Transcription
Inflation is currently following the exact same path that it did in the 1970s. The only problem is that last time this happened, the way they dealt with it was raising rates. And this time they can't afford to do that. So what is going to happen?
Take a look at this chart. You can see 1970s inflation is the blue line. And that starts in 1966 and it goes through about 1983ish. And you can see it rose moderately for a number of years and then fell. And right around 1972, this was once the impact from leaving the gold standard started to hit the dollar, you saw inflation skyrocket and it shot up to about 12%. You can see the percentages for this blue line are going to be on the right hand side. The axis on the y- axis on the right. You can see that after it peaked out around 12%, it dropped again and bottomed out around 1977 before taking off vertical yet again and peaking for the last time in 1980 above 14% before finally cratering again from there.
Now take a look at the green line. You can see the green line is starting in 2014 is the inflation rate that we are seeing now today. We can see it's following virtually the exact same path, rising moderately for a couple of years until about 2018 when it starts to fall and then 2020 when all that money printing was unleashed by the Federal Reserve. Inflation skyrocketed. We saw virtually the exact same time frame for when it peaked and started moving down again from there. As the Fed raised rates in order to try and reign in that inflation and it stalled, moved sideways slightly down for a while until recently about right on target, it is starting to pop yet again.
Now, if this pattern continues to hold true, we would see for the next year and a half or so until about 2028, the inflation rate continuing to move up until it tops out at its peak and then moves lower from there.
Now, I want you to notice something here because I pointed this out, but you might have missed it. These inflation rates have different y-axis. And so just because they're plotted on the same time frame, does not mean they're the same inflation rate. So you can see the blue line, which is the '70s inflation rates, that's going to be this y-axis on the right. The green line has a different y-axis with different numbers. That's over here on the left. And so the CPI peaked out in 2022 at around 9%, which is significantly less than what 1974, 1975 inflation rate was, which was around 12% there at that same point in time. Which means that if we do follow the same pattern, that would mean that the CPI peaks out this time in between 10 to 11%. Not the 14 to 15% that it was in the '70s or 1980.
If you want to see what that looks like just on one consolidated straight line chart, you can see that the beginning of the 1970s chart would start right around here around 1966. This is where it moved up and then down and then up and then down and then up and then down. And then fast forward to about 2014. Right here is where it starts on the other chart. You see it moves up and then down and then up and then down and then here it would be moving up to about this 10 to 12% if it were to follow the exact same pattern. So you can see once you compare it on the exact same chart with the exact same y-axis, you can see that it doesn't actually look as similar as it does when you manipulate the y-axis to make it kind of fit. But still the overall pattern is holding true. And many people would argue that the way that they measure the CPI today is skewed in favor of keeping that CPI number suppressed, which means that maybe the real CPI, the real inflation numbers do match more closely to what they did in the '70s.
Which would mean that incoming Fed Chairman Kevin Walsh, who just got signed into his position within the last couple of weeks, is in for a very difficult assignment because he was put in that position in order to lower interest rates. But last time the Federal Reserve got them into this position of inflation taking off out of control, their response was to raise interest rates. So what is he going to do about it?
You can see this is the federal funds effective rate. So this is the interest rate that the Federal Reserve actually controls. And when inflation took off in the '60s, they raised rates to try and stop it. And then once they did, then they lowered it. But then it took back off again. So they raised rates again. And then they stopped it. So they lowered it. But then inflation took off again. So they raised rates all the way up to a peak of almost 20%, just a little over 19% in 1981. You can also fast forward to what they've done recently. So when inflation rate was slightly rising, they were raising interest rates up until 2019. Then all the money printing they crashed interest rates down to zero. Then inflation really took off. So they raised interest rates again in order to get a handle on that inflation. And once they thought they did, they started lowering interest rates. And now inflation has taken off again. So both the pattern of inflation and the pattern of interest rates being cut and raised in order to deal with that inflation are following the exact same pattern of the 1970s.
But as I stated at the beginning of the video, this time is different because they cannot afford to do the same thing that they did in the 1970s when inflation really ripped out of control. On this last big move from 1978 through 1980 as inflation ripped higher from 6% up to 14.5%. You can see the federal funds rate went from 4.5% all the way up to 20%. But they were only able to do that because of the amount of debt that the US government had at that time relative to the size of the economy. In other words, the government could afford to pay higher those higher interest rates as the Fed jack those interest rates up.
