The Peter Zeihan Podcast Series - The Federal Reserve and Its Inflation Target || Peter Zeihan

Episode Date: July 5, 2024

For all the hungover Americans out there, I heard the best cure after a long day of drinking is to talk about inflation. Well, maybe it will just make your head hurt more, but you still have the weekend ahead of you to relax... Full Newsletter: https://mailchi.mp/zeihan/the-federal-reserve-and-its-inflation-target

Hey, everybody. Peter Zion here coming to you from the Lost Wilderness in Colorado. This is Lost Canyon that I have found myself in and turned out to be a little bit more than I bargained for. Anyway, we're going to take an entry from the Ask Peter form today. Specifically, it's that I've said that we're going to be facing several years of inflation around 10% or higher. And so should the Federal Reserve revise their policy on interest rates? For those of you who are not financial aficionados, the prime rate is what the Fed sets. And the idea is you want it low enough to generate economic activity by making credit cheaper, but high enough that the demand doesn't get out of control and generate runaway inflation.

So if we're looking at a 10% inflation rate, that's a bit of a problem because the Federal Reserve targets a 2% inflation rate. So big difference. And a little bit of rain. We're going to continue this in a minute. So during the financial crisis into COVID, we were basically at a 0% prime rate, and we've been ticking up ever since. We're around, oh, geez, Fed met while I was gone. Let's call it 5.5%, 6%, somewhere in there.

Anyway, the question is whether they should go higher. Yes and no. First and foremost, the Fed is going to be wrestling with things that I can't even imagine. So I'm not the kind of guy who says the Fed should do this or the Fed should do that. I would just say that the Fed has a lot of tools. And as we saw during COVID and the decade before, they can use them in ever more creative ways. However, however, however, the key thing to keep in mind is the reason we're going to be having these high inflation rates is not necessarily because of growth per se, although it will be that. But also because we're going to be doing a historically unprecedented industrial buildout.

we basically need to double the size of the industrial plant and probably increase the amount of processing capacity we have for raw materials by a factor of 10 that's going to use a lot of electricity, a fair amount of labor, and a huge amount of land. So normally, if the Federal Reserve was looking to get inflation under control, they would raise interest rates to make borrowing more expensive. But if you do that now, you're going to choke off that industrial expansion. And we're not engaging in this industrial expansion because we think it's just a Pitchie-Kean idea. This is not normal economic activity.

No, no, no. We're anticipating the collapse of the Chinese into a lesser degree of the European industrial systems. So if we still want manufactured goods, we have to build the manufacturing plant. If you were to raise rates in that environment, you would choke it off and we would be left with higher costs of living because of a lack of goods rather than because of inflation. and so basically we get the worst of all worlds. There's another reason why I'm not going to be needling the Federal Reserve to do anything specific, and that's because the rules as we understand that are changing. Going back to the dawn of the first era of globalization that Columbus kicked off in 1500,

economic activity on this earth has been based on more interaction, larger populations, more interconnections, greater financial penetration, more markets, more technology, and the core of all of that is more people. Well, that's not happening anymore. Countries is as diverse as Japan, Korea, China, Taiwan, Thailand, Germany, Spain, Poland, Russia. You know, they've all aged out. It's not that they're going to die in the next year, although some of them are getting close, but they will never have larger populations again unless something really weird happens with migration.

So if you remove that component, larger and larger populations, that has undergirded economic activity for the last five, 500 years, you know, we need a new model. Because if it's not based on population expansion and the market expansion that comes from that, what is it based on? Well, we don't know. Any guide that we have is literally futile 500 years ago or more. So we're going to have to figure out something new. We're going to have to figure it out as we go. Now, the advantage that the Federal Reserve has in this is the United States is the first world country that does not face the same degree of demographic degradation as everyone else. Yes, the American birth rate has recently dropped by quite a bit.

Millennials have more kids. But if we keep dropping at our current rate, we're not going to be in the same situation as a China or Germany or Korea or in Italy for another probably 40 to 60 years. So we will get to see what everyone else does with monetary policy in an environment when there's no demand to regulate. Because let's be honest here. Interest rates going up and down. All that is designed to do, is to regulate the amount of demand in the economy. And if your populations are bombing, there's no demand left. So the Federal Reserve has more tools. Its tools work better.

And it's a growth story. So regardless of what happens with policy, this is still a pretty positive outcome. The only way that I can see that the Federal Reserve might be forced to do something different, if the inflation gets to the point that it becomes a political problem, and then you will have the executive and the legislative of the U.S. government, basically working together to pass a law to tell the Federal Reserve what its goals are and how to achieve them. We're nowhere near that yet, but I would argue that's the thing to look for. Not this year. Not next year, but thereafter. All right, let's see if I can get out of this canyon. Take care.