Well, inflation is up again. You’re probably not surprised, and neither are we.
Over the past few months, in fact, we’ve repeated again and again that inflation will keep rising, and even identified some strange reasons why.
Remember back during the early days of the pandemic when used car prices went through the roof? Supply chain dysfunction and stay-at-home orders prevented the big auto manufacturers from producing too many new cars. So, demand for used cars surged… and used car prices shot to the moon.
But used car prices eventually started to fall back to earth. And throughout this year, the government inflation reports showed steep drops in used car prices– like 10 to 12% year-over-year declines.
We made two key points about this:
1) The big drop in used car prices was essentially dragging down the inflation average. Other prices, like housing, medical care, etc. were still rising by 5% or more. But after averaging in the negative 10% used car price declines, the overall inflation rate seemed to be falling.
2) We also said this would be temporary. Used cars could only fall for so long before they reached ‘normal’ levels. And once that happened, inflation would start to rise again.
This appears to have now happened.
During the summer, for example, used car prices fell 10.9% year-over-year in the month of July. Then in August, the year-over-year decline decelerated to -10.4%. Then the following month to -5.1%. Well, the October data was released just this morning, and used cars index fell 3.4%.
In other words, we’re almost at the end of the ‘used car deflation’ benefit that dragged down the government’s inflation report. So, it’s no coincidence that we also see inflation once again rising, from 2.3% in September to now 2.6% in October.
And there are plenty of categories that are WAY more that 2.6%, especially the things that people buy on a regular basis. Health insurance is up 6.8%. Car insurance is up 14%. Airfare is up 4.1%. Housing costs are up 5.2%. Daycare is up 6%.
Sure, there are obviously categories where prices have fallen. And congratulations if you were in the market for a men’s sport coat last month– you paid 5.9% less. Plus, the all-important “dishes and flatware” category plunged 7.4%.
But these hardly make up for the big price hikes in the key categories that are essential to most people.
This is what makes the Fed’s policy actions so bizarre.
Last week they cut rates, again, for the second time this cycle… which is the OPPOSITE of what a central bank would normally do in the face of rising inflation.
In the same way that they pretended inflation was “transitory” throughout 2021, they are now asserting with equal vigor that the inflation beast has been tamed.
They’re so full of self-congratulatory hubris, in fact, that Fed Chairman Jerome Powell stated that he will refuse to step down if Donald Trump demands his resignation.
Bear in mind, Powell is the guy who totally missed inflation in 2021. I mean, he was MISTER Transitory. He failed to act in a timely manner and waited until mid-2022 to start hiking rates in earnest. He then failed to predict any negative consequences from the rate hikes– including the meltdown in the US banking system.
Powell even testified before Congress– just TWO DAYS before Silicon Valley Bank went bust last year– that he saw “nothing in the data” to suggest there were any risks to the Fed’s monetary policy decisions.
I would also point out that during Powell’s chairmanship, two of the most senior Fed officials were found to have been personally profiting from their monetary policy decisions through questionably timed stock trades. It was almost as if Nancy Pelosi was running the joint.
So, Powell– who has been consistently wrong in the most remarkable ways– now insists that he will NOT step down. Apparently, HE and HE ALONE can lead the Federal Reserve. And we’ve seen that arrogance before from Joe Biden, Tony Fauci, etc. It’s not a good look and doesn’t bode well for the Fed.
All that aside, it’s pretty clear that the Fed is in a bind. Inflation is rising, so they should realistically hike rates. But interest rates– even at current levels– are killing the federal government.
The US spent an unbelievable $1.1 trillion in the last fiscal year paying interest on the national debt. That will almost certainly increase for this current fiscal year. And if rates stay where they are now, the total interest bill will exceed $2 trillion in a few years.
That’s a pretty bad situation considering that interest rates are still relatively cheap on a historical basis.
But it’s not just the federal government. Current interest rates are also bad for banks.
Remember that banks across the United States bought mountains of Treasury bonds during the pandemic– at a time when interest rates were at record lows, and those bonds yielded as little as 5 basis points (i.e. 0.05%).
Thanks to the Fed’s interest rate hikes, those banks’ bond portfolios have tanked in value. (When interest rates go up, bonds lose value.) In fact, across the entire US banking system, the total unrealized bond losses exceed $500 BILLION. That’s about 20% of the total capital in the US banking system.
Naturally banks don’t want to take that hit. And the only way to unwind those losses is for interest rates to fall, i.e. the bonds once again increase in value. So, yeah, banks desperately want rate cuts too.
But the most important one is the Fed itself.
Just like banks across the country bought US government bonds during the pandemic, the Federal Reserve bought literally TRILLIONS of dollars of bonds. And their interest rate hikes have caused unbelievable losses to the Fed’s own bond portfolio.
How big are their losses? Roughly ONE TRILLION dollars.
In other words, the Fed is wildly, woefully insolvent. And at this point, they’re just out for self-preservation. Cutting rates is the only way to reduce those unrealized losses and prop up their solvency, even if that means more inflation… or even stagflation that could be worse than the 1970s.
That is especially significant since, during his last press conference, Powell admitted that the Fed has no contingency plan for stagflation. They’re not even thinking about the risk. They’re just focused on saving themselves at your expense.
