The Fed’s Loch Ness Monster
Posted September 13, 2023
In the 7th century, Saint Columba, an Irish monk, came across locals burying a man by the River Ness in Scotland.
He learned the man had been swimming in the nearby river when he was attacked by a "water beast".
Columba had a few die-hard followers at the time. So, naturally, he sent one of them (perhaps his least-favorite) to swim across the river.
The beast approached the swimmer, but Columba apparently shouted: "Go no further! Do not touch the man! Go back at once!”
According to Columba, the creature stopped and fled.
(That’s the story and he stuck to it.)
In 1933, a road alongside the loch unveiled clearer views of its waters.
That April, a couple reported seeing a massive creature in the loch.
A year later, the infamous "Surgeon's Photograph" emerged.
And yet, despite countless expeditions, from basic to technologically advanced, solid evidence of the Loch Ness creature, now termed "Nessie", remains elusive.
I’m reminded of this story whenever I hear about the Federal Reserve.
Namely, the Fed’s quest for another mysterious beast.
The Fed’s Own Nessie
In the late 19th century, Swedish economist Knut Wicksell posited that there was a “natural rate” of interest that would ensure full employment without inflation.
As central banks around the world, including the Fed, increased their scope in the 20th century, they adopted the practice of setting short-term interest rates as a means of influencing economic activity.
The goal was (and remains) to achieve a balance between promoting economic growth and controlling inflation.
The central banker’s job became an infinite quest to find the natural rate, also known as the terminal rate.
OK. At a glance, the tales of Nessie and the concept of the terminal rate may seem as different as chalk and cheese.
But upon closer inspection, there is one parallel:
Nobody knows if either actually exist.
Blurry photographs and anecdotal accounts spur on Nessie hunters. In the same way, murky data drives central bankers forward, too.
The problem: Nobody’s hurt if the Nessie hunters are wrong about Nessie.
What Happens if the Fed’s Wrong?
At the Fed’s annual retreat in Jackson Hole, Wyoming, Powell made it clear that at least two more rate hikes are on the way.
One came at the July FOMC meeting. Our colleague Jim Rickards suggests the next one will come on September 20.
Powell believes these measures are essential for controlling inflation and seems unconcerned about a potential recession based on the current data.
After all, the Atlanta Fed projects growth for the third quarter of 2023 of 5.6%. Off the charts.
In fact, it’s similar to the kind of growth we saw from 1983–1986 during the Reagan recovery.
But here’s what the Atlanta Fed left out: The key driver? Mountains of credit card debt.
“What if,” asks Jim, “inflation is coming down on its own, and the Fed has already hit the terminal rate but just doesn’t know it?”
Worse, says Rickards: “One more rate hike by Powell (which we expect) could make a recession even worse and possibly trigger a financial crisis.”
If Jim’s wrong? No problem. Things hum along. No worries.
If he’s right?
Anyone who owns stocks, bonds, or holds significant equity in their homes could be at risk.
The Full Lowdown
The banking failures of SVB, First Republic and Credit Suisse were a shock. But most believe -- the Fed included -- the worst is behind us.
His new research suggests that, while the Fed is busy chasing mythical beasts, the regional banking industry is at risk of imminent meltdown in the coming weeks.
It’s why Jim’s holding an emergency ZOOM briefing tomorrow at 7PM for all Paradigm subscribers.
This Zoom will be 100% live, and you’ll have the chance to submit questions and participate in real time.
(Keep in mind, though, Jim can’t give personalized investment advice).
Jim will reveal:
→ Why he believes we are days away from another “Lehman Moment”
→ How to protect your assets from a banking system meltdown (as well as a sneak-peek list of banks at risk)
→ And how to use this crisis to score what could be historic gains in the weeks ahead