Remember, every Fed tightening cycle ends in disaster and then, much more Fed easing.
That’s a tweet Zero Hedge put out back in January.
Zero Hedge is a financial news aggregation site. And it’s incredibly popular in the alternative finance space. I browse its headlines every day to keep my thumb on the pulse of what’s happening out there… and what people think about it.
Of course, Zero Hedge’s tweet here implies that the Federal Reserve (the Fed) will have to “pivot” soon. That is to say, the Fed will have to end its rate-hiking campaign and get back to pouring cheap money into the system.
This is a common theme within the financial echo chamber. And to be sure, it has historical merit.
The Fed embarked upon the path of zero-bound interest rates and funny money in 2008. This created an incredible bull market in U.S. equities. That’s because funny money always feeds speculative booms.
But the Fed did start to “tighten” in 2016. It gradually raised its target interest rate from 0.5% at the start of the year to 2.5% by December 2018.
Then the S&P 500 tanked by nearly 20%… and the Fed went back into easing mode. It quickly dropped its target rate back down to 0.5% and began funneling cheap money back into the financial system.
This stemmed the tide and allowed the S&P 500 to resume its historic bull run.
Many analysts point to this episode and say the Fed will do the same thing this time around. I think they’re missing the big picture here.
Cheap money and excessive “stimulus” only go so far. And now we’re at the end of the road.
By raising rates aggressively, the Fed is forcing fiscal responsibility upon the economy once again. They have to.
Don’t get me wrong – I’m no fan of the Fed. Its creation in 1913 was itself a coup against free markets.
That said, those of us who have studied free market economics know very well that zero-bound interest rates and easy money policies are not sustainable. I’m surprised we managed to go this long without a major blow-up.
Ludwig Von Mises spelled out the dilemma very clearly in his great work Human Action: A Treatise on Economics. Here’s Mises:
There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.
What Mises was saying is this…
Once you go down the path of manipulating interest rates lower and printing new money from thin air, you necessarily sow the seeds of a future crisis.
If you keep going down that same path for too long, you’ll destroy the currency and wreck the economy beyond all recognition. This is the worst-case scenario.
But if you recognize that your current trajectory is unsustainable, you can make the decision to reverse course.
This will result in a painful economic contraction. Artificially low interest rates and funny money fuel all kinds of malinvestment… and that malinvestment must be liquidated.
That’s what the necessary recession does. It clears out the bad debt and gets rid of unproductive companies.
It’s not fun to go through. But it’s far preferable to destroying the currency and the entire economy.
Most of us in the alternative financial space assumed the Fed would never reverse course. But they did. They chose Mises’ voluntary abandonment option.
The media claims that the Fed’s rate-hiking campaign is about fighting inflation. That’s not its primary purpose, however. It’s about saving the legacy financial system.
Again, this doesn’t mean the Fed is “good”. It’s simply acting in its own best interest.
But what we need to understand is that normalizing rates is the path back to a healthy economy. That’s what’s happening here.
We’re going to have to endure a recession first. That’s unavoidable.
But there’s a decent chance that we’re staring down the barrel of a new American renaissance. I never thought I’d say that two years ago. But now there’s now a path forward.
Of course, that presumes the Fed maintains its current course.
Thanks to the prominent banking collapses we discussed last week, the Fed now has all the cover it needs to stop raising rates and return to its old cheap money ways. But I don’t think it will.
We’ll get a better feel for where they stand at the Federal Open Markets Committee (FOMC) meeting this week. Stay tuned…
-Joe Withrow
P.S. The chaos within the banking sector has lit a fire under the price of gold.
As I write, gold is trading around $1,985 an ounce. It’s now up 9% on the year.
And to use trading terminology, gold’s price has “broken out” on the weekly, monthly, and quarterly charts. There are no guarantees this run will continue, of course. But such a strong technical breakout across several time horizons is typically very bullish.
That said, I don’t see gold as a trading vehicle. It’s not something we should put dollars into only hoping to get more dollars out later.
Instead, gold is real money. And there’s a good chance that we’ll see it “re-monetized” within the global financial system in the coming years. We’ll talk more on that another day.
So the best thing to do with gold is simply to accumulate it over time. I prefer to do so by purchasing one-ounce gold coins several times a year.
I also give my kids gold coins as Christmas gifts. That’s one of my two favorite holiday traditions.
For anyone who would like to learn more about gold and how to buy it, check out Taggart Trading at https://southfloridabullion.com/.
This is a small firm run by a friend of mine. He provides clients with excellent personalized service that we simply can’t get at the large online dealers.