Fed to Induce Recession: Serious Pain Ahead for Workers
The following is a lightly edited transcription from The Punch Out with Eugene Puryear, a daily news podcast that comes out Monday through Friday, 5pm ET. Subscribe here.
Almost every major economic commentator is now predicting a recession in the United States in the second half of the year — as we have been predicting here on The Punch Out since last year. But what most are obscuring is the underlying fragility of the U.S. economy.
The immediate reason for the recession fears is the Federal Reserve’s approach to inflation: raising interest rates.
It's no secret that inflation is plaguing the US and making it more difficult for millions to make ends meet. In the last 12 months inflation has increased 8.3%, while wages have only increased 5.5%. This is, in essence, a pay cut and inflation is straining budgets at every level in a major way.
Raising interest rates is the Federal Reserve’s main method against inflation — and something of a blunt force instrument. This is sometimes referred to as “draining liquidity” from the economy and it works like this: Raising interest rates means making it more expensive to borrow money. Since the economy essentially runs on credit, by making it more expensive to borrow money, the overall economy is going to shrink, as people become less likely to lend or borrow money for new investments or expanded ventures.
How does this affect prices? With a weaker economy and a smaller overall market, both capitalists and consumers are more selective with their money, and so to remain competitive in a smaller market, the price has to be right. For instance a company might have to internalize a slightly increased cost rather than pass it on to you, the consumer.
The bottom line is that raising interest rates to defeat inflation essentially means forcibly making the economy smaller to reduce inflation — otherwise known as inducing a recession.
Fed Chairman Jerome Powell has been doing the media rounds noting that there will be increased interest rates hikes and warning, in his words, that this will involve some “pain.”
There are three questions that flow from this: 1) How much pain, 2) For who? and 3) Is this blunt force approach really the best and only way to contain inflation?
As for the depth of the pain, Powell has been saying it will be slight. This is a very rosy scenario — the suggestion that there may not be a major recession, or depression.
In fact, as we have been pointing out, the warning signs are all over that the Fed’s rate hike moves could knock down some serious dominos.
When you raise interest rates, companies that are struggling to pay their debts are likely to go under. There is a phrase for companies in the most precarious position with debt, that aren’t earning enough to cover their interest expenses, and are most at risk if interest rates go up: “zombie companies.”
According to a report from the Federal Reserve itself, 10% of publicly traded companies are zombie companies and 5% of private companies. These aren’t just random companies. In 2020, the ranks of zombie companies included Boeing. On top of that, zombie companies in the US owe at least $2 trillion, more than even at the height of the 2008 crisis. So this is a pretty ominous situation. It raises the obvious question: who loaned them that money? How interconnected are those banks and lending institutions with other companies? One major bank lending to too many failing companies can bring down the whole financial institution, and endanger even healthy companies. There are some signs that this could in fact be the case.
For instance, the repo loan market, which is one of the most central markets for the day-to-day operations of the financial system, based on short-term lending between institutions, has had trillions of dollars pumped into it by the Fed in the past couple years. In fact, in the fall of 2019, before the pandemic, the Fed had to pump $9 trillion in just a few months into the repo market, and, in fact, created an entirely new program last year to facilitate the pumping of as much as $500 billion a day into the repo market.
So, ask yourself, if the Federal Reserve is routinely having to prop up one of the most major loan markets out there, to keep the casino open so to speak, what does that say? Obviously that there are all sorts of bad bets sloshing around — just the type of thing that interest rate hikes might turn into a disaster.
Further, as the Wall Street Journal reported late last year: Record sums in borrowed money, in excess of $814 billion this year, has been spent by stock speculators. That amount was “up 49% from one year earlier, the fastest annual increase since 2007, during the frothy period before the 2008 financial crisis. Before that, the last time investor borrowings had grown so rapidly was during the dot-com bubble in 1999.”
In short, people are borrowing money to play on the stock market at a rate that has not been seen since the 2008 financial crisis and the 2000 dot-com crisis.
It doesn’t take a rocket scientist to see that the economy is fragile and that big rate hikes could send a lot of these risky bets tumbling down, and that could take a lot of other stuff down with it. Before you know it, we could be in a full blown economic crisis — and you can guess who is going to be asked to foot the bill for all these “too big to fail” institutions if that happens. In every recession, it’s the workers who feel the actual pain in all this: who lose their jobs or see their wages cut, whose public services are reduced via austerity budgets, along with small business owners and homeowners who find themselves holding loans and mortgages they can’t repay. The big financial players who induce the recession get bailed out and buy up assets on the cheap.
The final question I raised: is this really necessary and is there another way? Here it is important to understand what is causing inflation to determine what would be most effective, and least destructive way to handle it.
As we’ve noted before on this show, a recent analysis from the Economic Policy Institute made the very notable finding that the biggest contributor to inflation is corporate profits.
The Economic Policy Institute analysis, put together by head of research Josh Bevins, looked at price increases from the second quarter of 2020 until the end of the year in 2021. The analysis found that 53.9% of the price increase was due to fatter corporate profit margins, 38% to non-labor input costs (the supply chain, more or less), and only 8% to wages.
So just to underscore what that means, out of every dollar that prices go up, about 54 cents goes to pad the corporations’ profits, about 38 cents goes to deal with supply-chain issues and only about 8 cents goes to increasing wages. The idea that higher wages are driving inflation is an outright myth.
So, bottom-line: To keep profits high, corporations are increasing prices well above their increased costs, and then just telling the world prices are higher because of the “supply chain” or “wages.” No one is talking about addressing this real issue, the core of inflation.
This is important because it speaks to another way to address inflation without tanking the economy: an “excess” or “windfall profits” tax, which can be set by public policy. If corporations have to pay higher taxes on profits, they will be far less likely to increase prices as fast as they have been, helping to curtail inflation, but not the economy.
Sounds reasonable, right? But there is really not much chance at all anything like this could actually happen. It certainly couldn’t pass Congress, where the bought-and-paid-for politicians will do nothing substantive to challenge the profits of their corporate donors.
That's U.S. capitalism for you. They cause the inflation crisis, and then decide to fix it in the way that’s most harmful to you and least harmful to them.