The Fed May be Killing the Private Sector to Save the US Government

The Fed May be Killing the Private Sector to Save the US Government

The Fed May be Killing the Private Sector to Save the US Government

The Federal Reserve’s balance sheet reached its all-time high in May 2022.

Since then, it was supposed to drop at a steady pace and shed three trillion US dollars by 2024. The normalization of monetary policy was built on the idea of a soft landing for the economy. However, the Fed may be killing the private sector to save the government.

Curbing inflation requires a significant reduction in the money supply and aggregate demand. However, if government deficit spending is left untouched, the entire burden of normalizing monetary policy will fall on families and businesses.

The current situation is the worst possible. The Fed’s balance sheet is not falling as fast as it should; government spending has not even been scratched, but the money supply is falling at the fastest pace since the 1930s, and rate hikes are hurting the productive economy while the government seems unaware of the need to reduce its bloated budget.

The first-quarter GDP figure is extremely concerning. Government spending showed yet another big rise at +4.7%, much higher than expected. However, consumption, at +3.7% annualized, was well below estimates and driven by a worrying new record in credit card debt. Even more concerning, gross private domestic investment fell by a massive 12.5%.

There is robust evidence of a negative trend in the real economy. Rising federal expenditure, more bureaucracy, higher taxes, and weaker activity in the part of the economy that drives growth and jobs

Rate hikes have two direct negative effects on the economy if the government does not reduce its deficit spending spree. They mean higher taxes and a massive crowding out of available credit. The government deficit is always going to be financed, even if it is at higher rates, but this also means less credit for businesses and families. The crowding-out effect of the public sector over the productive economy means lower productivity growth, weaker investment, and declining real wages as the government keeps inflation above target by spending additional units of newly created currency, but the productive sectors find it harder and more expensive to find credit. Additionally, the government borrows at a much lower cost than even the most efficient and profitable businesses.

It is impossible to achieve a soft landing for the economy when the Federal Reserve ignores the signals of the banking system and the real economy. The first pillar of a true soft landing must be to preserve the real disposable income of workers and the job creation and investment capabilities of businesses.

When the government continues to increase spending, there is no signal of the mildest budgetary control, and the entire “landing” comes from the private sector, what we get is upside-down economics.

The Federal Reserve has stopped paying attention to monetary aggregates just as the money supply is contracting at an almost historic pace. Even worse, the money supply is contracting but federal deficit spending is untouched, and the debt ceiling was raised again.

The money supply is collapsing due to the inevitable credit crunch and the difficulties faced by consumers and businesses. It is impossible to grow with rising taxes, persistent inflation—a tax in itself—and carrying the entire burden of the normalization of monetary policy.

Fighting inflation without cutting government spending is like reducing weight without eliminating fattening foods.

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Daniel Lacalle

Global Economy Expert

Daniel Lacalle is one the most influential economists in the world. He is Chief Economist at Tressis SV, Fund Manager at Adriza International Opportunities, Member of the advisory board of the Rafael del Pino foundation, Commissioner of the Community of Madrid in London, President of Instituto Mises Hispano and Professor at IE Business School, London School of Economics, IEB and UNED. Mr. Lacalle has presented and given keynote speeches at the most prestigious forums globally including the Federal Reserve in Houston, the Heritage Foundation in Washington, London School of EconomicsFunds Society Forum in Miami, World Economic ForumForecast Summit in Peru, Mining Show in Dubai, Our Crowd in Jerusalem, Nordea Investor Summit in Oslo, and many others. Mr Lacalle has more than 24 years of experience in the energy and finance sectors, including experience in North Africa, Latin America and the Middle East. He is currently a fund manager overseeing equities, bonds and commodities. He was voted Top 3 Generalist and Number 1 Pan-European Buyside Individual in Oil & Gas in Thomson Reuters’ Extel Survey in 2011, the leading survey among companies and financial institutions. He is also author of the best-selling books: “Life In The Financial Markets” (Wiley, 2014), translated to Portuguese and Spanish ; The Energy World Is Flat” (Wiley, 2014, with Diego Parrilla), translated to Portuguese and Chinese ; “Escape from the Central Bank Trap” (2017, BEP), translated to Spanish. Mr Lacalle also contributes at CNBCWorld Economic ForumEpoch TimesMises InstituteHedgeyeZero HedgeFocus Economics, Seeking Alpha, El EspañolThe Commentator, and The Wall Street Journal. He holds a PhD in Economics, CIIA financial analyst title, with a post graduate degree in IESE and a master’s degree in economic investigation (UCV).

   
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