This is a “great” dispatch.
By which I mean we deploy the word “great” quite a bit in America: Great Lakes, Great Smoky Mountains, Great Depression, Great Recession. The Great Moderation.
Today, I’d like to introduce another “great” I’ve begun using: The Great Reflation.
For the last 40-ish years of my life—pretty much the entirety of my investment career—the American economy only knew a few facts: Interest rates pretty much always go down, asset prices pretty much always go up, and the Federal Reserve pretty much always gets the big calls wrong.
I had real hopes for the Fed earlier this year when that band of economic alchemists warned Americans that a recession was likely the end result of the rapid-fire interest rate hikes we’ve seen over the last 18 months. That was a legit expectation.
In the last few days, however, the Fed’s internal munchkins had a great rethink, and they’ve concluded that their original prediction was wrong: That a recession is not in the cards… That the U.S. will skirt an economic downdraft… That inflation will shrink to low levels once more.
As per the Fed, the Goldilocks effect and her just-right economy will reemerge. And she will lead us back into the Great Moderation we grew so accustomed to that we can’t remember anything else.
Ah, the Great Delusion…
The Upside-Down World of The Great Reflation
See, thing is, we crossed the Rubicon in the aftermath of COVID-19 when Western governments drowned the world in extreme amounts of liquidity. As such, we’ve left that quaint, Pollyanna world of yesteryear and are now living in what the Stranger Things series on Netflix would call “The Upside Down”… or what Superman would know as Bizarro World.
Here in the Great Reflation, things are, well… different.
We’re not going back to a low-interest-rate world. Too many factors are keeping inflation higher than the Fed wants. Resurgent oil prices. An ongoing war. Mother Nature’s moodiness that is causing all kinds of food-security issues that, in turn, are driving crop prices higher all over the world.
And there’s still all that free money sloshing around the world.
COVID was just the most egregious example. But prior to the pandemic, politicians had spent the entirety of the 2000s dispensing all kinds of freebies: Prescription drug coverage introduced by Baby Bush to win over seniors before an election… Cars for Clunkers under Obama… Massive sops to the uber-rich and corporations that Trump gave us under the faulty pretense that it would juice the economy (it didn’t).
And now Biden has exploded the deficit by proposing to write off student-loan debt and other gimmes.
Seems wasting American money and charging all the costs to Uncle Sam’s overloaded credit card is neither a red nor blue issue, but rather an issue tied to the word “politician.”
There is, of course, a comeuppance coming.
That will be one of the nastier side effects of the Great Reflation.
The Fed has all kinds of tricks it likes to use to ward off such nastiness. None of them are tried and tested. They’re all pulled from a chapter in the Econ 101 textbook called “Wing & Prayer Gimmicks.” They might work for a time, if only because the markets want them to work for financially selfish reasons. The power of positive thinking and all that…
But certain truths populate our existence.
The sun sets in the West. Rain is wet. The Earth is round…
People can deny the truth for a while. At some point, however, truth always wins the day because, well, it’s the truth. Nobody puts truth in the corner (Dirty Dancing reference, for those who get it).
This Time, The Pain Will Be Greater
The truth I am most worried about—for now—is the fact that the U.S. must manage $32-plus trillion in debt. Higher interest rates are already imposing quite the penalty in the form of debt-repayment costs. For fiscal year 2023 (ending September 30), interest payments will likely exceed $900 billion—more than 2x last year’s tally.
That’s more than 15% of the federal budget—a significant percentage. One might call it The Great Pain in the Wallet.
This cannot go on… but maybe it does. The Fed seems hellbent on raising rates, regardless of its impact on the debt. (Again, a wrong move by the Fed).
But if the rate hikes do end, we will have $32-plus trillion in debt and high interest rates. We still have that Great Pain in the Wallet.
What I’m trying to emphasize here is that the Great Reflation is upon us. And it has legs.
The Fed will do all it can to fight inflation until it realizes that A) the fight is a losing cause and B) Uncle Sam cannot handle the extreme interest costs the Fed’s fight is imposing.
And just like that, the Federal Reserve, Congress, Wall Street, and Main Street writ large will realize that an economic super shock has arrived. In substance, it will be no different really than the super shock that slammed America in the late 1970s.
Only this time, the pain will be Greater.
Why?
Because America’s balance sheet is fundamentally weaker.
U.S. debt jumped the shark long ago. Consumer debt is beyond the pale; cumulative credit-card balances recently topped $1 trillion for the first time ever. Corporate debt is at nose-bleed levels and will begin causing problems next year as low-rate debt matures and companies face refinancing at much higher rates.
In short, the fan is soon to get shitty.
Prepare accordingly.