The Real Reason the Fed Will Resume Printing Money

The Fed announced a 50-basis point rate cut in September 2024.

What does this mean? How is it done? Why was it done? What are the future implications? How should we think about this with regards to investing?

These are the questions I aim to answer, perhaps controversially, in this article.

Disclaimer: I have no idea what I’m talking about, and you should most definitely NOT make a financial or investment decision based on some half-baked idea from me.

What Does Cutting 50-Basis Points Mean?

As if economics wasn’t confusing enough already, those in finance talk in basis points.

Why? Primarily because 50-basis points sounds more sophisticated than point five percent (0.5%), but these phrases are synonymous.

100 basis points = 1%

50 basis points = 0.5%

Simple enough, but when someone mentions basis points, I still pause to re-arrange my thinking into percentages.

How The Fed Cuts Rates (the actual mechanics)

To achieve the new target rate, the Fed conducts what it calls “Open Market Operations”. In typical fashion, the Fed makes up a cryptic phrase for what the rest of us would call “buying stuff”, U.S. Treasury bonds in this case.

When the Fed cuts rates, it usually buys government securities from banks.¹ This increases the reserves (liquidity) that banks hold, which makes more funds available for lending. As reserves rise, the supply of available funds increases, pushing the federal funds rate down toward the new target range.

But where does the Fed get the money to make these purchases? It just pretends to have it. And we all pretend together. This is what we now mean by “printing money”. It’s not actually physically printed by the Fed, just credited electronically. It’s magic.

The Real Reason the Fed Cut Rates

The Fed talks about economic signals like inflation, GDP, growth, unemployment, etc. to publicly justify its target rate policies. But the real answer, the one no one says out loud, is that The Fed is largely influenced by our nation’s ability to service the interest payments on our debt.

When the Fed raises rates to tame inflation, the Federal government has a higher interest rate on newly issued debt. Over time, as U.S. Treasuries are sold with higher interest rates compared to the older, pre-existing securities with lower rates, (we have had very low rates for the past decade plus), the weighted average cost of our debt increases.

The weighted average interest rate on outstanding U.S. debt reached 3.33% in July 2024, the highest since January 2010. This is still low compared to historical standards. How high can it go? No idea. But given the significant increase in our national debt, it can’t go too high or we will bankrupt the country, because the interest expense will be too large as a percentage of our tax revenues collected.

Interest on U.S. debt for 2024 is expected to be ~$1 trillion. Meanwhile, the total tax revenue collected is expected to be ~$5 trillion. This means that roughly 20% of taxes collected in 2024 will go to service interest payments on the debt. To be clear, this is NOT to reduce/retire the debt, just to pay the interest.

Because personal income taxes make up ~50% of taxes collected, approximately 40% of the taxes you and I pay collectively as individuals go to pay our interest expense on debt, not to benefits and services for the citizens.

In effect, we work from January 1 through the fourth week in May just to pay the interest on our debt… and it’s increasing… both in amount of debt and the interest rate on the new debt. This is a real predicament.

Future Implications

• The Fed must balance the need to control inflation with the growing burden of interest payments on the national debt.
• Dilemma – cutting rates reignites inflation, but maintaining high rates increases the cost of servicing the debt.
• The projected increase in interest costs over the next decade will pressure the Fed to continue to cut rates to alleviate some of the burden on the federal budget.
• While the Fed’s primary mandate is price stability and maximum employment, managing the government’s interest costs weighs heavily.
• Bottom line – if we can’t pay the interest on our debt, we are in default. In this case, there is no price stability and a lot less employment.

As I have previously written, potential solutions to the debt problem include:

• Raising taxes
• Cutting benefits
• Reducing wasteful spending
• Selling government assets
• Inflating the currency

Politicians that campaign on raising taxes and cutting entitlements and benefits are not electable (which is why there are none). While selling government assets might bring in some revenue to help reduce debt, this is a one-time fix… and it’s not entirely clear to me how much the government can sell. The only other legitimate strategy to stay solvent as a country is to inflate our way out of the debt, which necessitates printing money.

It is therefore my view that the Fed is predisposed to purposefully create inflation at elevated levels, (compared to the last decade), for the foreseeable future.

Reducing interest payment burden is the primary, unspoken reason the Fed will continue to lower rates by printing more money.

