Fed Acknowledges Financial Crisis, But Hikes Rates Anyway

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 28, 2023

1. Overview: Fed Hikes Rates Despite Warning Signs

2. What If This Perception Is Wrong & Fed Gets It Right?

3. Biden’s New Budget Calls For More Plundering Of US Taxpayers

4. Biden’s Raid On Taxpayers Would Hit In Several Waves

Overview – Fed Hikes Rates Despite Warning Signs

Last week was highlighted by the Federal Reserve hiking short-term interest rates, despite clear warnings that our financial system is under stress, complete with two bank failures. The Fed Open Market Committee (FOMC) met last Tuesday and Wednesday to set interest rate policy for the coming weeks and for the first time this cycle acknowledged we have a “banking crisis” on our hands.

The so-called banking crisis exists now because two mid-level banks failed earlier in March and had to be rescued by the Federal Deposit Insurance Corporation (FDIC). Going into last week’s Fed policy meeting, we were told most FOMC members wanted to raise the Fed Funds rate by 50 basis points (0.5%) and up its forward guidance for future rate increases.

Yet with the surprise failures of Silicon Valley Bank and New York’s Signature Bank, we are told the Fed’s policy committee decided to back off and raise its key rate by only 25 basis points (0.25%) in its effort to bring US inflation down. This is what was ultimately decided, and Fed Chairman Jerome Powell made it clear the Fed is still very committed to getting inflation under control this year.

The question is, of course: How can the Fed raise rates enough to slow the economy and get inflation under control without sparking a recession this year? It’s a serious question.

The Fed made it clear it still thinks there is a path to lower inflation without throwing the economy into a recession. As such the Fed moved forward with its plan to raise the Fed Funds rate by 0.25% in March, presumably with additional small rate hikes at subsequent policy meetings later this year. Chairman Powell emphasized this was the plan several times in his post meeting press conference last Wednesday.

Not surprisingly, many interpreted this move as the Fed being tone-deaf to the credit crisis. And that makes them believe the central bank will hike the US economy right into a recession.

Those feelings were exacerbated when stocks, commodity prices, and Treasury yields all dropped after the Fed’s announcement. That’s a rare combination which typifies pre-recession behavior in the financial markets.

But What If This Perception Is Wrong & Fed Gets It Right?

The question is: Why would the Fed pursue policies it knows would most likely drive the economy into a recession? It is widely agreed the people on the Fed’s policy-making Committee
are a smart bunch. So, why would they make such a policy decision?

Picture of the federal reserve bank building

Maybe the Fed knows more than we think they do. Perhaps Jerome Powell & Company believe they know the issues well enough to guide us to lower inflation without sparking a recession. That’s a tall order, of course, but it seems to me this Fed believes they can pull it off. In any event, it looks like they are going to give it a try.

The next two Fed policy meetings are on May 2-3 and June 13-14. That may seem like a long way off, but they’ll be here before we know it. At the least, we would expect the Fed to raise its short-term rate by 25 basis points at each of these meetings.

What the Fed does beyond that is anyone’s guess. We have to see how much inflation comes down and how much it affects the economy going forward. There is broad disagreement on what happens beyond the Fed’s June meeting. Sometimes we just have to wait and see what develops. This appears to be one of those times when we have to wait and watch.

Consider this: The Federal Reserve hasn’t discussed “tightening credit conditions” during this rate-hike cycle. Yet, last week, Powell mentioned it about a dozen times in his post-meeting press conference. He kept saying over and over again that because of the bank failures, credit conditions are tightening.

Clearly, he wanted to emphasize to everyone that bank lending standards are tightening significantly. Still, he kept saying that it is too early to say what these tightening credit conditions will do to inflation.

Tighter credit conditions mean it is harder to get access to capital. The harder it is to get access to capital, the less capital consumers and businesses have at their disposal. The less capital they have at their disposal, the less they spend. The less they spend, the lower inflation goes.

