same time, the federal debt grew by slightly more than $1 trillion. $8.9 trillion of new debt replaced old debt.
That’s right. The vast majority, some 90% of federal debt, isn’t funding the military. It isn’t training new Immigrations & Customs Enforcement officers, or helping the Food and Drug Administration monitor food safety.
It’s simply paying off old debts by taking on new, more expensive debt!
And if you look at the chart again, you’ll see that debt service payments are rising much faster than tax revenue – faster than GDP (which, theoretically, if the government imposed a 100% tax, would represent the entire income of the U.S.)
This looks like a debt trap.
Governments, however, can draw out a bankruptcy for decades, because they have the power to print their own money (and force citizens to use that money).
Businesses, however, can’t print their own money…
A recent New York Times article summarized the potential for a new bankruptcy crisis:
The fear is that as debt comes due and businesses still in need of cash are forced to renew their financing at much higher interest rates, bankruptcies and defaults could accelerate. That risk is especially pronounced if the Fed keeps borrowing costs higher for longer — a possibility investors have slowly come to expect.
Already, corporate defaults this year are running at their fastest pace in more than a decade for companies with public debt that trades on financial markets outstripping the immediate aftereffect of the pandemic’s start in 2020, according to S&P Global Ratings.
Lending and banks are already suffering thanks to higher rates, and another banking crisis could ensue if they continue to rise.
Business Insider reported on the contraction of credit:
Total commercial and industrial (C&I) lending shrank 1% year-to-date, compared with a 9.3% expansion during the same period last year, according to Robin Brooks, chief economist at the Institute of International Finance. The median growth for the comparable periods from 2010 to 2022 was 4.5%, according to him.
It's not just credit that’s contracting, though – liquidity is down some $500 billion across the banking system.
Tighter credit is bad news for anyone counting on loans to survive. Such as the average American household, which has been borrowing heavily to afford higher prices. Consumer debt recently breached a historic record high.
Of course, consumers will suffer consequences of higher interest rates on credit, which in some cases was being used to combat the inflation that the Fed is fighting.
- The U.S. government can’t afford higher interest rates
- Businesses (especially banks) can’t afford higher interest rates
- Most American households can’t afford higher interest rates
We can be pretty sure, from past experience, that the Fed will prioritize “financial stability” over its inflation fight.
The real question is, which will happen first: a credit crisis bringing on a severe recession? Or a pre-emptive return to quantitative easing and money-printing, fueling another inflationary surge?
One of the two looks extremely likely in the next six months…
Finding stability in an unstable economy
Consider everything we discussed above, it’s no wonder that global de-dollarization is all over the news these days. No one wants to pin their financial future on a bankrupt nation’s rapidly-devaluing currency…
Maybe the only good news is that there’s an asset that can not only diversify your savings, but provide shelter from dollar devaluation: Physical precious metals like gold and silver. There’s a reason gold and silver are the historic safe-haven assets of choice. In addition to being some of the few inflation-resistant investments that are practical for individuals to own, they have a centuries-long track record of preserving purchasing power regardless of economic crisis.
So right now, it might be a good idea to take a few minutes to help yourself by learning about them. You can get all the information you need about both gold and silver for free to make an informed decision right here.
Peter Reagan is a financial market strategist at Birch Gold Group. As the Precious Metal IRA Specialists, Birch Gold helps Americans protect their retirement savings with physical gold and silver. Based in the Los Angeles area, the company has been in business since 2003. It has an A+ Rating.
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