The Fed Is Fuct (Part 4)…

Sign Up for Kuppy’s Korner Updates

If you’d like to subscribe to Kuppy’s Korner, please enter your email

I believe the Fed is trapped in a box of their own creation. As a result, they may want to talk tough, but their ability to maneuver looks severely restricted. The Fed claims that they’re targeting a terminal rate of 4.6% for Fed Funds, but if they did that for any period of time, they’d likely only succeed in blowing up the Treasury.

Our government has run obscene deficits over the past two decades. This was made possible by the Fed suppressing interest rates. Despite a succession of Treasury Secretaries, the US debt was never termed out. The majority of the debt is actually quite short term. During 2021, the Federal government paid $392 billion (about $1,200 per person in the US) in interest on $21.7 trillion of average debt outstanding—or an average interest rate of 1.8%.

Now imagine if Fed Funds actually got to the terminal rate and stayed there for any period of time. What would paying an average rate of 4.6% on year-end 2021 debt do to the interest expense? Well, it rises by $636 billion to $1.028 trillion or the more than the cost of our entire military spending of $801 billion in 2021. Ignoring the budget pressure, the interest cost would then be 4.5% of total GDP, up from 1.7% in 2021. That’s like tying a lead weight around the neck of our economy.


Both political parties have engaged in a drunken spending spree. There appears to be zero political desire to reduce spending and it seems almost inevitable that deficits will continue and even expand into the future. The question is, “who then funds the increased cost of interest expense in addition to the already egregious annual deficits?”

Over the past few years, our deficits have increasingly been funded by the Federal Reserve purchasing government bonds through their QE, which appears quite inflationary as we’re now learning. Except, QE is now going in reverse as the Fed claims that they’ll be selling off bonds as they conduct QT. If they’re selling bonds while the Treasury needs to accelerate their own debt issuances to cover the increased cost of interest, then rates will likely be forced higher—potentially much higher. As rates go higher, government interest costs will increase, and the cycle will accelerate the cash drain from the Treasury. At some point, I believe the Fed will be forced to step in and monetize this debt as the buyer of last resort—which is effectively what happens in most Emerging Market crises—often making the crisis much worse. This is a cycle that once started, may get ugly quite fast.

Just look at how fiercely the Japanese are defending the interest rate on their own sovereign debt. The Japanese seem to believe that once rates rise, the whole game is over. The Bank of England belatedly came to a similar conclusion after only testing QT. Over here in the states, I’m not sure if the Fed has actually done any math on the issue.


Look, Powell may want to be Volcker. He may want to crush inflation. However, I think he’s trapped. The Fed simply cannot take rates up beyond a certain point without blowing up the Treasury and then being forced back into even more aggressive QE to absorb the bonds from the Treasury—which I believe would only accelerate inflation. Besides, despite Powell desiring a recession to crimp inflation, he must realize that a recession will certainly crimp tax receipts—only making the deficits worse.

It’s all quite reflexive and low rates are what’s stopping the snowball from rolling down the hill. Raising rates could set an avalanche in motion. When your debt to GDP exceeds 100%, your ability to maneuver is restricted. I believe the US is on the precipice of an Emerging Markets debt crisis and Powell seems determined to be the one who sets it all in motion, but only after he first blows up every other global Central Bank.

I am always reminded that the Fed is full of useless academics, but in the end, it’s a highly political institution and they’ll craft the white papers to justify whatever idiotic course they choose to take. As the above scenario begins to unfold, the political class will likely force Powell to back down. They will decide that increased inflation is preferable to detonating the treasury. I believe “The Pause” is coming and it will send equities parabolic. There will be a few more nasty moments between then and today. The trick is to survive and then max it out when the Fed admits that they’re trapped. It’s going to be one of the great wealth transfers of all time. Who’s ready??

* Above meme images were self-generated using third party software. Logos are protected trademarks of their respective owners and Praetorian Capital LLC disclaims any association with them and any rights associated with such trademarks. This blog makes no representations, guarantees, or warranties as to the accuracy, completeness, currency, or suitability of the information provided via this website. We specifically disclaim any and all liability for any claims or damages that may result from providing the website or the information it contains, including any websites maintained by third parties and linked to or from this website. External links within the website are for information purposes only. The website does not adopt or endorse, and cannot be held responsible for, the contents of any externally linked pages.

Past performance of Praetorian Capital Fund LLC and its feeder fund Praetorian Capital Offshore Ltd. (collectively, the “Funds”) is not indicative of future results. No representations or warranties of any kind are made or intended, and none should be inferred, with respect to the economic return or the tax consequences from a potential investment in the Funds. Each investor should consult their own counsel and accountant for advice concerning the various legal, tax and economic matters concerning their investment. The information provided herein does not constitute an offer to sell an interest in the Funds. Such offer can only be made to qualified investors pursuant to the Funds’ Confidential Private Placement Memorandum (“Offering Memorandum”), the Subscription Documents relating thereto and the Limited Liability Company Agreement, as applicable, which set forth the complete terms of the offer. 

No representation or warranty (express or implied) is made or can be given with respect to the accuracy or completeness of the information found within this website. Certain information constitutes “forward-looking statements” about potential future results. Those results may not be achieved, due to implementation lag, other timing factors, portfolio management decision-making, economic or market conditions or other unanticipated factors. Nothing contained herein shall be relied upon as a promise or representation whether as to past or future performance or otherwise.

FULL DISCLAIMER

Sign Up for Kuppy’s Korner Updates

If you’d like to subscribe to Kuppy’s Korner, please enter your email

Sign Up for Kuppy’s Korner Updates

If you’d like to subscribe to Kuppy’s Korner, please enter your email

Related Posts