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Fed Chair Jerome Powell Is Playing with Fire

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Jerome Powell is like a kid playing with matches and he’s dangerously close to starting a fire he isn’t going to be able to control.

The Federal Reserve nudged interest rates up again last week. It was the seventh hike since the Fed launched the current tightening cycle in December 2015. The Fed Funds Rate (FFR) currently sits at around 2%. Although this remains historically low, it may already be near the cycle peak. That means we may be close to a major economic downturn, as indicated by analysis by GoldMoney’s Alasdair MacLeod recently published at the Mises Wire

Simply put, suppressing interest rates, as the Fed did for almost a decade in the wake of the financial crisis, creates unsustainable excesses in the economy and generates unsustainable debt. Eventually, the bubble bursts and the economy crashes.

The chart below shows we could be living dangerously close to another tipping point, whereby the rises in the FFR might be about to trigger a new credit and economic crisis.

Previous peaks in the FFR coincided with the onset of economic downturns. They exposed unsustainable business models. On the basis of simple extrapolation, the area between the two dotted lines, which roughly join these peaks, is where the current FFR cycle can be expected to peak.  The chart indicates the Fed is already living dangerously with its most recent hike. Further rate increases will all but guarantee a credit crisis.

Notice the cycle. Each peak has gotten successively lower. This a function of the rising level of debt indicated by the red line. Theoretically, economic crashes should clean up the system by eliminating malinvestments and resetting the economy. But the central bank has not allowed that to happen. After every downturn, the Fed has intervened and reinflated the bubble. McLeod points out that except for a temporary slowdown during the last credit crisis, debt has been increasing over every cycle.

Instead of sequential credit crises eliminating malinvestments, it is clear the Fed has prevented debt liquidation for at least the last forty years. The accumulation of debt since the 1980s is behind the reason for the decline in interest rate peaks over time.”

Despite the fact that Powell and most of the mainstream insist everything in the economy is great, it’s clear from this simple graph that we are dangerously close to the next major crash. If you think back to 2006 and 2007, the mainstream swore everything was great then too. And then it wasn’t.

In a podcast last week, Peter Schiff said he sees a recession on the horizon and when that happens, the Fed is going to do what it’s always done – reverse course and try to reinflate the bubble once again.

Powell was saying if we see evidence that the rate hikes are hurting the economy, well we can always do something about it. Yeah. By the time they acknowledge that the rate hikes have hurt the economy, or are hurting the economy, it all will be in a recession. And then, of course, it’s going to be too late to do anything about it – is if they could have done anything about it anyway. What are they going to do? They are going to reverse course. They are going to start cutting rates from wherever they got them – however high they made it, they’re going to start slashing them pretty quick. But they’re not going to have a lot of room to go between where they get to and zero, and so they’re going to have to launch QE4. That is what’s coming.”

While this is all pretty clear for those who have eyes to see, the mainstream remains oblivious. MacLeod described the attitude of the mainstream financial experts and the central bankers as “hubris.” He said it will end with devastating results.

All central banks are proceeding on the assumption there is no credit crisis on the horizon. This hubris was vividly demonstrated by Janet Yellen who a year ago told us she did not believe there would be another financial crisis in her lifetime, thanks largely to reforms of the banking system since the 2007-09 crash. That crash was a surprise to central bankers then, as was every crash before. Even Benjamin Strong in the late-1920s believed his new Federal Reserve System had tamed the business cycles of the previous century, though he died before being disproved by the 1929 Crash.

Strong’s hubris then was the same Yellen’s hubris last year. Central banks have learned nothing about the credit cycle in nearly a century. If they had, they would be promoting sound money and a hands-off policy, while ensuring commercial banks restrict their credit expansion. They would let malinvestments wash out of the system, not build up for one huge crisis. They are not even aware, it seems, that they are living dangerously as they raise interest rates into and beyond the zone that will trigger the next credit crisis.

A credit crisis today will be more catastrophic than that of ten years ago. And when the crisis comes, the response is always the same, except the quantities involved are far greater. The banks will be rescued by the Fed printing new capital for them without limitation, on condition they don’t foreclose on their customers. The Fed will take bad and doubtful debts off the banks at the same time. Government borrowing will rocket, reflecting increasing social liabilities and falling tax revenues. All the money required will be created out of thin air.

The great financial crisis of 2007/08 will be eclipsed. In a nutshell, this time the quantity of new money required will likely lead to the destruction of the “full faith and credit” in the currencies themselves, which until now has been broadly unquestioned by ordinary members of the public.

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