Rate Hike Shows Expectation of Debt Repayments

Perhaps as a bluff to strong-arm the markets into optimism, or perhaps as a sign that they do know something useful in that pile of information that they’re keeping secret from the markets, the Federal Reserve has announced that they’ll be slightly raising the rate they change banks to borrow money.  Of course, banks will still be paying less than 1% while we have student loans that average 10% and credit card rates closer to 20%, but that’s what we call a “free market” for some strange reason.

But absent real financial and political reform, it is unlikely that consumer wages will be able to maintain the demand for most economic activity.  The problem we’re encountering is actually a relatively simple one:  Labor hasn’t enjoyed the benefits of increased productivity, and they’re starting to learn that they have nothing to gain from being so productive.  Further, since wages haven’t kept pace with the cost of living, individuals have to choose between making the mortgage on an underwater house or buying things that keep the future economy running.  Without seriously writing down the expected value of the financial sector’s mortgage loans, there’s just no way that American workers can support both sides of the economy – the fictional paper pushing one, and the real manufacturing and transportation one.

Its likely that this move will be remembered as a tragic act of hubris – one last attempt to prove that the economy could recover with just a bit of academic hocus pocus and the old trickle-down theory of printing more money for the ones who already had the biggest share.  Not only will a lot of houses be hitting the market this year, but so will a lot of mortgages reset triggering the next wave of defaults in high-end residential and commercial real estate.

Severe Weather Warning

Regardless of what business you’re in (well, unless you’re a banker I guess) you should probably hold on tight and get ready for one heck of a ride.  All signs point to sharp deflationary contractions through the coming year, but that won’t stop the supply of dollars from growing at the same exact time foreign demand for them falls.

Inflation or Deflation?

Yes, the deflation vs. inflation debate is over.  We can indeed have both and here’s how it will happen:

The value of American owned assets will deflate, and this will be followed up by the Federal Reserve releasing more money into the economy in an attempt to compensate or even that first effect out.  Since the only mechanism the Federal Reserve & Treasury use to put money into the economy is to transfer it to chartered banks, they’ll continue to hold this free cash in reserve so they can stay in business at all.

Since the aggregate money supply doesn’t actually “correct” the original over-pricing of American assets, foreign investors lose their appetite for dollar-denominated assets.

So what happens in the end?

The number of dollars doesn’t change, but the home-owning middle-class has fewer of them and the investors and bankers have more of them.  All of the dollars buy fewer raw materials, or food items, or manufactured products than they used to (except in that technological and production improvements cause real prices to drop.)

So energy and food and medicine and tuition all continue to skyrocket at the exact same time that people are losing jobs or working fewer hours.

Misery loves company

Is there any kind of hope or silver lining?  Well, as bad as America has screwed up its finances, places like Greece, England, Iceland, and Spain might just be worse off than we are.  The fact that other nations also got caught up in the bubble frenzy might actually protect us from some of the worst consequences.  Or, because of how much the internet allows us to do business across borders and how we rely on foreign sales to balance out our budgets, it could just be the next feedback mechanism for a deep and prolonged economic crisis.