“Sometimes you’re the windshield,” Dire Straits once sang. “Sometimes you’re the bug.”
I have a suspicion that we’re moving into a transitional phase that sees the Federal Reserve morph from windshield into bug. At the root of this transition…a dollar that, like a lovebug slamming into a windshield, suddenly finds it has no lift left.
The dollar that spent early and mid-2022 in a near-straight line ascent has since September been in a continual grind lower. The buck is now down about 11%.
And therein lies the root of the windshield-bug paradox the Fed finds itself confronting as it heads into its first interest-rate meeting of the year next week.
The dollar’s decline is itself inflationary fuel.
Currencies move in pairs, and in opposition to one another. If the dollar goes up, it goes up relative to some other currency like, say, the euro. By definition then, the euro is sinking relative to the dollar. It’s a giant, global currency see-saw.
In terms your wallet feels…if the price of an imported, European car is €30,000 when the dollar and euro were trading at parity back in the fall, then the dollar price in the States is $30,000. Today, however, the price for that exact same car is $32,700 simply because you now have to spend $1.09 to buy €1.
Even though the manufacturer is selling the car for the same price, Americans have to pay more simply because the dollar has weakened.
Apply that across the vast universe of goods that America imports—shoes, clothes, electronics, food, toys, commodities, etc.—and you begin to get a sense of the Fed’s dilemma: Even as it aims to curtail inflation, the act of curtailment leads to inflation.
The dollar rose in 2022 because the extreme interest rate hikes made owning dollars more profitable for international traders. So, they dumped euro and yen and whatnot, and dove into the buck. That demand pushed the dollar to highs it hadn’t seen in 20 years.
Now, the global markets are widely expecting the Fed will have to slow its roll because the U.S. economy cannot absorb rates that are much higher without causing widespread destruction.
America’s big banks—JPMorgan, Bank of America, Wells Fargo, et al.—are talking about a recession on the horizon, and they have been adding hundreds of millions of dollars to their reserves to cover what they expect will be increasing consumer losses tied to credit-card, loan, and mortgage defaults (JPMorgan added $1 billion in the fourth quarter).
Uncle Sam is feeling the pinch, too.
In fiscal year 2022, which ended last September, the U.S. spent $724 billion on interest payments, much more than expected. Back in May, the nonpartisan Congressional Budget Office projected full-year interest expenses for 2022 would clock in at just over $639 billion.
The prior year’s interest payments on Treasury debt totaled $575 billion.
With rates even higher today than they were in May or September, the math seems quite the hurdle for dear ol’ Uncle Sam. These Fed-induced higher interest rates are ravaging his pocketbook…and it’s not like he has some whizbang economy that’s explosively growing in order to generate enough tax revenue to help offset all of this.
Which once again brings us back ‘round to the windshield and the bug…
The Fed can keep on playing the role of windshield, but it does so at great peril to the economy. Keep rates high, and consumers will crumble…which will hit banks and consumer product companies, which hits Wall Street’s earnings and share prices, which creates a negative-feedback loop that reverberates with consumers who retrench even more.
Stop raising rates, or even cut rates at some point to revive the economy, and the dollar weakens, driving inflation higher…hitting the consumer, and causing the Fed to panic about inflation.
Where does that leave us?
Well, right where I said we would end up months ago: Semi-permanent higher inflation that will likely bounce around in the 4% to 7% range longer term, well ahead of the 2% pace the Fed prefers.
Basically, we’re heading for the stagflationary economy I’ve been writing about for the last couple of years. I was early to this party, but the graffiti was on the wall long ago.
The ultimate takeaway is this: Gird your portfolio for what’s to come. Own gold and silver. Own commodities. Own bitcoin. They’re long-term survivors as this new era of semi-permanent inflation settles atop the land.
Your might call them…bug repellant.
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