You see what the Federal Reserve's changing of interest rates did to the 10-year Treasury yield. This was about 1962. So, this was in the beginning of that inflation and interest rate cycle. You can see the yield on the 10-year went up first to about 8%, then back down to six something, and then back up to about 8%, and then down to about seven, and then finally it peaked out around 15%. Can you imagine getting 15% on a risk-free US Treasury government bond? Can you imagine the government actually being able to afford to pay that?
Now right now the 10-year yield is peeking above 4.5%. And yet the total amount that the US government is forced to pay on their national debt just at these interest rates is over a trillion dollars a year. So why is that a problem? Well, it's because of this chart right here, which is federal receipts as a percentage of GDP. This chart shows that pretty much no matter what the federal government tries to do with tax rates, it's really never able to get above that 17.5, maybe 20% mark or how much money it can suck away from the economy without crashing the economy. Whether tax rates go up or tax rates go down, the percentage that the US government is getting from the economy is very, very stable over time. This is because if they raise tax rates too much, it hampers the economy, stifles growth, and they suck more percentage away from the economy, but the economy shrinks. On the other hand, if they lower tax rates, then the economy grows and they're able to collect more revenue even though it's a smaller percentage. And so there's this cycle where they're able to get a little bit more and then a little bit less. But over time it stays very, very stable. Despite the fact that we've had all sorts of different tax regimes, tax brackets, corporate tax rates, individual income tax rates, government is always only able to suck around 17.5% of GDP out of the economy. And this is a problem because at their current debt level with the amount of money that it costs them to keep that debt around, they need to suck away more than that from the economy.
If you take a look at this chart, this is the debt to GDP ratio. You can see right now the government, its total debt load is around 121% of the size of the economy. But back in the '70s when inflation started to take off and the Fed raised interest rates to stop inflation, their debt load was only around 30% of the economy. So even though the Fed raised interest rates on the Fed funds rate and even though that made government debt way more expensive and the yield on the 10-year went all the way up to almost 16%, US government was still able to afford that because even at that peak in 1981, the debt to GDP ratio is still only 30%. But today the debt to GDP ratio is over 100%, 122%. But remember, they can only withdraw a constant source from GDP, which means as their debt gets more expensive, they have less and less taxing power in order to be able to afford it. And so if the Fed tries to do this again, and it makes debt more expensive, well, then it makes the total debt go up because they have to borrow even more just to pay the interest on the debt, which is already $1.2 trillion a year. See what I'm getting at here?
The higher inflation goes, the more maybe the Fed wants to raise interest rates like they did in the '70s. But the more they do that, the more expensive government debt gets. The more expensive government debt gets, the more they have to borrow to pay for that more expensive debt. But the more expensive that debt gets, the less they can afford it because they already have a debt load that is bigger than the economy. This is called a sovereign debt crisis. And fortunately for us, this has happened many times before in the past in many different countries. And we can see exactly how they play this because as you probably noticed from this chart, we've actually been here before in 1946 when the debt to GDP ratio was also around the same level that we're at right now. And you can see they successfully deleveraged.
Now, they did this partly through austerity because they spent less money when the war ended. They did this partly through a productivity boom when all the soldiers came home and started working productively again instead of literally destroying all their resources. But another way that they dealt with this was through yield curve control. And that meant that the Federal Reserve not only changed the federal funds rate, but they pegged interest rates on short-term Treasury bills at a fixed interest rate and they capped interest rates on longer-term Treasury securities. If they would have tried to do this in the 1970s, that would have meant that the 10-year yield would not have actually gone up to 15%. It would have stayed lower at whatever rate they chose. Maybe that was 10. Maybe that would have been seven and a half. Maybe that would have been five. Which means that this time if inflation does start to follow this same path because the government would not be able to afford to borrow everything they need just to cover their expenses, let alone everything else, all the additional spending they're always trying to tack on. It means the only way that they can do that is through something like yield curve control to make sure the market can't force treasury yields up that high. Simply put, even if inflation starts following this exact same path that it did in the '70s, they cannot follow the same playbook that they did in the 1970s to deal with it. They have to go back to the 1940s playbook in order to deal with it.
