Last week we discussed the consequences of continued high inflation. It will bring economic devastation, the dollar would lose its status as the world currency, the destruction of the middle class, and likely another Great Depression.

Chuck Butler outlined what happens if the Fed flinches and doesn’t do what needs to be done – quickly:

“Soon after the Fed Heads will turn around and cut rates, print currency, and start the whole shootin’ match over again.

…. Bottom line, they will attempt to get the economy going and the mess will eventually get bigger –

Dennis, they call that ‘stagflation.’ Basically, it’s the Fed trying to burn the candle at both ends and making things worse.”

In the early 1980’s Fed Chairman Volcker, saw high inflation and worried the dollar would lose reserve currency status. He raised interest rates to almost 20%.

He raised interest rates to 15%, cut them back to 10%, and then raised them to 17.5% – kept rates high until inflation got under control. He solved the problem, but times were tough!

Recently Fed Chairman Powell said:

“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.

…. We will keep at it until we are confident the job is done.”

What happens if the government and Fed make the tough choices to get inflation down to their 2% target?

CNBC reports:

“The Federal Reserve on Wednesday enacted its second consecutive 0.75 percentage point interest rate increase as it seeks to tamp down runaway inflation without creating a recession.

…. The moves in June and July represent the most stringent consecutive action since the Fed began using the overnight funds rate as the principal tool of monetary policy in the early 1990s.

…. The fed funds rate…feeds into a multitude of consumer products such as adjustable mortgages, auto loans and credit cards. The increase takes the funds rate to its highest level since December 2018.”

The Fed followed with another 0.75% increase.

Compare the following graph to the Volcker years.

When Volcker did the job, interest rates were 5%+ above the inflation rate. Does Powell believe he can bring inflation under control with rates 5% below the rate of inflation? Sure, and a fart will tame a hurricane!
 

The citizens and politicos are getting restless – Powell is talking tough; he is doing something – but has a long way to go.

Rates should be at least 10%. Should the Fed get serious and raise rates above the current inflation rate – and hold them high until inflation is at the 2% target, expect some turbulent times.

Pundit and TalkMarkets contributor Bill Bonner gets to the point in "America on the Verge?":

“The Fed is also stepping up its QT program…. It will be extinguishing nearly $100 billion per month…. Instead of buying bonds…the Fed will be selling them (or letting existing bond holdings expire).

And here is where the battle against inflation becomes a fight for survival. It’s where the pain really begins…and where the Fed begins to fear for its own safety.

…. If the Fed isn’t buying US bonds, who will? If fewer buyers appear at the Treasury bond auctions, bond prices will fall…and bond yields will rise…mortgage rates will go up too. And soon, there will be mobs forming…of homeowners, stockholders, politicians, the media – with ropes in their hands and Jay Powell in their sights.

Without the Fed there to buy up bonds (providing more ‘liquidity’) borrowers will have to depend on real savers. …. The US government is still running deficits and expects to borrow more than $1 trillion in FY 2022.

…. If all the available savings are gobbled up by the federal government -private corporations, local governments, and mortgage lenders will be starved for credit.

What we are going to see is something we haven’t seen for many years – a bidding war, not for houses…not for meme stocks…not for gas…but for scarce credit. …. Mortgage rates will go up. Housing prices will go down…and the whole economy will tip into a deeper recession.

Then we will see what stuff Jay Powell is really made of.”

What about current debt?

Statista reports:

“Between 2000 and 2021, the total outstanding (public and private) debt in the United States…[grew] from 28.7 trillion U.S. dollars to 88.2 trillion U.S. dollars.”

It’s now $90 trillion+. Each 1% increase in interest would add $900 billion to the cost of renting money. US Gross Domestic Product is around $25 trillion. Each 1% increase equals about 3.6% of the entire economy. If rates were 10% on all outstanding debt, 36% of the economy would go to service the debt. Ain’t gonna happen…. Powell needs to act quickly before all the debt matures.

Reuters reports:

“U.S. household wealth fell by a record $6.1 trillion in the second quarter to its lowest in a year as a bear market in stocks far outweighed further gains in real estate values….

…. Through June, Americans’ collective wealth had fallen by more than $6.2 trillion from a record $150 trillion at the end of 2021.”

We’ve only just begun….

Bonner summarizes in his TalkMarkets article, "Bonds, Lame Bonds:"

“As interest rates rise, fewer people borrow, and more existing credits are cancelled or go bad. Our monetary system is based on credit; a decline in the amount of credit outstanding is the same as a contraction in the money supply….

….so, a decline in the bond market tells us that the tide of credit, on which the whole economy – real and fake – floats, is going out.

Already, the Dow boats are down 15%. The 10-year Treasury bond yield has more than quadrupled from its 2020 low. And mortgage rates have doubled.

But these are, so far, just mild corrections. If this is the Primary Trend we think it is, it may take us all the way down to where the last one began – in 1980. If so….

The Dow will keep dropping…down below 20,000.

Bonds will be crushed. Low coupon bonds will be regarded as ‘certificates of guaranteed confiscation’ as they were in the ’70s.

Mortgage rates will shoot up to more than 18%.

And the US – economically and politically – will turn into a quivering jelly of confusion and despair.

A Bonner dictum: the force of a correction is equal and opposite to the claptrap that preceded it. By that alone, the developing Primary Trend should be one for the record books.”

More By This Author: