Why The Federal Reserve Is In A Catch-22

In October 2017, the Dow Jones Industrial Average eclipsed 23,000 for the first time in its history. In fact, 2017 saw the first 19,000 stock market ever, the first 20,000, the first 21,000, and the first 22,000. It looks like a great time to be an equity investor, but dig a little deeper and you’ll uncover shaky fundamentals and troubling, speculative trends.

This brings us to the U.S. Federal Reserve, whose experimental and inflationary policies of the 21st century have played no small part in creating an unstable stock market. Fed officials realize this, and current Chairwoman Janet Yellen appears to want to slowly deflate the enormous bubble in stocks by creeping up interest rates 25 basis points at a time.

Insane Valuations in Stock Market

If the stock market functioned appropriately, the prices at which ownership shares trade should correspond to the economic value of the underlying business. Businesses that make more profit or set themselves up well to make more profit down the road should expect to see a bump in their valuations.

During the current bull market run, however, valuations appear to keep rising irrespective of the underlying fundamentals. This can be emblematic of two issues: 1) an inflationary market, where new currency enters a system looking for a home; or 2) speculative behavior from investors looking to ride a wave of returns instead of building returns on the backs of well-run businesses.

Both issues appear to be at play.

Consider the following charts, borrowed from a concerned Bloomberg report about the lack of rationality behind stock market prices. Therein, you can observe that the stock market of late 2017 is more than twice as valuable as the extreme bubble years leading up to the 2007-08 crash.

It shouldn’t take long to expose the silliness of growth exhibited in equity markets. Are the corporations at the top of the stock market really twice as productive and valuable as they were in 2007? Does a decade of terrible economic growth justify record stock market prices?

The answer is “of course not.” The Federal Reserve pumped trillions of dollars worth of funny money into the economy. Most of that came through the banking system, which means that wealthy elites got to dump un-backed money into their investment portfolios at record paces.

So now there is a stock market bubble to go along with student debt bubbles, auto loan bubbles, and even troubling signs in mortgage markets. If the Fed doesn’t fix this soon by raising rates, the country could experience runaway inflation or a dramatic recession, or both.

Investors must also detangle the bizarre growth seen in unproven, unregulated cryptocurrencies and emerging markets. Both markets are extremely volatile.

The National Debt Problem

The Fed has had a hand in creating another calamity — the national debt. Super-low interest rates and direct purchase programs allowed the federal government to borrow an incredible amount of money.

At $20.4 trillion and counting, the United States government is on the hook for trillions of dollars in interest payments alone over the coming decade. Most of that debt owed is on relatively short-term instruments, which means the government could potentially have to borrow at much higher costs if interest rates increase too much.

(You can read one analyst’s breakdown here.)

If interest rates rose to a very modest 2.25%, which the Fed predicts will happen, then the United States government will see its interest obligations rise nearly 50% within five years. If interest rates rose anywhere close to historic standards, the majority of annual revenue collection could be absorbed by interest payments alone.

A Catch-22

The Federal Reserve may need to raise rates quickly to avoid the potential for terrible long-term inflation. The Fed also needs to raise rates quite slowly to avoid popping the bubbles it help blow up in debt and equity markets. The Fed should avoid raising rates if it doesn’t want to overwhelm the federal government’s balance sheet.

This is not an easy conundrum to resolve. Given that the Federal Reserve has a very poor track record when it comes to economic stability, there is very little reason to believe the economy will successfully walk this tightrope.

How to Protect Your Wealth

As most frequent readers of this blog are aware, the Federal Reserve carries immense economic influence. It has the ability to dictate open market operations, set the discount rate, change bank reserve requirements, and use supra-market asset purchases to reshape the role of borrowing and lending in the economy.

Continuation of low-interest rate policies could send stocks higher and the dollar south. Poor timing on increasing rates could send the country (and globe) into recession. This catch-22 only strengthens the case for diversifying through precious metals.

You can own real, physical silver bullion and store it in a tax-advantaged retirement vehicle. American Bullion can discuss your options and help you every step of the way. Our #1 goal is to help you take control of your own finances – and we promise to be transparent, safe, and efficient in the process.

Although the information in this commentary has been obtained from sources believed to be reliable, American Bullion does not guarantee its accuracy and such information may be incomplete or condensed. The opinions expressed are subject to change without notice. American Bullion will not be liable for any errors or omissions in this information nor for the availability of this information. All content provided on this blog is for informational purposes only and should not be used to make buy or sell decisions for any type of precious metals.