The Fed’s Paper Handcuffs

Sometimes the simplest charts say the most: here, for your viewing “pleasure” is a comparison of long-term government spending versus its long-term rate counterpart. It’s a stark look at how much less the government has had to pay borrowers even as their spending has increased (some sevenfold) since 1980.

The chart shows what government does best (lay out money) versus what the Fed (at least nominally) tries to do. That is, keep the whole ongoing spending spree from bringing down the household.

Imagine you’ve been married for 30 years, and your spouse has been whipping out the credit card on a constant basis. It’s clear your spouse is addicted to spending, as the receipts just keep piling up.

So far things haven’t been disastrous, because, despite your spouse’s credit binges, your interest rate has actually fallen. But, as you probably suspect, this unlikely situation can’t last forever.

Metaphors aside, more government spending means a greater need to borrow, and thus more debt that needs to be sold. So far the government has been lucky enough to find itself smack in the middle of a multi-decade bull market in bonds, but, again, that can’t last forever.

This runaway spending, or “fiscal profligacy” as it’s so warmly known, is what dominates monetary policy (in other words, what the Fed does). This is what happens when fiscal policy determines monetary policy. The mandate becomes lowering rates and inflating away the debt bubble. So lower rates went, time and again, often to fix a variety of financial crises from Long Term Capital to the Big One in ‘08.

But what happens when rates plummet to near zero, and your big market repair tool becomes blunted? Once you’ve lowered down to nothing you can’t go any further, right? What do you do with your hands when you’re handcuffed?

Well for one thing you start thinking the unthinkable: pondering negative interest rates. It’s already all the rage in Europe. Think you’re getting a lousy return on your money now? To borrow from a popular phrase, perhaps you ain’t seen nothing (or maybe even less than nothing) yet.

So let’s recap what we see right now: the coming putting-out-to-pasture of the bond-market bull; long-term rates that the Fed’s buying programs can’t control; and, at the other end of the curve, some pretty colorful trial balloons floated out there, printed with the chilling words “negative rates.”

Now add in a new Fed chairperson who, from the looks of things, seems unconcerned that the stuff that makes up the CPI is rising above the Fed’s stated inflation benchmarks. So far nothing appears to be standing in the way of tradition, i.e. believing that rising inflation goes hand-in-hand with a growing economy.

Are there better reasons for buying gold? I’d say not, and by the looks of the latest rise in prices, it seems a lot of people are in agreement.

Gold’s been bought for reasons that include anything from its shine to its eminent exchangeability, but these days, it might serve best as a hedge against the people in Washington with the loose wallets bulging with plastic. There’s every reason to own it, unless, for some reason, you’re convinced that one day the government will actually roll back its free-spending ways and start acting responsibly.

Meanwhile, those hawkish types at the Fed who’d love nothing more than to end this low-rate game are handcuffed by government spending. And while those handcuffs may be made of paper, they don’t look to be broken any time soon.

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