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The Age of Deflation & the Fed

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It appears that many people are married to the idea that the Fed creates INFLATION by expanding the money supply. Sorry, it does not work that way. Others confuse the fact that interest rate increases are bearish and declines are bullish. All you need to do is look at Japan to see that did not work out very well.

The pundits are betting on a Fed rate increase of 25 basis points in September. That is most likely correct, but not for the reasons many suspect. The jobs report came out showing a solid trend of really only a couple hundred thousand jobs in an economy of some 300 million people. That is not what you would call a wild-eyed bullish trend.

Inflation is not the main factor for gold or the Fed. The Fed realizes that the economy is not in crisis and maintaining lower interest rates is highly damaging to the economy for it is creating the next crisis – defaults in pensions, both government and private. The entire idea of pensions has been set around the average 8% return in interest rates, but it has been pension funds that are primarily the cause of lower interest rates – NOT THE FED.

The number of pension funds out there created a bid for long-term bonds. They kept bidding higher and higher, because of the presumption that “Gentlemen buy bonds,” as Mellon once said. A lack of skills in fund management and regulation requiring bond investment created a lethal mix. This contributed to the lowering of interest rates and was the underlying bid that helped to create the mortgage crisis for 2007, as investment banks used AIG to guarantee their junk by calling it AAA so they could sell this type of paper to pensions.


Add the change in technology to this bull market in bonds and you introduce the opposite trend of the 1970s with the STAGFLATION result, thanks to rising taxation. When we put out our forecast back in 1997 that oil would rise from $10 to $100 going into 2007, many people said we were crazy, arguing that the world could not sustain such high energy prices. We warned that unless oil rose to $100, new technology would not emerge. Oil had to rise in order to create alternatives. Now that we have warned that oil will move back to retest $35, everyone likewise said we were wrong for the world would not be sustainable at such a low level. This wave of Creative Destruction is part of the whole shift into the technology age, just as the railroads altered the 19th century, and the combustion engine altered the 20th century. Welcome to the next economic phase transition to the technology age.

We now have solar cars in experimental stages that produce more energy than they consume. Goodbye oil. We have batteries that are efficient that have unleashed electric cars. The hybrid BMW I8 operates on a combustion engine at 28 mpg that recharges the electric when the gas engine is engaged without even needing to plug it in.

The Fed decision is NOT based upon inflation, but economic growth. We need higher interest rates to fend off the next crisis and this is serious. Yes, the stronger dollar will reduce profits of companies selling overseas. However, it will further reduce inflation and perpetuate deflation. So imports will remain reasonable but the high dollar along with FATCA will reduce the world economy as a whole insofar as American participation.

The Fed needs to raise interest rates seriously. They have to get the economy back in the direction of a more normal interest rate atmosphere for they are wiping out the elderly as well. So interest rates will rise and it has nothing to do with inflation. This is all about growth at this point and only higher rates will help to revive economic activity. Higher interest rates will help to revive inflation for the future.

Technology advancement is reducing jobs on the low end and the higher minimum wage, the greater the trend toward robotics will emerge, for it is not just the hourly wage, it becomes the healthcare costs and taxes on top of that that which will continue to change the demographics of employment. Formal education is a disaster and it is not preparing the youth for the new age of technology.