Will the Fed signal interest rate cuts with the July FOMC meeting? That's the question on everybody's mind. But interest rates are really a sideshow in this Fed drama. The real action is on the Fed balance sheet.
In this episode of the Money Metals' Midweek Memo, host Mike Maharrey explains what's going on with the balance sheet, why it matters, and what it tells us about the likely trajectory of price inflation and the economy. He also touches on a new milestone for the national debt.
Most casual football fans just follow the ball. And they miss a lot.
"In fact, you can completely miss the most important action in a football game if you are just laser-focused on the ball. A lot of plays succeed or fail based on play along the offensive and defensive lines. A missed or successful block far from the ball can alter the entire trajectory of a play. The same concept is true when it comes to investing. The mainstream financial media fixates on certain things, while often completely ignoring things that are much more important."
For instance, when it comes to the Federal Reserve and its war on inflation, the mainstream is focused almost exclusively on interest rates - and more specifically, when the fight will end and the central bank will cut rates.
"As regular listeners know, the markets are desperate for a return to easy money. They want rate cuts because everybody knows deep down that this debt-riddled, bubble economy can’t keep chugging along with higher interest rates. ... So, that’s why we have all this attention on interest rates. And it’s not unwarranted. Higher interest rates and debt don’t play well together. And my goodness there’s a lot of debt."
Mike notes that the national debt surged above $35 trillion this week and highlights just how fast it's growing.
"We just had this talk in January. It only took the Biden administration seven months to add another $1 trillion to the debt."
He also notes that borrowing and spending are a bipartisan sport.
"That’s because politicians on both sides of the aisle committed to one thing – spending money to buy votes."
Mike provides an overview of the interest problem, pointing out that the federal government will likely spend over $1 trillion on interest payments in fiscal 2024.
And this is just one prong of the debt trifecta. Households and corporations are also levered to the hilt.
"So yeah, no wonder everybody is jonesing for rate cuts. And I’m pretty certain they’ll get them. They’re going to pretend inflation is beat and they are going to start making more inflation. But that’s not really the part of the play you should be watching."
Mike drops a little bombshell.
"Did you know the Fed has already loosened monetary policy?
"While everybody focuses on the prospect of a rate cut and salivates in the anticipation of easier money, most people completely ignore the other prong of central bank monetary policy – the Fed balance sheet."
In June, the Fed started slowing down its balance sheet reduction scheme. Mike explains why this matters.
"The balance sheet serves as a direct pipeline to the money supply. When the Fed buys assets – primarily U.S. Treasuries and mortgage-backed securities – it does so with money created out of thin air. Those assets go on the balance sheet and the new money gets injected into the economy."
As Mike goes on to explain, the expansion of the money supply through the Fed balance sheet is inflation.
"This monetary inflation is the root of the price inflation we’re still suffering from today."
A lot of people imagine inflation is beat, but it never will be because creating inflation is the policy.
"It’s not that government officials and central bankers want price inflation to go away. They just want it low enough that you don’t notice. The goal is to increase prices by 2 percent every year. Price inflation doesn’t help you at all, but it helps government. The ability to increase the money supply makes excessive borrowing and spending possible. If we lived in a world with sound money and no central bank tinkering with interest rates and printing money, government would be much smaller and much less involved in the minutia of your life."
Mike draws the logical conclusion: If expanding the money supply is inflationary, it logically follows that to truly beat down price inflation, the Fed needs to shrink the balance sheet.
"If the Fed is serious about taming inflation, it needs to significantly reduce the size of the balance sheet. In other words, it needs to undo the money creation of the past decade-plus.
"I didn’t.
"And it won’t."
As Mike points out, the balance sheet reduction plan wasn't terribly ambitious to begin with. Had they stuck with it, it would have taken over seven years to run shrink the balance sheet to pre-pandemic levels.
A look back at the trajectory of the balance sheet after the 2008 financial crisis reveals an ugly secret - the Fed can't unwind its balance sheet because the economy is addicted to easy money.
"The central bankers know they’re playing with fire. They know that this economy can’t run without easy money. And that’s exactly why they’ve already slowed their roll even though they continue to claim inflation isn’t dead yet. Keep this in mind as you digest all the talk-talk-talk surrounding the July FOMC meeting. The mainstream talking heads and the markets will focus on 'will they or won’t they' cut rates. But the Fed has already loosened monetary policy. And it wasn’t all that tight to begin with."
So, what's the bottom line?
"The Federal Reserve has already waved the white flag. It has surrendered to inflation. That means you’re getting more inflation.
"Be prepared."
Articles Mentioned in the Show
Gold's Role as an Inflation Hedge in the 21st Century
National Debt Blows Past $35 Trillion (Yawn)
Here's a Dirty Little Secret: Federal Reserve Monetary Policy Is Still Loose
Kids Understand Price Inflation Is Bad; Where Are the Adults
About the Author
Mike Maharrey is a journalist and market analyst for MoneyMetals.com with over a decade of experience in precious metals. He holds a BS in accounting from the University of Kentucky and a BA in journalism from the University of South Florida.
