The FED isn’t getting how the supply chain is adjusting

After twelve years of near-zero interest rates — did anyone truly believe that a surge in interest rates wouldn’t create a major financial crisis?

Under the near-zero interest rates, regime debts soared everywhere. From China to the United States and Turkey to Britain, asset bubbles were created, leading to a misleading view that things were good. Sure, median wages didn’t do so well, but who cares when the value of our wealth soars? Or so went a narrative.

In 2021, global debts passed US $300 trillion.  And now it is coming to an end. Will there be tears? There will be lots.

In such an environment where debts prove unsustainable, demand will be squeezed out of the economy, a recipe for deflation.

In the US, interest rates are now at 4 per cent from just 0.2 per cent in March this year.

But whilst rates rise, something interesting has been happening to the supply chain. It is adjusting.

It is always thus. When commodity prices rise, suppliers find new ways to produce the commodities, substitutes emerge, and demand falls.

And consider how commodity prices have fallen. The lumber price, measured in dollars board feet, is now around a third of the price seen in March this year. 

Brent crude is down by around a third since March,  iron ore is down around a third over the last year, DRAM has fallen sharply.

The Manheim Used Vehicle Value Index has declined ten per cent over the last year, and the Baltic Dry index, a measure of shipping costs, is now almost a third of the value seen earlier this year. 

Meanwhile, the US money supply appears to be contracting. 

The above indicators were all flashing red before inflation began to surge; now, they are pointing the other way.

Inflation is likely to fall sharply even without recent interest rate hikes.

The supply chain was adjusting, but the FED has embarked on a recession-creating rate hike spree anyway.

Even if rates hadn’t risen so fast, recession was a distinct possibility; now, it looks likely to be deep and nasty.

US rate hikes have pushed up the dollar forcing other central banks to increase interest rates, even if they would have preferred not to. The result will likely be a recession across much of the world, maybe a global recession.

But the adjustment in the supply chain means that we might be suffering unnecessary pain, like banging our heads against the wall, when we already have a headache.