The bigger problem with that is that there's no austerity this time. There's no ending the war. There's no just cutting Medicaid and Medicare and Social Security, which are the vast majority of the entire budget. There's no stopping the spending, which means the only way through is printing if they want to avoid a default.
So, what complicates that? Well, Kevin Walsh, the new chairman of the Federal Reserve, has repeatedly stated that his goal is to aggressively reduce the Fed's balance sheet. The Federal Reserve cannot engage in yield curve control if they're reducing their balance sheet. The only way the Federal Reserve can engage in yield curve control is to expand their balance sheet. Because the reason Treasury yields rise is because more people are putting selling pressure, pushing the prices of those bonds down. If you want the yields to go down, you need somebody to be buying up those bonds and pushing up the bond prices. But if inflation is skyrocketing out of control, nobody's going to be doing that. So the Fed steps in to be that buyer, and they do that through printing money and putting those new bonds on their balance sheet. That's exactly what they did following the financial crisis. That's exactly what they did following the repo crisis. That's exactly what they did in 2020, 2021. And that's exactly what they are doing right now. They are buying bonds to put onto their balance sheet that keeps bond prices higher and bond yields lower. But if Walsh actually does what he has repeatedly stated he wants to do, that means this thing will be moving down, not up. Which means not only can they not follow the 1970s playbook of just raising interest rates to stop inflation, but that also means they can't follow the 1940s playbook of yield curve control to inflate the debt away.
If you've been watching my channel for any length of time, you know what I'm about to say as to what their solution is probably going to be. That is to do the 2020 playbook, which is eliminating the supplementary leverage ratio rule from banks. And they did this specifically to ease strains in the treasury market resulting from, well, it wasn't actually resulting from that. It was resulting from all their money printing and it increased banking organizations ability to provide credit to households and businesses. So in plain English, what they did was they said, "Banks, we are no longer going to restrict how many treasuries you can buy and how much lending you could do to the private market. Go crazy. Buy all the debt, make all the loans that you want." Now, this was temporary. They said this will be in effect until only March 1st of 2021. And you can see that they did in fact end that temporary suspension to the supplementary leverage ratio on schedule in March of 2021. This time it will be permanent because when they did that in 2020, it had the effect of pushing yields on government bonds way down. You can see that in 2020 the 10-year yield got to only about half a percent. That's because there was so much demand for buying up those treasuries that it pushed those yields low. Now, I don't think it'll have that exact same effect this time, but it will push yields lower. In effect, this allows banks to do QE for the Fed. That way the Fed can have its cake and eat it too. We can see the Federal Reserve's balance sheet go down. But we can also see yields on government debt go down, which means government debt gets cheaper, which means that even if inflation starts following this same path, they don't have to raise interest rates.
This will also have the added benefit of increasing lending to the private sector, which means mortgages could get cheaper, auto loans could get cheaper, credit card debt could get cheaper, and all sorts of refinancing across business loans could happen, and corporate debt, which means that the productivity boom that we saw following World War II may not happen to the exact same extent, but it definitely could offset some of the inflation because if every individual, every household, and every business suddenly has more cash flow because they're able to refinance some of their expensive debt into cheaper debt. They've got more room on their balance sheet. That means they've got more cash flow to spend on other things, on research, on hiring, on development, on factories, on production. And that's more income in the pockets of other people who can then turn around and spend that income, which means we may have a boom in GDP and in economic activity coming up around the corner. Even though if nothing changes right now, we'd be following that 1970s path. Ironically, if they can do this and get interest rates lower through bank deregulation, that may be actually what stops inflation in its tracks this time.
Don't get me wrong, none of this is prescriptive. This is descriptive. Meaning, I'm not saying what I think should happen. I'm telling you guys what I think will happen. And if I'm right, that means we've got a couple really good years of the economy and the stock market ahead of us. Because you know what this will do to asset prices if money printing through the banks starts to go off the rails? That means a boom. Now, be warned because booms fueled by credit expansion always result in busts. That's why it's called the boom bust cycle and it's driven by artificial credit expansion and contraction. So enjoy it if it happens. Take advantage of it, but be prepared because the booms never last forever. As always, thank you so much for watching. Have a great day.