I’ve been watching the Fed raise interest rates while the size of the national debt keeps rising. The dangerously high national debt is so high now that the annual debt payment is itself dangerously high. Interest expense may soon be the biggest annual federal expenditure. At the same time, inflation is still too high and the Fed won’t reduce interest rates until inflation is back to the Fed’s 2% target. Interest rates can’t come back down until inflation is slain, but interest rates have to come back down to save the national budget. It sounds like an impossible quandary.
The Fed has a mandate to control prices, and based on that they should raise and hold interest rates high until inflation is back to its target of 2%. The stock market is generally priced as though nothing too bad will happen if interest rates are high temporarily and that inflation and interest rates are going to drop soon. But there are reasons to wonder how high rates will get and what damage it will cause.
It's sort of simple, inflation is when prices go up and deflation is when prices go down. The key is what price are we looking at and what time period are we measuring over?
For example, let's say we want to measure the inflation in the price of tricycles. The price history might look like this:
We’ve had the highest inflation since the 1970’s. It’s come down some, but what happens next? The conventional wisdom is that inflation is on its way down and that we’ll have a soft landing, the fed will pivot soon and start cutting interest rates, inflation will drop back to 2%, and the economy will rally from here,