New Financial Climate
Are we in a new financial climate where restrictive monetary policy today would have been deemed normal, maybe bordering on expansionary, fifty years ago?
The 1970s are remembered for muscle cars, trouser flare jeans and high inflation. Surprisingly, the average inflation rate of the 70s was around 6.8%, lower than most people thought.
So, the high inflation of the 1970s was not that much higher than the core inflation at 6.6% in September 2022.
In reality, inflation in 2023 is probably higher than in the 1970s, bearing in mind the data today is so cooked. The inflation rate is calculated using the Fed’s preferred measurement, Core CPI inflation, which strips out food, energy and shelter.
Restrictive Policy in a New Financial Climate of Single digit interest rates
A trip down memory lane shows the core inflation of this decade is similar to the 70s, half a century ago, with a significant difference.
During the last era of similarly high inflation, the Fed fund rate was 13.6% in 1974, and seven years later, interest rates hit 18. 39%, 1981, according to the Fed fund Rates Historic Chart.
Despite the relatively high Fed fund rates of the late 70s and early 80s, my preliminary investigation revealed no US bank failures.
The Fed’s Restrictive or tight Monetary Policy, of the 70s and early 80s to tackle inflation triggered a nasty recession, high unemployment and bankruptcies, particularly property developers.
In 2023, a Fed fund rate of 5.5%, today considered restrictive, burst the multi-trillion dollar US treasury market, prime collateral pledged by commercial banks to underwrite loans.
The fallout was a brutal bear market in medium-long maturity treasuries in US history, which threatened to blow off the collateral chains of the entire Western-aligned banking system. Five high-profile banks failed in 2023, and the Fed only raised the Fed funds rates to 5.5%
The Fed was forced to open all kinds of emergency lines for banks, from the Fed’s Discount Window Lending, the Repo Market, and the Fed’s credit swap lines to keep the banking system liquid.
When the Fed’s fund rate of 5.5% is restrictive, that is a new financial climate
A highly leveraged economy, ballooning public deficit, and sky-high business and household debts have ushered in a new financial climate of low-interest rates.
Single-digit Fed fund rate of 5.5% in the new restrictive rate of the 2020s, in the 1970s, the same rate would be considered normal, even expansionary.
“A tighter monetary policy from here is akin to central banks shooting themselves in the foot,” written in a piece entitled, Distressed Bank, February 2023. The Fed has held rates stable since July.
Takeaway of this new financial climate
Demand for dollars and treasuries walk lockstep, with US hegemony imposing global rules of the game.
Interest rates can remain low in a world of TINA, where global demand for treasuries is buoyant. Geopolitics is the wildcard, and Europe, the Ukraine War, and the Middle East War are testing US hegemony.
“Military, Monetary get together whenever they think it is necessary,” Gil Scott Heron, Work For Peace.