Looking ahead, nearly all Committee participants view it as likely that some further rate increases will be appropriate this year…
That’s Federal Reserve (Fed) Chairman Jerome Powell speaking to the financial media earlier this month.
The Fed’s Federal Open Market Committee (FOMC) decided to keep its target interest rate steady in their June meeting. But Powell didn’t want the market to get the wrong idea. The Fed won’t be cutting interest rates again any time soon.
In fact, Powell said that if the Fed does cut interest rates again in the future, those cuts will only be in proportion to a falling Consumer Price Inflation (CPI) print.
Powell explained that his Fed will keep the “real” interest rate steady. By this, Powell means that he intends to keep the Fed’s target rate a certain percentage above the rate of consumer price inflation.
This speaks to an important concept. Within a fiat monetary system – a system where governments and central banks can create money from nothing – nominal numbers don’t tell the real story. This is true when it comes to annual incomes, investment returns, and interest rates.
That is to say, it doesn’t matter how much our income goes up on paper in a given year. What matters is if our income goes up more than consumer price inflation. If it doesn’t, we’ve actually lost purchasing power… despite our nominal income being higher.
The same concept applies to interest rates.
When Powell refers to the real rate of interest, he’s talking about the difference between the nominal interest rate and the Fed’s measurement of consumer price inflation. So if inflation falls a certain percentage and the Fed cuts rates by the same percentage, the real rate of interest remains the same.
Powell is making it abundantly clear that the days of easy money are over. We’ve come to the end of the road.
It’s worth pointing out that this isn’t a new development. Powell’s been signaling that the Fed would not “pivot” and cut rates again for over a year now.
The only difference is, the market didn’t believe him at first. Now it does.
Powell’s dead set on getting interest rates back up to what the Fed calls a “terminal” level. That’s the point at which the Fed sees its monetary policy as neutral – neither stimulative nor restrictive to the economy.
Of course, how the Fed could possibly know what the terminal rate of interest will be is a completely different discussion. The great Austrian economist Friedrich Hayek would call this kind of thinking a fatal conceit.
That aside, Powell has made it clear that the Fed will not go back to its old ways. It will not drop rates and goose the market every time the stock market hic-cups going forward. And that means the Age of Paper Wealth is over.
And then there was this curious interaction at the Fed’s press conference this month:
EDWARD LAWRENCE, FOX BUSINESS: So I want to go back to comments you made about, in the past, about unsustainable fiscal path. The Congressional Budget Office (CBO) projects the federal deficit to be $2.8 trillion in 10 years. The CBO also says that federal debt will be $52 trillion by 2033.
At what point do you talk more firmly with lawmakers about fiscal responsibility? Because—assuming monetary policy cannot handle alone the inflation or keep that inflation in check with the higher-level spending.
JEROME POWELL: I don’t do that. That’s really not my job… I will say, and many of my predecessors have said that we’re on an unsustainable fiscal path, and that needs to be addressed over time.
EDWARD LAWRENCE: Is there any conversation then about the Federal Reserve financing some of that debt that we’re seeing coming down the pike?
JEROME POWELL: No. Under no circumstances.
This is interesting. If I’m interpreting this correctly, Lawrence asked Powell if the Fed would lower rates to help finance government deficits in the future. And Powell unequivocally said no… under no circumstances.
That’s all he said. He didn’t hedge his comment whatsoever.
What’s so interesting here is that Powell’s predecessors Janet Yellen, Ben Bernanke, and Alan Greenspan almost surely would have stumbled through this question with “ifs” and “maybes” and “conditions”. Powell didn’t. He just said no.
If he’s being honest here… and if he sticks to his guns on this, the implications are huge.
The U.S. government simply can’t afford to run trillion-dollar deficits with interest rates at current levels. Interest payments on the federal debt are now rapidly approaching $1 trillion a year. And that number will only increase if the government continues to run massive deficits that pile up debt.
At some point something has to give. Either Congress stops spending money like a drunken sailor… or something is going to break in a big way.
Or, perhaps the Treasury has a wild card up its sleeves. What if it were to back part of all Treasury bonds by gold?
We’ll explore that possibility tomorrow.