Fed to End Inflation Fight Before Job is Done

Go way back, and further still.

To Florence, Italy,  in 1397. To the establishment of the Medici Bank by Giovanni di Bicci de’ Medici.

There you will find the early framework for interlinking banking, business, and politics to consolidate wealth and power.

The Medici family, during a stretch of the 15th century, was estimated to be the wealthiest family in Europe.  The family owned vast amounts of land, gold, and art.  And it used its wealth to acquire political power, first in Florence, and then extending out into Italy and Europe.

Strategic marriages also elevated the Medici family’s influence.  Catherine de Medici, for example, became the queen of France through her marriage to Henry II.

Not long after Medici Bank, the first real precursor to a modern-day central bank was formed.  In 1407, the Banco di San Giorgio was founded.  This bank served as the financial institution of the Republic of Genoa.  Its initial purpose was to bailout the government.

After years of war with Venice and a costly defeat at the battle of Chioggia in 1381, the republic of Genoa was bankrupt.  After floundering for years, in 1407, Genoa’s Council of Ancients authorized the Casa di San Giorgio to create a bank that would facilitate the repayment of Genoa’s debts.

This was the beginning of the Banco di San Giorgio which became the forerunner to modern merchant and investment banking and survived for nearly 400 years (1407-1805).  It also served as the prototype to the Bank of England, the central bank to the United Kingdom, which has been in operation since 1694.

Private Interests

The Federal Reserve, the central bank to the U.S. government, has been in operation for just over 110 years.  During this time, it has engineered numerous booms and busts, while overseeing the long-term debasement of the U.S. dollar.

The Fed attempts to moderate the business cycle by monkeying around with the supply of money and credit.  When called upon by the U.S. Treasury, it also finances government debt with credit created out of thin air.

But what is especially important to understand about the Fed is that, through its twelve regional Federal Reserve Banks, it serves the interests of privately-owned commercial banks.  All efforts to enhance the economy are secondary.

Understanding who butters whose bread is crucial to making sense of Fed words and Fed actions.  In particular, the Fed’s words and actions don’t always line up.

This was a busy week for Fed Chair Jerome Powell.  On Tuesday, he appeared before the Senate.  Then, on Wednesday, before the House.  Powell’s testimony attempted to walk a fine line between containing inflation and supplying bank liquidity.

“We know that reducing policy restraint too soon or too much could stall or even reverse the progress we have seen on inflation.  At the same time, in light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face.  Reducing policy restraint too late or too little could unduly weaken economic activity and employment.”

To be clear, economic activity and unemployment are not the Fed’s real concerns.  Here’s what we mean…

Public Debt

Powell and the Fed have painted themselves into a corner.  The real decision at hand is whether the Fed should let inflation run and bailout the U.S. government or whether it should contain inflation and bankrupt Washington.

The reality is Washington has borrowed too much money.  Its debts are too large.  This isn’t a problem that can be pushed out into the future.  The chickens are coming home to roost this year.

We’ve mentioned it before, and we’ll mention it again.  The U.S. government is on track to run a budget deficit of $1.9 trillion in fiscal year 2024.  This deficit is racked and stacked on top of the national debt, which is currently at about $34.9 trillion.

Theoretically, this debt must be repaid.  At a minimum, the debt interest must be serviced.  And right now, at this very moment, debt interest is consuming a larger and larger portion of the federal budget.

Through June, spending for net interest on the debt has amounted to $682 billion.  That’s more than any other category apart from social security ($1.1 trillion).  For perspective, over this period, health spending was $670 billion, defense spending was $644 billion, and medicare was $629 billion.

More than half of the $1.27 trillion deficit spending that has occurred thus far in FY2024 went to paying the $682 billion interest on the debt.  In addition, as these massive deficits continue to rack and stack on top of the debt, more and more borrowing is needed to service the debt.

As this continues, less and less money is available to fund other budget categories.

Fed to End Inflation Fight Before Job is Done

In short, relatively higher interest rates are strangling U.S. government finances.  Paying the net interest on the debt is choking out the budget.

Hence, Washington must borrow more and more money to cover its obligations – both past and present.  This only makes the debt and debt financing problem worse, as it is impossible to borrow your way out of a debt crisis.

At this point the only relief mechanism available is for the Fed to lower interest rates.  By lowering interest rates, the Fed can reduce the net interest on the debt amount paid by the Treasury.  However, by doing so the Fed is ending its efforts to contain consumer price inflation before its job is done.

This week’s CPI report showed consumer prices declined 0.1 percent in June.  Though over the last 12 months consumer prices have increased at a 3.0 percent rate.  This 3.0 percent annual CPI increase reported in June is 50 percent higher than the Fed’s arbitrary 2 percent inflation target.

At a 3.0 percent annual inflation rate, the purchasing power of the dollar halves every 23 years.  This presents an enormous uphill battle for anyone attempting to save and invest for their golden years.

Wall Street bloviators took the latest CPI reading as an indication the Fed will cut rates later this year.  This is the signal they have long been waiting for.  They’ve pumped the stock market up for months in anticipation.

Yet, on the CPI report the S&P 500 and NASDAQ sold off.  Certainly, other factors were involved.  Correlation does not imply causation.  But perhaps there’s a recognition that the economy is on the fritz and stocks are grossly overvalued.

Fed rate cuts in the face of a CPI reading that’s above its inflation target won’t immediately boost economic growth.  But they may buy a little relief on the Treasury’s net interest on the debt budget item.  So, too, they may serve to incite another inflation flareup.  Gold, if you hadn’t noticed, is back over $2,400 per ounce.

In short, the Fed’s inflation fight is not over.  The job’s not done.  Still, the Fed will soon declare “mission accomplished” anyway, as it moves to cut rates.  Washington’s finances depend on it.  The big banks’ finances depend on it too.

This article originally appeared in the Economic Prism.