At the start of 2023, there were high hopes among investors. Many believed that the stock and bond markets had turned a corner, and the events of 2022 would not be repeated.
The dominant expectation was that inflation would ease, leading to a decline in interest rates. This would pave the way for a new stock market boom, revitalizing the modest retirement savings of aging baby boomers.
However, the reality has proven starkly different. Inflation remains stubbornly high, interest rates are on the rise, and both stock and real estate prices are steadily declining.
In a recent report, Fed Chair Jerome Powell indicated during his semi-annual testimony to Congress that interest rates would go “higher than previously anticipated.” He also mentioned that he’s “prepared to increase the pace of rate hikes.”
This shift means the expected pivot from Powell is not on the horizon. Investors may choose to challenge the Fed by buying stocks, but they may not like where that leads them.
Additionally, the ramifications of Fed rate hikes extend beyond the federal funds rate. These increases also affect Treasury rates.
Since March 2022, the Fed has raised the federal funds rate from a target range of 0 to 0.25 percent to between 4.50 and 4.75 percent. During this period, the yield on the 2-year Treasury has surged from 1.75 percent to over 5 percent.
What does this mean for the economy?
Radical Action
As interest rates rise, borrowing costs increase, leading to a larger portion of income being allocated to debt servicing.
This development has significant implications. More income directed toward debt repayment means less is available for savings, investments, or consumer spending.
With reduced funds accessible for spending or investing in capital markets, economic growth stagnates. This cycle exacerbates the issues at hand.
With diminished capital and consumer spending, overall economic activity declines. And when economic activity wanes, cash flow to service existing debt also dwindles.
To bridge this gap, consumers often resort to accumulating more debt to maintain their current lifestyle. This approach is a temporary fix for a long-term problem.
Debt does not simply vanish; it accumulates until drastic measures must be taken. Creditors face unpaid debts, or debtors may drastically cut their spending in an effort to repay what they owe.
This is straightforward. By facing reality and making the necessary changes, individuals can transform the struggle of repaying debt into a platform for building wealth.
A debtor who successfully reduces their expenditures will eventually find the opportunity to create genuine wealth. Once debt is eliminated, excess funds can be saved and invested.
Americans on the Hook
Living below one’s means is crucial for building substantial wealth. Even the best investment opportunities can be wasted if there’s no capital to utilize.
Unfortunately, many lack the discipline to spend less than they earn and to save and invest the surplus. This is why so many may end up facing a bleak retirement—potentially eating unappealing canned lima beans reminiscent of their childhood school cafeteria.
Over the years, American debtors—both individuals and the government—have sunk into overwhelming debt. Low interest rates have shrouded these debts for decades, but the era of refinancing at declining rates has ended.
With interest rates now increasing, one must wonder: what if they rise far beyond Powell’s forecasts?
Critical factors exist beyond Powell’s control. For instance, while Japan may hold the largest amount of U.S. Treasuries, their appetite for these bonds may be faltering. The Wall Street Journal recently reported:
“Last year, the Federal Reserve’s interest-rate increases weakened the yen and raised the cost of hedging against currency fluctuations for Japanese investors buying U.S. assets. This led many to dispose of U.S. bonds, diverging from their previous trend of purchasing. Now, concerns are growing that this selling may continue, especially as Treasury yields approach highs not seen in over a decade.”
“Without that support, Americans could face increased borrowing costs on everything from mortgages to business loans.”
Are you an American? Are you ready to handle the prospect of soaring borrowing costs?
What Comes After the Great Liquidation
Continued Fed rate hikes, aimed at curbing inflation, are pushing Treasury rates and borrowing costs ever higher. This trajectory will persist until a breaking point is reached.
But what exactly will break first? Will it be inflation, which is the soft-landing scenario Powell hopes for?
Or is it the economy and major banks that will falter first? Such an outcome would likely trigger mass layoffs, business failures, and a wave of bankruptcies that could affect large investment banks or significant funds.
Unfortunately, the soft-landing scenario seems increasingly unlikely. The reckless behavior leading up to the coronavirus pandemic and its subsequent escalation must be addressed.
There are no easy exits from this situation. Mass liquidation is on the horizon. When the situation normalizes, consumer prices are expected to remain elevated compared to 2020 levels.
A return to 2020 prices is unrealistic due to the substantial changes in the economy. Similar to how penny candy has disappeared, the inflationary effects of financial policies have forever altered price dynamics.
The centralized decision-makers, eager to deliver easy solutions, have inadvertently created a monumental crisis. Their actions will persist, and they will continue to claim they are acting with courage. What will happen next?
Most likely, through further monetary expansion and currency debasement, central planners will remain on an inflationary course—either at a slow, gradual rate or potentially triggering runaway inflation that could surge prices dramatically in a very short time.
Only time will tell. In the meantime, focus on reducing debts, saving cash, and considering investing in gold and silver. With some luck, you may emerge from this period with a healthier financial outlook and a stronger skepticism toward those in charge.
[Editor’s note: There are also potential crises to consider. Is China secretly preparing for conflict with Taiwan? Are your financial strategies equipped to handle such uncertainties? Insights into these critical questions can be found in a unique Special Report titled “War in the Strait of Taiwan? How to Exploit the Trend of Escalating Conflict.” You can access a copy for a nominal fee.]
Sincerely,
MN Gordon
for Economic Prism
Return from What Comes After the Great Liquidation to Economic Prism
