Author Topic: Debt—and Why the Fed Is Trapped  (Read 103 times)

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Offline Ptarmigan

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Debt—and Why the Fed Is Trapped
« on: September 21, 2022, 09:14:22 PM »
Debt—and Why the Fed Is Trapped

The massive debt levels provide the single most significant risk and challenge to the Federal Reserve. It is also why the Fed is desperate to return inflation to low levels, even if it means weaker economic growth. Such was a point previously made by Jerome Powell:

“We need to act now, forthrightly, strongly as we have been doing. It is very important that inflation expectations remain anchored. What we hope to achieve is a period of growth below trend.”

That last sentence is the most important.

Long read, but worth reading.

As shown, economic growth trends are already falling short of both previous long-term growth trends. The Federal Reserve is now talking about slowing economic activity further in its inflation fight.

The reason that slowing economic growth, and debilitating inflation, is critical for the Fed due to the massive amount of leverage in the economy. If inflation remains high, interest rates will adjust, triggering a debt crisis as servicing requirements increase and defaults rise. Historically, such events led to a recession at best and a financial crisis at worst.

The problem for the Fed is trying to “avoid” a recession while trying to kill inflation.

The Federal Reserve is trying to avoid a recession.

Recessions are not a bad thing. They are a necessary part of the economic cycle and arguably a crucial one. Recessions remove the “excesses” built up during the expansion and “reset” the table for the next leg of economic growth. Without “recessions,” the build-up of excesses continues until something breaks.

In the current cycle, the Fed’s interventions and maintenance of low rates for more than a decade allowed fundamentally weak companies to stay in business by taking on cheap debt for unproductive purposes, such as stock buybacks and dividends. Consumers have used low rates to expand consumption by taking on debt. The federal government increased debts and deficits to record levels.

The assumption is that increased debt is not problematic as long as interest rates remain low. But therein lies the trap the Fed faces.

The Fed’s mentality of constant growth, with no tolerance for recession, has allowed this situation to inflate rather than allowing the natural order of the economy to perform its Darwinian function of “weeding out the weak.”

Recessions are inevitable. Debt has been increasing.

After three decades of surging debt against falling inflation and interest rates, the Fed now faces its most difficult position since the late 1970s.

The U.S. economy is more heavily levered today than at any other point in our history. Since 1980, debt levels have continued to increase to fill the income gap. Bigger houses, televisions, computers, etc., all required cheaper debt to finance it.

The chart below shows the inflation-adjusted median living standard and the difference between real disposable incomes (DPI) and the required debt to support it. Beginning in 1990, the gap between DPI and the cost of living went negative, leading to a surge in debt usage. In 2009, DPI alone could no longer support living standards without using debt. Today, it requires almost $7,000 a year in debt to maintain the current standard of living.

The real disposable incomes (DPI) has been decreasing as debt increases.
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Offline Wineslob

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Re: Debt—and Why the Fed Is Trapped
« Reply #1 on: September 22, 2022, 11:39:30 AM »
Just wait till the stock market crashes and debts are called in.......
“The national budget must be balanced. The public debt must be reduced; the arrogance of the authorities must be moderated and controlled. Payments to foreign governments must be reduced, if the nation doesn't want to go bankrupt. People must again learn to work, instead of living on public assistance.”

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