Today, let’s start with a prediction rooted in a conspiracy theory I’ve devised.
The prediction: The Federal Reserve will raise rates several more times this year… on the way to cutting rates sharply.
The conspiracy theory: The Fed is specifically trying to impale the U.S. consumer and the U.S. economy in order to save Uncle Sam. And the only way the Fed can accomplish this is by raising rates to such painful levels that it creates a self-inflicted financial crisis, which then allows the Fed to step in with a string of emergency rate cuts that brings interest rates down closer to 1%.
Granted, I might be the only one voicing this conspiracy theory, but it does make a lot of sense when you work through the math…
I’ve pointed out many a time that America’s debt sits at the edge of an abyss. The size—more than $32 trillion—is simply too large to ever repay. Instead, Uncle Sam’s political and bureaucratic minions are stuck in what is ultimately a losing game of Kick The Can Down The Road.
The dangers with that strategy were minimized over the last decade or so thanks to extremely low interest rates. When money is essentially free—when the Fed prices interest rates at or near 0%—who cares about the cost of borrowing?
But when borrowing costs surge, the pain sets in.
We saw this on a consumer level in 2007.
Running the World’s Largest Adjustable-Rate Mortgage
Homebuying speculators relied on low interest rates to become flippers and landlords, or to buy vacation properties. Very often they used adjustable-rate mortgages with crazy-low teaser rates of 0% to maybe 2%.
Then, when interest rates popped higher, those adjustable-rate mortgages reset. Suddenly, the cost of servicing the mortgage soared beyond the owner’s ability to pay. A tsunami of bankruptcies ensued…
That’s where Uncle Sam is today.
Interest rates over the last 15 months or so have surged to more than 5% from nearly 0%. That’s a huge problem for America, which operates what is effectively history’s largest adjustable-rate mortgage.
The U.S. never pays off its debt, it just constantly rolls maturing debt into new debt.
No doubt, you can see the challenge: As America’s older debt matures—debt that still carries extremely low interest rates—the interest expense balloons. We saw early indications last year of just how problematic that can be.
For fiscal year 2022, Uncle Sam spent $476 billion on interest repayment, the largest amount ever and up 35% from 2021.
The Fed saw that too, obviously, which brings me back to my conspiracy theory…
How The Federal Reserve Interest Rate Game Will Play Out
Fed officials cannot allow interest rates to remain too high too much longer. The risk of a true fiscal crisis and a dollar collapse is too great.
But the Fed can’t just reverse its interest-rate hikes… not after making such a fuss about continuing the crusade against inflation until it’s dead and buried. That would call into question the Fed’s resolve, and the markets would forever second-guess future Fed assertions.
No… the best course of action, from a Fed perspective, is to cut rates because it’s necessary to save the economy. And the only reason that would be necessary is if the economy is deep into an obvious crisis.
But where to find a crisis?
Why, you invent one, of course!
A deep one.
One that sees employment fall apart… that sees the economy shrink… that sees problems in the banking sector worsen… that sees the housing market under increasing duress.
Only then can you, a Fed official, step in and say, “Have no fear, dear Americans. We’re here to save the day! And (sotto voce) pay no attention to the fact that we created the crisis we’re saving you from… shhhh!!!!”
Thus, I now expect we’re going to see the Fed raise interest rates until a crisis emerges. That will likely be another bank failure of some kind, or multiple failures, that causes a panic sell-off on Wall Street.
We will also see Corporate America and Small-Business America increasingly go bankrupt. Already, small-business Chapter 11 bankruptcies are up 68% in the first six months of 2023, and it will get worse.
As the crisis emerges, the Fed will slash interest rates by half, maybe even one full percentage point immediately (leading to a huge rally in stocks). And then it will slowly grind interest rates lower over many months until we are back in the 1% range.
And all so the Fed can keep Uncle Sam’s house of monetary cards from collapsing into a heaping mess.
That’s my theory, anyway. (Good reason to keep on loading up on gold and Swiss francs.)
But maybe I’m wrong. Maybe the Fed doesn’t cut rates.
Then again, if that’s the case, then we’ve got a whole different kettle of rotting fish to deal with.