What Is the United States’ Most Powerful Weapon?
ANSWER: None of the above.
The United States’ most powerful weapon is… the dollar.
This is because the bulk of international trade is in dollars, almost all energy is purchased in dollars, and other countries just desperately need dollars in general to operate.
And – when the Fed increases short-term interest rates, the demand for dollars increases and the value of the dollar goes up.
This puts enormous pressure on other countries because they have to raise their rates too to protect their bond markets – which in turn hurts their economies – and they have to pay much more for imports (especially energy).
The above is oversimplified a bit, and there are other reasons the dollar is a weapon (because we can impose sanctions too), but suffice it to say that the dollar is a very powerful weapon indeed.
And imposing that power may be one reason why Jerome Powell and the Fed seem so determined to continue to raise rates when so many macro analysts think they have already gone way too far.
Here Are Several Reasons Why the Fed Is So Determined to Push up Rates
- To fight inflation – the obvious reason. The Fed believes that raising rates and killing demand will reduce inflation.
- To not be Arthur Burns. Arthur Burns is the much-derided Fed Chairman from the 1970s – who presided over the worst inflationary period in U.S. history. He actually significantly raised rates several times, but he gave into political pressures to reduce rates too soon every time and allowed inflation to run amok. Mr. Powell desperately wants to avoid that legacy.
- To create ammunition for the upcoming recession. The Fed’s primary recession-fighting tool is sharply reducing interest rates. So, it’s possible that Mr. Powell is well-aware that we are steaming headlong into a bad recession, and he is continuing to raise rates anyway because he wants to ensure he has sufficient ammunition to help fight off the upcoming recession. By sufficient ammunition, I am referring to a Fed Funds Rate that is high enough to give Mr. Powell sufficient room to lower it enough to create a positive effect.
- To weaponize the dollar. I discussed this above.
So, will the Fed be able to continue to push rates up?
The Fed will try, but the bond market will continue to push long-term rates back down in anticipation of a recession.
Jeff Snider explained again today in his latest podcast why we are heading into a worldwide recession, focusing heavily on inverted yield curves – which predict recessions very accurately.
Steve Forbes excoriated Powell’s entire inflation-fighting perspective in a short 3-minute podcast today, explaining that low unemployment rates do NOT cause inflation.
Barry Habib also continually reminds us that inflation will come down once lower shelter costs are properly reflected in CPI (inflation reports), and that the recent employment numbers are not as strong as they appear.
Habib thinks we might see relief tomorrow in fact when updated employment figures are released.
All this is to say that I still firmly believe rates will fall this year (based on the analyses of the above macro-observers – and not on my own analysis), despite Mr. Powell’s bluster.
And finally, in regard to my comments about using the dollar as a weapon, here is the podcast where Mark Moss and Brent Johnson discuss exactly how the U.S. weaponizes the dollar.
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