It’s not rocket science. It’s Economics 101.

Biden’s New Budget Calls For More Plundering Of US Taxpayers

Farmers know a thing or two about stewardship. If they don’t take care of their land, eventually it will cost them their livelihoods. Unlike farmers, who work to steadily build a better future, Vikings would plunder villages, taking all they could carry away before moving on to their next target.

President Joe Biden’s budgets take the latter approach, going after more and more of the American people’s hard-earned treasure every year.

Last year, his budget sought an additional $2.5 trillion in taxes beyond the $55.8 trillion in revenue that was forecast to be collected over 10 years. His latest budget is even more aggressive. The president is calling for $65.2 trillion in taxes and other revenues—nearly $7 trillion more than his last mega-budget.

Yet even with all the extra spoils, Biden’s budget would somehow manage to spend $17 trillion more than it would collect. This would shackle the American people with an additional $120,000 in federal debt per household by the end of the decade.

Picture of President Biden

While the left portrays America’s billionaires as a bottomless well of tax revenues, the government could confiscate every penny of wealth from all the billionaires on the Forbes 400 list, seizing their companies’ assets and bankrupting them overnight, and that would barely cover half of Biden’s newest round of proposed increase in taxes. It wouldn’t even cover 5% of Biden’s total 10-year budget.

Clearly, all of Biden’s tax hikes can’t be limited to the very rich. Inevitably, they will reach the doorstep of every working American.

The Biden budget document repeatedly boasts it is “fiscally responsible.” The truth is, it is unsustainable, and it would doom the middle class to massive future tax increases.

Biden’s budget would allow across-the-board tax hikes by permitting most of the Trump individual tax cuts to expire. However, the biggest taxpayer raids would directly target upper- and upper-middle-income taxpayers. The collateral damage would be devastating and widespread, reducing investment, stifling entrepreneurship and leaving fewer good jobs for all Americans.

Biden’s proposed tax hikes on the upper middle class are a foreboding sign for the middle class. In the days of the Vikings, if a richer nearby town was hit with repeated raids, surrounding villages had even more reason to fear they could be the next target.

Biden’s Raid On Taxpayers Would Hit In Several Waves

Under Biden’s plan, federal taxes on wages for upper- and upper-middle-income Americans would rise from 37% to 44.6%. If they invested some of their after-tax wages in stocks, they would face a 28% tax on any profits at the corporate level (up from 21%) and up to 44.6% tax at the investor level (up from 23.8%).

And that’s just the federal income taxes. Factoring in inflation and multiple layers of state and local taxes, many investors would be left with none or almost none of their investment gains after the government ransacking. It’s insulting that Biden refers to this as their “fair share.”

Small businesses—and those who rely on them—wouldn’t escape the wrath of Biden’s new taxes. Currently, small business active income is exempt from the net investment income tax, a surtax applied to investment income. Biden’s plan would extend this tax to directly hit most small business income and would raise the surtax from 3.8% to 5%.

Even death may not protect businessowners from Biden’s new taxes. The president’s proposal would nearly triple the number of taxpayers subject to the 40% death tax in 2026. If the deceased owned a business, the tax would apply to any increase in the value of a business since it was started or acquired. These changes would punish families for experiencing tragedy and force more owners of family businesses and farms to liquidate their assets to pay the steep taxes.

When businesses and farms are ruined, it’s not just the owners who suffer. Store clerks, janitors, and laborers will struggle to put food on the table when their employers are forced out of business.

For too long the president and Congress have treated taxpayers as though they should be allowed to keep only what the government decides, as though taxpayers serve at the pleasure of the government. This is precisely backward.

The government exists—at the consent of the governed—to defend us against threats to life, liberty and property, not to take our liberty and property in a less violent way.

That’s a LOT to think about it one sitting. I’ll leave it there for today.

Very best regards,

Gary D. Halbert

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