It’s now 2024 - 53 years later. In 1971, US debt reached $400 billion. Even nine years later, it was still only $800 billion. At that level, the Fed’s last honest chief, Paul Volcker, could still fight inflation with extraordinarily high interest rates. His top Fed rate — 20% in June of 1981 — caused the worst downturn since the Great Depression. That is what it took to wring inflation out of the system. It was a heroic move. Politicians and economists squealed. Volcker was widely despised. He was burned in effigy on the Capitol steps and denounced by thousands of economists.
And today? A 20% Fed Funds rate would be impossible. Here’s why. After Volcker’s save, cheaper and cheaper credit made it profitable to borrow and speculate like never before. Consumers, businesses, investors, and the government all went deeper and deeper into debt. They bought bigger houses, better cars, more fighter jets and aircraft carriers... mergers and acquisitions... dotcoms... cryptos — whee!
A subtle corruption infected the whole financial system. The new money was a credit from the banks, not an asset. It was borrowed into existence – at absurdly low rates - rather than earned. Who could borrow it most cheaply? Big, credit-worthy institutions — big banks, big business, and big government. That’s how firms like BlackRock were able to outbid families and buy up thousands of homes; they could borrow at lower interest rates.
At 10%... debt payments would quickly absorb all income tax receipts. At 20%, all Hell would break loose immediately.
What this means is that the Fed can no longer ‘save the system.’ It can’t afford to. There’s too much debt. Floating on a tide of ultra-low interest rates, debt seemed almost weightless. But the farther out to sea it floated, the harder it was to get back onto dry land. Today, even a 10% fed funds rate - half the level of 1981 - would be so devastating the Fed wouldn’t dare to try it.
Today, there is $34.6 trillion in federal debt, rising by more than $120 billion per month. And the Treasury, trying to keep its debt payments down, is choosing shorter- and shorter-term debt - 2-year notes, rather than 10- year bonds, for example. The result is that more of the total debt gets ‘marked to market’ each year. And the whole lot of it becomes more sensitive to interest rates.
