The Federal Open Market Committee released the minutes from its May meeting yesterday. Most analysts characterized the Fed minutes as more "dovish" than expected. The FOMC hinted that it will continue its gradual pace of raising interest rates, with a June increase likely. But it did not give any indication that it might push rates up faster. The minutes also reiterate that the Fed may allow inflation to creep above the much ballyhooed 2% target.
Peter Schiff talked about the FOMC minutes in his latest podcast. He said they were pretty much what he expected, but he thinks the Fed is actually more dovish than the minutes indicate.
Peter talked about the Federal Reserve's new policy of "symmetrical inflation" after the FOMC meeting earlier this month, noting that while the central bank might be "comfortable" with higher inflation, US consumers probably won't be.
In his discussion of the FOMC minutes, Peter wondered what the Fed even means when it says inflation could rise "modestly" above 2%. Does that mean 2.1%? Could it be 2.5%? What about 3%? Some might call that "modest."
"I think the Fed is going to be looking for every excuse under the book not to raise interest rates aggressively, no matter how high inflation gets. But of course, they're not going to be that transparent. That's the last thing they'd want to do is let the markets know that they're that impotent when it comes to inflation fighting. But certainly, their language leaves a lot of room for opinion."
Some people interpreted language in the minutes to imply the Fed may already be close to what it considers a neutral rate and that the hikes may end sooner than expected.
"Maybe the markets are looking for two or three rate hikes this year. But I think what people are now starting to think is that that may be it. I mean, after this year, the Fed is done hiking. And so maybe the highest the Fed gets is about 2.5% and then they're done hiking. Now, the question that people should be asking is why? I mean, why are they stopping at 2.5%? They've never stopped at such a low level before."
After the dot-com bust, the Fed eventually moved rates back to around 5%. Peter said the reason they don't want to go to that level again is obvious - it's because we have so much more debt now than we've had in the past. We can't afford a 5% interest rate. Maybe the central bankers think the economy can handle 2.5, but Peter doesn't even think it can cope with that.
"I don't even think we can afford the interest rates that exist today. Of course, it's going to take some time for the markets to come to that conclusion, but given the amount of debt that exists, both on a government level, on a corporate level, and then of course also on an individual level, I think they have already raised interest rates to the point where it's going to be very problematic for the economy."
There's another important implication here. If the Federal Reserve only takes rates to 2.5%, it has very little room to cut when the next recession rolls around. That means it will have to more quickly move to quantitative easing and the QE program will have to carry more of the burden of "fixing" the economy.
Peter has been saying he doesn't think that Fed can reinflate the bubble economy again. But let's say he's wrong and it manages to pump things back up again after the next recession. Where do interest rates go then? To 1.25%?
"Because every time they do this and they blow a bigger bubble and they create more debt, the high point of where interest rates can go is going to have to be lower and lower every time. And so eventually, they're going to be stuck at zero indefinitely. They won't be able to raise them at all, which is obviously a non-sustainable situation."
At some point, there will have to be a crisis that ends this downward spiraling cycle. Peter said that's why he thinks it's going to end now.
"I think the next time the Fed has to go to that well, it's going to be dry. The next time they try to stimulate the economy with rate cuts and quantitative easing is going to be the last because they are going to end up destroying the dollar and destroying the bond market in the process."