If aliens swooped down and stole 90% of the world’s cattle tonight, the cost of beef would likely increase at least tenfold.
And the Fed’s response would be to raise interest rates to bring down the cost of beef. This is because in Fed land – all price increases are “inflation.”
Comically and paradoxically, higher rates would likely increase the cost of beef.
SIDEBAR: Warren Buffett just invested $1 billion in housing. It was actually two builders: Lennar and D.R. Horton, but it says much about Buffett’s confidence in housing, at a time when Buffett is sitting on so much cash and investing in little else.
Renowned real estate investor Ken McElroy discusses Buffett’s investment at length in this short podcast. This is one more item to share with anyone concerned about the long-term prospects of housing.
Back to the Fed’s Obsession with High Rates to Fend off High Prices
I am going to oversimplify for brevity’s sake. But the Fed raises rates to curb inflation by increasing borrowing costs ostensibly. This in turn reduces consumer and business spending, slows demand, and eases price pressures. Slumping auto sales are a great example of this working, as consumers demand far more cars when auto loans are at 1% instead of 7%. Higher rates also ostensibly strengthen the dollar – which can lower import costs.
So, in other words, the Fed wants to lower prices by destroying demand – every time.
But sometimes we need a greater supply of goods to bring down prices – and my cattle example is a case in point. Lower rates would spark more investment in cattle, and that would do far more to bring down cattle prices than destroying demand.
In addition, the Fed ignores the primary cause of inflation (much to economist Steve Hanke’s consternation) – an increase in the money supply. When M2 (checking, savings, and money market funds) increases too quickly, prices always increase.
The primary source of an increased money supply is bank lending, and not “money printing” by governments, as I remind readers often. So yes, higher rates can inhibit bank lending and lower the money supply, but not nearly as much as a soft economy will.
In a strong economy, banks will lend regardless of the circumstances – as we saw in the 1980s, when rates were significantly higher.
The good news is that a soft economy will bring down rates no matter what the Fed says or does. So even if the Fed does get confused about high beef prices or the impact of tariffs, rates can and will still fall. The Fed just slows things down.
What About the Value of the Dollar and Imports?
Yes, higher rates make American stocks, American debt, and thus the dollar more attractive to investors – and push up the value of the dollar.
But the total supply of dollars also influences the value of the dollar.
So, when overseas banks stop lending dollars (Eurodollars) in a slow economy and when overseas firms pay off dollar debts, the overall supply of dollars decreases. And that too pushes up the value of the dollar, irrespective of interest rates, as Brent Johnson explains often.
