For all the talk about combating inflation, the Federal Reserve is likely to reverse course and continue to print substantial amounts of money because doing otherwise would threaten the federal government with insolvency, according to macroeconomic analyst Luke Gromen.
Fed chairman Jerome Powell has been talking about the central bank’s aggressively raising interest rates in order to tighten the money supply, curb demand, and thus relieve inflationary pressure in the economy. Inflation hit a four-decade high of 8.6 percent in May. The Fed raised rates two weeks ago by 0.75 percent, the most in over 20 years.
It will only take a few more months, however, for the Fed to reverse course, Gromen predicted.
The problem is that higher interest rates mean that government will have to pay more interest on its debt, which now stands at over $30 trillion. Moreover, higher rates mean less credit and less economic activity. What is already becoming apparent is that higher mortgage rates mean fewer home sales and less construction. That means the government will start collecting substantially less in taxes, according to Gromen. Meanwhile, a contracting economy translates to higher welfare expenses as more people go to the government for relief.
“The U.S government is not going to be able to cover its interest and interest-like expenses, which I call the true interest expenses—entitlement, pay-gos, Treasury spending—they’re not going to be able to cover that with tax receipts, which means they will have to default or the Fed prints the difference,” Gromen said.
He believes the Fed won’t allow a government default.
“At the end of the day, if push comes to shove, they’re going to print the money,” he said.
He expects the “decision point” to come by the end of September “at the latest.”
Printing more money, however, will make inflation worse and the problem can quickly snowball, especially if the government decides to appease the public with more giveaways, such as some form of "Universal Basic Income."
“You’re basically put in a position where the Fed’s balance sheet is got to go, you know, $9 trillion, $10 trillion, $20 trillion, $40 trillion very fast and inflation goes 8 [percent], 10, 20, 50, 80—you know, very fast,” he said.
The losers of this scenario are people with savings in cash and government bonds as the dollar loses value and the interest on bonds continues to fall well below inflation.
“There’s really only one way out of this. You have to have significantly negative real interest rates for a sustained period of time,” Gromen said.
He blamed the predicament on past bailouts.
“If you don’t allow the defaults to happen, as we’ve repeatedly done, then the debt gets so big that it’s no longer a choice [of whether] the bondholders win or the bondholders lose. Now it’s the bondholders lose by inflation or the bondholders lose by default,” he said.
He expects the bit of tightening the Fed is executing now will only partially curb inflation. Prices in some parts of the market, such as housing and retail, may come down, but not so much in energy, he said, where the United States and Europe are putting constraints on oil and gas production even as the price of extracting the commodities will get higher because the cheap-to-acquire deposits are gradually running out.
Simply adding more debt won’t help, he noted.
“You can’t print over energy.”