41. When Dementia Replaces Meritocracy – Can you hear it

That noise you hear is a combination of the sucking sound caused by The Fed removing massive liquidity from the global economy and the resulting breakage caused by the speed of rising interest rates. The first crack in the global financial system occurred in the British Pension Funds but cracks are also appearing in the American residential market. The damage has just started. It will build to a crescendo next summer. Cinch up your saddle, this ride will be rough.

It appears the majority of participants in the financial markets are still suffering denial on the commitment of The Fed to defeating inflation. Given the behavior of The Fed since 2000 that is quite understandable. Every time we have had some economic distress over the last 20 years, The Fed has lowered interest rates and printed money (Quantitative Easing). Simply put – that behavior is unsustainable, and we are now at the end of that trend. Time for big boy pants.

Financial market participants are debating when The Fed will pivot and how much damage will have to occur in order for The Fed to pause in raising interest rates or actually reduce them. Obviously, their perspective is impacted by their investments which are melting in front of their eyes. That is a very painful experience which distorts one’s perspective.

But here are the three questions that they (and everyone of us) should be asking:

1. What happens if The Fed does not pause until they can declare victory against inflation?
2. What happens if The Fed declares victory at an inflation rate of 3% per annum?
3. What happens if The Fed declares victory against inflation because they have positive real interest rates versus the negative real rates we have been experiencing?
   

There is no doubt in my mind that globalism is dead. We are experiencing the dislocations associated with that funeral –Reshoring and Just In Case inventories. The postmortem will show that like many academic theories it was impractical because not all world leaders share a desire for common prosperity and happy world citizens. Some prefer to accumulate power and to control all the wealth.

Reality is that Reshoring and Just In Case inventories mean higher cost for goods for several years, maybe a decade. Both will require massive amounts of capital which will put upward pressure on interest rates in addition to the activities of The Fed to control inflation. The combination is inflationary so it may be a decade before inflation returns to 2% per annum.

While I do not have a crystal ball, the highest probability is that The Fed will get interest rates high enough so that adjusted for inflation, money once again has value. If real interest rates are 2% higher than inflation and the annual rate of inflation in 2023 is 4% then the Federal Funds rate will be 6% and mortgage would be perhaps 8% If inflation reduces to 3%, the Federal Funds Rate would decline to 5% and mortgage loans would decline to maybe 7%. My spreads
are wrong, but I believe the trend of higher interest rates is illustrated correctly.

The answer to Question #1 above is we will experience a global financial disaster. I believe The Fed is determined to get control of inflation. However, I have difficulty believing that Powell wants to go down in history as The Fed Chairman that nuked the global economy. Question #2 enjoys a high probability; however, I believe Question #3 is the winner and perhaps combined with Question #2 by The Fed.

It takes 12 months for a change in policy by The Fed to be fully reflected in the economy. Hence it will be next summer before we can accurately gauge the impact of The Fed’s interest rate increases this summer. Therefore, The Fed will not just break something, it will crush numerous economic “things” because it is flushing the liquidity of the world down the toilet of higher interest rates. The adjustment is critical to our long-term financial health but still painful.

Once higher interest rates become the norm, the lower valuations of EVERY Asset will be painful. We have not yet reached that point of RESET, but it is close. It will be BRUTAL. CASH WILL BE KING. Massive losses in the commodity, stock, and bond markets will occur but I expect the private equity companies to be the epicenter of the correction ripples through all the asset classes as higher interest rates will reset Capitalization Rates for investments, financial and real estate.

In the future there will be some equally massive benefits including:

1. Climate Change and the associated Environmental Social and Governance for Justice (ESG) will be thrown in the trash. Hunger, cold, and sitting in the dark will correct that foolishness.
2. Increased automation will improve productivity and ultimately deliver lower cost products eliminating inflation. It will take time to get to that point.
3. Meritocracy will enjoy rebirth. Who wants a stupid heart doctor?
4. Silly assets like crypto currency will disappear from the mainstream portfolios.

Do not underestimate the short-term global risks which include the combination of the Chinese economy imploding, the European economy crashing, and our economy declining into very serious recession. This “economic dislocation” could easily evolve into a global economic depression. The solution is Supply Side Economics – cut taxes and regulation to spur an increase in the supply of goods including petroleum. No recovery will occur in the global economy until there is economic growth. Prime Minister Truss in Great Britain is the only world
leader that understands the real world and is being abused for being correct.

It may help you endure the pain if you keep score by watching for these steps:

1. The strength of the Dollar will cause companies with substantial foreign earnings to
   report lower earnings thus reducing the value of their stock.
2. Higher interest rates will slow new home construction to a below normal level which will
   generate layoffs in the construction trades and ripple through their suppliers.
3. Things in the economy will break.
4. There will be a stock market capitulation.
5. Economic recovery does not start until The Fed begins to reduce interest rates.

Residential development land is experiencing softer prices due to less demand. I expect some short-term declines in most land values because of increased interest rates, the collapse in liquidity, and economic turmoil. Environmental regulations will continue to drive up the cost of development as illustrated by the new regulations regarding two bat species and Wood Turtles. Fortunately, no dinosaurs have been found alive, so they are not on the Endangered Species list.

Amazing self-delusion is rampant in the current Biden administration, the majority of congress, and the participants and financial analysts on Wall Street. Their singular focus the accumulation of earthy treasures is something to watch tempered by the reality of the pain they are causing others.

Also fascinating to watch as the emergence of the truth about the Demented Marxist’s attacks on Trump comes to light:

1. The U. S. Supreme Court just outlawed undated mail-in ballots.
2. Which is worse-
   a. Testimony in the Igor Danchenko trial revealed that the FBI offered $1 Million for collaboration of the Steel dossier.
   b. Without collaboration the FBI still used it to bludgeon Trump for four years.

3. The Colorado Secretary of State admits to sending ballots to 30,000 ineligible people and keeps her job.
4. The CEO of Konnech sued True the Vote in 2021 for saying that Konnech had stored election data on servers in China. But the same CEO was just arrested on those charges.

Fortunately, God is real, Jesus was resurrected, the Holy Spirit is active, and God is in control, but He expects us to be his hands and voice.

“Do not store up for yourselves treasures on earth, where moth and rust consume and where thieves break in and steal; but store up for yourselves treasures in heaven, where neither moth nor rust consume and where thieves do not break in and steal. For where your treasure is, there your heart will be also.”

(Matthew 6: 19-21) New Revised Standard Version, Oxford University Press)

Stay healthy,
Ned
October 12, 2022

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