The witless high priests of "Economism" and the greed-happy gurus of Wall Street preach this constantly as an article of faith: Raising interest rates suppresses inflation.
Here's the thing.
These people couldn't be any more wrong if they made the cable TV talking-head circuit and assured us all that the sun would rise in the west tomorrow.
The truth is that rising interest rates help trigger inflation. In fact, inflation and lending continue to increase through most of a rising rate cycle. Borrowers and consumers want to stay ahead of rising interest rates by accelerating their borrowing and spending. Of course, that only promotes inflation.
I'm going to prove this – all of this – to you beyond a shadow of a doubt, because I don't want you to get sandbagged by what's coming; the U.S. Federal Reserve is wrong, and that means it will be behind the curve until the very end, just like 2008, just like always.
When it's all said and done, when it's all over but the crying, the Fed will be confronted with the obvious consequences of this faulty thinking. It'll deny it six ways from next Tuesday.
It might even get raked over the coals (or ashes) for it, but that'll be cold comfort to people who didn't listen.
But you, armed with the facts, will be safely in cash, ready to move at your leisure.
So let me show you the proof…
We've Seen This Before; the Fed Always Willfully Misses It
The great rate raising cycle of 1977 to 1980 is a case in point.
The Fed began to increase the fed funds rate in the middle of 1977. The Consumer Price Index (CPI) stayed hot, between 6.5% and 7%, in the early stages of that cycle.
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As the Fed began to accelerate the increases, the CPI got even hotter. From 1978 to April 1980, the Fed raised the fed funds rate from 7.5% to 17.5%. CPI skyrocketed – better than doubling – from 6.5% to 14.75%.
In fact, CPI did not begin to drop until mid-1980, when the Fed cut the fed funds rate from 17.5% to 9%.
The next rate increase cycle was a short one, from March 1988 to March 1999.
Once again, bank lending never skipped a beat, growing persistently at a clip of 8% to 9%. And just look what happened to CPI. The Fed started raising rates in March, and CPI started heating up in June.
CPI rose with every fed funds rate increase, getting to 5.3% in May 1999, as fed funds were peaking near 10%. And once again, CPI followed fed funds in starting down.
This is, of course, exactly the opposite of what the textbooks tell us is supposed to happen – and what the economic priesthood caste in the West takes as an article of religious dogma.
The economic high priests never explain why things move in practice exactly the opposite of how they are supposed to in theory. In fact, they act as though facts simply do not exist.
To economists… facts are fake.
I hope you are with me now, but, in case you're not, once again in the 1994 to 1995 rate increase cycle, CPI and bank lending followed the fed funds rate higher.
The Fed's next rate increase cycle was in 1999 to 2000. Here we go again.
CPI and bank lending followed the fed funds rate upward and started down after the Fed started cutting.
Once again, we see in black and white another cycle that worked exactly opposite of how Economism's prayer books assured us it would.
Next came the 2003 to 2006 rate increase cycle.
In this case, CPI and bank lending only followed the rate rise two-thirds of the way. Then, they plateaued. That's because the housing bubble was on its last legs, and there were fewer and fewer buyer/borrowers – everybody else was already broke.
So in this extraordinary case, CPI did peter out in the last months of the rate cycle. But still, it rose from the beginning through well past the middle of the cycle.
Then we had the Great Bear Market and housing collapse.
In 2009, the Fed took rates to zero and kept them there until 2015. It didn't really start tightening in earnest until 2016, however.
In the current rate increase cycle, CPI actually moved a little ahead of the Fed moves.
That's a signal to buckle up…
Why the Current Cycle Is Going to Unleash Mayhem
Here's why this time CPI began to move before rates did.
Back in the good old days – you know, before Ben Bernanke decided to sacrifice millions of middle-class American savers for the benefit of the investing über-class on the Altar of ZIRP – the Fed did not telegraph its policy moves.
But having perhaps realized that it's now directly controlling stock prices (and, as such, directly responsible for the mental well-being of traders everywhere), the central bank has turned Chatty Cathy, blabbing about what it plans to do months in advance.
Once Fedheads start talking about a policy change, the market reacts to that change as if it is effectively already in place.
That's because it is.
First, the Fed's Wall Street dealer and media surrogates talk about it. Then, the Fedheads talk about it.
Then, some months after the initial trial balloons are floated, the Fed does it. CPI thus began its move when the Fed Open Market Mouth Committee started talking about it.
In effect, the Fed said, "We're gonna raise rates because there's gonna be inflation." And the crowd believed them and acted accordingly.
No doubt CPI will continue to heat up every time the Fed increases the fed funds rate, until the tightening policy becomes truly punitive.
And that is a long, long way off. A 3% borrowing rate never stopped anybody from borrowing and spending.
In fact, historically, it has taken rates at least in the high single digits, reflecting a truly tight monetary policy, to choke off rising consumer prices.
But it's not rates that we have to we have to worry about. It's the fact that the Fed's policy, which it calls "normalization," is already a true tightening policy.
To reach a "normal" level of reserves in the banking system, the Fed is actively draining cash from the system at an increasing rate, month in and month out.
It's not so much that the Fed is raising rates. The Fed is merely rubber stamping the fact that rates are rising in the marketplace because monetary conditions are, in fact, tightening.
And they will continue to tighten.
Here's What to Do as the Fed Crushes Stocks
Starting this month, the Fed's schedule calls for draining $30 billion per month from the system. In July, that goes to $40 billion. And in October, it goes to $50 billion.
If you don't think that annualized sucking rates of $360 billion, or $480 billion, or – heaven help us – $600 billion, starting in October, are enough to absolutely hamstring and cripple the financial markets, then I wish you luck preserving your capital.
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The joke, if history is any guide, is that, as the Fed follows the money market in raising rates, consumer prices will continue to heat up. That will only harden the Fed's resolve to hold to its schedule of normalization.
It will stand on the sideline as stock and bond prices take a beating. Don't bet on the Fed reversing its dogmatic policy to rescue your portfolio any time soon.
But look: Those of us who have been long this market for at least the past several years have made a lot of money.
Instead of stressing about the bear market that we are entering, it's time to take your money home and let it hug you.
You don't have to do it all at once.
I've been recommending since last September to gradually raise cash through regular sales to 60% to 70% of your portfolio. First, I said to do so by the end of January. Then, for latecomers, I recommended that it be done by the end of March.
More recently, I have added that if you started even later, there's usually a rally in April through May that would be a good time to sell.
But there is light… at the end of a very long, very dark, and very brutal tunnel: I believe there's going to be an opportunity to start buying back in, at much lower levels, in 18 to 30 months from now.
In the meantime, there will certainly be opportunities to trade for profits from both the short side and even the long side at times.
Lee Adler was one of very few analysts to consistently warn of the danger the Fed poses to the financial system – and your wealth – throughout the entire 2009 to 2018 bull market. Click here to get the charts and recommendations each week in his free Sure Money service.
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About the Author
Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.