Will 1% Rates Cause Inflation?

This time could be different

Donald Trump wants to slash interest rates.

Will this bring inflation roaring back? Or *is* this time different.

After last week's big job revision, it looks like Jerome Powell's long dark winter of interest rates is finally ending.

Futures are now predicting rate cuts could happen as soon as September -- in five weeks.

In fact, futures are now projecting a three-quarter point cut by the end of the year. And a full point cut by the time Jerome Powell's term ends next May.

Trump’s Dream: 1% Rates

Trump, characteristically, is pushing harder, potentially for the 1% interest rates we get whenever Wall Street needs a bailout.

The problem with low rates, of course, is they create inflation.

This is because low rates make it cheap to borrow. Which is good for consumers and small businesses. But if rates are too low -- like, say 1% -- it fuels too much lending.

Cheap money funds stupid businesses like pets.com or fake meat -- “malinvestments” in Austrian economics. As in their business plan only worked because loans was artificially cheap.

But all that lending also drives inflation because commercial banks literally print the money they lend.

The new money chases goods, driving the price of everything up.

Also known as inflation.

This time is Different

Low rates causing inflation has been true for literally centuries of central banking.

But, interestingly, this time could actually be different. Courtesy of a once-obscure Fed program called Quantitative Easing, or QE.

Since the 2008 crisis QE has taken over as the main driver of inflation, with rates playing second fiddle. In fact, during Covid, QE was almost 2/3 of money printing.

So Quantitative Easing is where the Fed literally prints fresh dollars and uses them to buy everything in sight -- mainly treasuries and mortgage bonds.

It does this to flood money into the economy fast -- rates can take 12 to 18 months.

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The stuff it buys goes on the Fed's balance sheet. While the trillions of fresh dollars it printed to buy all that stuff swims free, driving up inflation — there’s too many dollars.

QE is controversial because it hands trillions to the rich people -- and Wall Street -- who own all those treasuries and mortgage bonds. The poors get the inflation.

QE started in the 2008 crisis but during Covid it went supernova, with the Fed buying over $5 trillion in assets. Taking them to a hoard of one in three dollars in the world.

Using QE to Reverse Inflation

And that's where the fun starts. Because what's bought can be sold.

And given all those QE trillions are already built into inflation -- the dollars are running around as we speak -- the Fed could cut inflation any time it wants by simply reversing QE.

As in sell the now $7 trillion stash and cancel the dollars.

This is called QT -- Quantitative Tightening. And the Fed's been doing it in slow motion -- about $40 billion a month -- since Bidenflation scared it straight.

But the Fed could sell a lot more -- if it sold the entire 7 trillion stash, prices would drop by roughly a *third.*

As in, you’d get $2 gas, $3 eggs, and $250,000 houses.

In short, the Fed’s giant hoard means low rates -- even goofy ones like 1% -- can easily be cancelled by simply pawning the horde.

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What’s Next

Happily, this is precisely the plan of Trump’s Fed Chair frontrunner, Kevin Warsh.

Who characterizes it as choosing Main Street over Wall Street.

As in Main Street gets cheap mortgages and small business financing. While Wall Street's bonds take a Robin Hood hit.

Even with 1% rates -- or more likely 3% -- QT could cancel enough inflation to get through Trump's term even with the cheap money boom he wants.

Alas, QT eventually runs out. Followed by inflation. Followed by the inevitable recession to fight that inflation.

A recession that, as always, nobody could have seen it coming.

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