Inflation and the Fed’s monetary policy

Jay Powell has signalled that inflation is moving sustainably towards the Fed’s 2% target and that the jobs market has cooled down. Hopes for an interest rate cut are rising, but the Fed is being misled badly…

The dynamics behind rate policy

Undoubtedly, market values everywhere are predicated on the Fed cutting rates. To a limited extent, this could become a self-fulfilling prophecy. So far, the effect on the 10-year US Treasury Note, which sets the valuation tone for all financial assets, has been to reduce its yield in recent months from 4.7% to under 4.2% currently. I have pencilled in a potential support line at 4.08% (the pecked line).

While there is little evidence that this line will provide a floor to the yield, taking it as a reference point it should be noted that an anticipated cut in interest rates in September is mostly discounted. But because Powell appears to believe that inflation is coming under control, we should question this assumption. If Powell is wrong, then at best it will be only one cut at most before the uptrend in bond yields continues.

Clearly, the Fed has little idea of what leads to inflation. The Open Markets Committee is only relying on questionable statistics of the past, because it appears to be clueless about the relationship between inflation and credit, and therefore the future course of the general level of prices.

Before Keynes’ invention of macroeconomics, it was widely understood that the expansion of debt for non-financial purposes was inflationary — more correctly it tended to undermine the value of existing credit measured in its purchasing power. A number of economists, such as Von Mises and banking experts such as Alfred Lansburgh, both having witnessed the European inflations in the early 1920s knew this. But following the publication of Keynes’s General Theory and particularly in this post-Bretton Woods era, the economics profession is in denial.

We can quantify inflation trends approximately by adding together additions in government and consumer debt, because these are undeniably unproductive debt. And we must incorporate changes in the volume of savings: if savings increase, immediate demand for goods declines, but if they decrease they become an additional source of inflationary pressure. The result is shown in the table below. 

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