Three Investment Strategies Aligned with This Thesis

1) Invest in Appreciating Assets with Fixed Rate, Long-Term Debt

I still believe the single best investment strategy right now, for the next decade, is to purchase as many appreciating assets as possible, especially if they are income producing, with as much fixed rate debt as possible. If the federal government is going to inflate away its debt as an unstated economic strategy, you can ride this same economic wave, inflating away your debt as well. This allows you to participate in the same debt arbitrage (or currency valuation arbitrage) over time alongside the U.S. government. The strategy is to borrow in today’s dollars and pay back the loan in dollars of less value in the future (due to inflation).

Of course, this was an even better strategy in 2021, when inflation was considerably higher, and interest rates were still low. That said, I believe this is still a viable long-term strategy (and aligns with the “If you can’t beat ‘em, join ‘em” philosophy).

2) Move some wealth overseas

The secondary strategy is to hold some portion of your wealth overseas, in appreciating assets in foreign countries (in the local currency) – ideally, in countries with a strong rule of law, stable (and reasonable large) economies, rich in natural resources, well-run capital markets, and low debt-to-GDP ratios.

I asked ChatGPT to rank the top countries that fit these criteria:^{2 3}

1. Norway

Norway has a debt-to-GDP ratio of 44.3% (as of 2023), is known for its well-managed oil wealth through its sovereign wealth fund, has strong rule of law, a stable economy, and is rich in natural resources (particularly oil and gas). Although technically Norway has debt, this debt is less than the value of its sovereign wealth fund. This makes Norway one of the few countries with a net national surplus and no requirement to borrow. This is why it tops the list.

2. Australia

Australia has a relatively low debt-to-GDP ratio of 22.3%, strong rule of law, a stable economy, abundant natural resources (including minerals and energy), and well-developed capital markets.

3. Sweden

Sweden has a low debt-to-GDP ratio of 30.2%, strong rule of law, a stable economy, and well-developed capital markets. Sweden has significant iron ore deposits, forestry, and abundant hydroelectric power.

4. Denmark

With a debt-to-GDP ratio of 30.1%, Denmark has a stable economy, strong rule of law, and well-functioning capital markets. It has some natural resources, particularly in the North Sea, though not as abundant as some other countries on this list.

5. Canada

Canada is known for its well-run capital markets, strong rule of law, stable economy, rich natural resources (including oil, minerals, and timber), and relatively manageable debt levels compared to many other developed economies. That said, I would weight investments in Canada lower in the near-term, to see if it settles down politically, and reverts back to its previous norms.

6. New Zealand

New Zealand has a reasonably low debt-to-GDP of 35.9%, a stable economy and government, and scores well with natural resources (forestry, water, and minerals).

It’s interesting to note that these six countries all have similar government structures and cultural values.

Strong Dollar

To further this thesis, at least as of this writing (October 2024), the dollar is strong relative to the local currencies in these countries (compared to historical levels), especially the Scandinavian countries (whose currencies are partially depressed, sympathetic to their proximity to Russia).

Here’s the historical trend for the US Dollar (USD) against the Swedish Kronor (SEK).

Incidentally, the strong dollar means it’s a great time to visit these historically expensive countries (if you are paying for the trip in dollars).

3) Buy an index fund (ETF) that tracks with basic commodity prices

As inflation works its way through the economy, it will fundamentally find its way to commodities, the basis for all products. This is especially true if China also stimulates its economy as well, which it will, to maintain the artificially low exchange rate of the yuan (¥) against the dollar ($) with an aim to continue supplying the U.S. with goods and services with a trade surplus (from China’s perspective).

The downside of this approach is that commodity prices might only scale with inflation, and not more than that. Nevertheless, it would be an inflation hedge.

The second downside is that most commodity ETFs have a higher expense ratio than one might prefer.

Again, this is not investment advice… just me thinking out loud… updating my macroeconomic thesis… and thinking about the potential implications.

---

Follow Past Midway if you would like an email notification of new posts.

---

FOOTNOTES:

1. Technically, the Fed can lower interest rates without buying U.S. Treasuries by:
   • Lowering the interest rate on reserves to encourage banks to lend more.
   • Reducing the discount rate to make it cheaper for banks to borrow directly from the Fed.
   • Using forward guidance to influence market expectations about future interest rates.
   • Providing liquidity through repo facilities to ensure low borrowing costs.

   But buying and selling Treasuries is absolutely the primary method of influencing interest rates.

2. Source.
3. By way of comparison, the U.S. debt-to-GDP is ~129%.