Today I want to cite another Market Watch article, written by Greg Robb, from the beginning of the month. It’s a pretty good article, and the author sticks to the facts at hand.

The article discusses a policy tool of the Fed, our central bank, which was last used during WWII, and which two Fed governors have now come out to suggest we could see it being used again.  That tool would be to peg the 2-year treasury at 1% during the next recession if the benchmark rate goes to 0%.

First, a little background. The benchmark rate is the interest rate that banks charge each other to borrow money from each other, from one day to the next. For example, if Citi borrows $30 million on Monday from Chase on condition to pay it back Tuesday, Chase will charge Citi the benchmark overnight rate. And the two-year Treasury is a treasury bond issued by the government, which is simply a 2-year loan from an individual or institution, to the US government, with a fixed interest rate.

So when Fed officials say they want to peg the two-year treasury at 1%, that means that regardless of what financial markets think, two-year loans to the US government will earn the lender 1% interest.

The hope of the Fed, as the author correctly notes, is that if the country moves into a recession and the Fed lowers interest rates not just the shortest time frame, but also for longer periods, businesses and individual consumers will be more likely to spend more money.

The problem with this is that just like the economy has been distorted with bad investments over the last 10 years because of abnormally low-interest rates, that will happen all over again if the Fed reenters this policy.  The author notes that Harvard Professor & Economist Ken Rogoff, previously a fan of lowering interest rates and QE, has already admitted that lowering interest rates didn’t work out too well over the last 10 years, so why would the Fed want to do this again?

The last item of note in this article, again, I liked this article, the last item of note is that the Fed is set to begin discussing its 2% inflation target.  That’s the rate of inflation that the Fed thinks would be good for the economy.  Now, it’s not good for the economy, but that’s not for this posting.  What it really means that they want to begin discussing it, is that they want to set the target higher.  The Fed already changed official policy to symmetrical around 2%, allowing the expectation for higher inflation on Wall Street.  This new direction they'll take will probably begin slowly with 3% because that is the long term average since WWII.  But the Fed won’t stop at 3% and what will eventually happen is that it will get out of control regardless of what the Fed tries to do. 

I’ve been saying that the next recession will see a stagnant or shrinking economy with much higher inflation, and this is a sign that the Fed 1) knows that higher inflation is already here, even though they’ve convinced the world that it’s only at 2%, and 2) the Fed is trying to plant the seeds in everyone’s mind that higher inflation will be the new normal once they recognize it officially.

That’s it for now, and thanks for reading Volume 81 of The Macro Market Wrap Up With The Mad Genius.  Make sure to leave any questions or comments below. Until next time remember that there is always a bull market somewhere in the world, and on the opposite side of every crisis there always lies opportunity.