The Federal Reserve seems to have finally committed to, but has not yet begun its “rate cutting cycle” of lower interest rates, specifically the Federal Funds Rate, or policy rate.

This lines up well with what I have been thinking and saying here and elsewhere; the Fed was not likely to cut rates until the fall of 2024 or later.

My thinking or guessing was based on the notion that the Fed wanted to remain perceived as tough on inflation for as long as possible and that they wanted to be perceived—eventually—as coming to the economy’s rescue, rather than just goosing the stock market higher. The Fed plays a “confidence game” with the general public.

More importantly, in my thinking, the rate cuts would line up well with and reinforce the un-inversion of the interest rate yield curve. Now, with the Fed’s Chairman Jay Powell fully making intentions known at the Jackson Hole, Wyoming Fed Conference, and market expectations now in full adjustment, the inverted yield curve is poised to pop!

You can see in the graph, it seems inevitable that short term rates (2-year government bonds) will fall below long-term rates (10-year government bonds). You can also see that this inverted yield curve cycle is the most severe and long-lasting inversion since the late 1970s.

As I remember it, that previous cycle was one of relative impoverishment for Americans, economic distress, unemployment and inflation, and more to come (the term Stagflation was coined in the 1960s in the UK) and one of the worse decades in stock market history in inflation-adjusted terms. Of course, every cycle has its differences. And of course, you cannot measure the maladjustment or erosion of the economy’s capital structure that the Fed has caused with its inflationary policies.

In addition to thinking the Fed would only begin cuts this fall or winter (depending on the election and severity of the downturn in the data), I also suspected that the Fed would engage not in the one or two quarter point cuts in rates it is currently talking about and that markets are expecting, but in a series of fairly rapid cuts, maybe 10 to 20 quarter point cuts.

This guess was based on guesses for a worsening employment situation and a fall in stock market leadership, and stock markets more generally, including real estate markets, whether in a bubble, such as new home construction or just teetering, such as commercial real estate.

My question today is what comes after all that happens, supposing that it does happen? If the Fed does cut its policy rate several times that will impact decisions. All the money in various bankable deposits might be considered for redeployment. There has been a huge increase in various types of demand deposits in the 2020s and this spiked upward higher still when the Fed raised rates, forcing banks to follow.

Banks themselves have tons of excess reserves on deposit with the Fed earning over 5%.

If the Fed lowers rates, what will happen to all that money? Here are most of the alternatives:

1. Part will stay right where it is in various forms of cash and demand deposits.
2. Part might be invested in stocks and longer-term bond investments, but which ones?
3. Part might be used to pay off or pay down debts at higher interest rates, such as credit card debt, mortgages, personal loans, etc. and businesses might do the same.
4. Part could be spent or consumed, or even invested in new businesses.
5. Part could be converted to alternative or defunct forms of money such as Bitcoin or the metal silver (Ag) which previously and widely served as money.
6. Part could be sent overseas to stock markets, bond markets, or foreign currency deposits. This type of flow would be influenced by foreign exchange rates, where the dollar has been falling lately.

These decisions will depend on expectations built on past experience and current conditions. For example, if you made a 1000 percent profit on Nvidia stock or Bitcoin and they are heading higher you might just deploy more cash into those investments. Banks also have a menu of choices should the Fed reduce their interest rate. For example, they may grant more loans and mortgages if they are optimistic, or they may increase their loan loss reserves if they are pessimistic.

Once this process is initiated by the Fed, it should happen rather “dramatically” in statistical terms, say over two years.

It is really hard to guess where the money will go, so let us drop back and see what the ABCT might tell us.

It says that in the upturn part of the business cycle that we have been in for a long time, resources will be invested in longer term capital in more roundabout production processes to the neglect of existing structures of production that produce close to the production of consumer goods.

The longer-term capital stock includes real estate creation which typically last more than 25 years, technology—especially new and “advanced” technologies that might not be deployed under free market conditions for years to come, if at all, and anything research related, such as pharmaceutical products that often don’t pay off for years or decades to come.

The theory predicts that such investments are overdone and premature and will probably suffer the most losses in the downturn.

The shorter-term capital stock is an investment that produces consumption goods or direct inputs into consumption goods.

For example, if I make a $1 million investment to clear some land and have it tilled up and plant a crop such as corn, I will have a product to sell in less than a year’s time. This is rather direct and starts to pay in a relatively short term, even though the process might last for decades.

In contrast, I could have made the same investment but planted grape vines for the production of wine, but I might not be able to actually produce wine for sale for a decade or more, which is similar to pharmaceutical research. That is, more roundabout.

This would suggest that the historically low-interest rate policy environment that we have been living in since the Great Financial Crisis, in the aftermath of the Fed’s Housing Bubble, has tilted the capital structure of our economy in favor of the longer term, or more “roundabout” production and away from the more direct and lower order consumer goods.

In terms of my guesses, the overinvested maladjusted component of the economy would be illustrated by Artificial Intelligence. AI will no doubt eventually bring many benefits, but it may prove to be a bad investment in the shorter run.

The underinvestment area of the economy, and again this is just my guess, is in the production of commodities that I illustrated above with growing corn.

This malinvestment pattern has probably been exacerbated by other government policies which have increased longer term, more roundabout production such as Covid treatment spending, Chips Act, and Green-Global Warming-Climate Change policies to discourage, for example, agriculture, ranching, mining, and energy.

This a transcript of the Minor Issues podcast, “Where Will All the Money Go?”

Originally Posted at https://mises.org/

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From day one of his presidency, it has been apparent that Argentina’s President Javier Milei wants the Argentinian regime to be a willing member of the US-NATO axis in international affairs. Milei has demonstrated this with a variety of overtures toward the State of Israel and by his repeated meetings with the dictator of Ukraine, Volodymyr Zelenskyy.

This all positions Burenos Aires as a reliable supplicant and friend of Washington. Or, as I summed it up back in June:

[Milei] displays no particular affinity for anti-interventionist foreign policy, and he’s certainly no threat to the established US-dominated geopolitical order. Milei is, and will likely continue to be, a reliable ally of the American security state. More succinctly, we might say that Milei is a “CIA-approved head of state.”

It should be noted that there is no reason why Milei is required to take these positions. Milei could easily stake out a position making Argentina a “non-aligned” country that refuses to participate in US and NATO meddling in Eastern Europe. Milei’s regime could easily choose to not take a position in the multiplying conflicts between Washington-Tel Aviv and half a dozen other states.

After all, Buenos Aires is 12,000 miles from Tel Aviv, and it is nearly 13,000 miles from Kyiv. The idea that Buenos Aires must choose a side in either of these two conflicts is absurd. Moreover, Argentina has a small economy and is an economic basket case so, frankly, the Argentinian military is tactically irrelevant to any global conflict. Support from Milei and Buenos Aires for the US and NATO serves only a diplomatic function—to help Washington manufacture legitimacy for its endless international interventions.

But that is apparently now not enough for Milei who has now signaled that he wants to increase military spending and to increase the strength and prestige of the Argentinian military establishment.

In a speech last month to supporters of the Argentinian military, Milei laid out his vision for what he called “a big Argentina, a strong Argentina, a powerful Argentina.” (And lest there be any question about mistranslation, these are his words: “queremos una Argentina grande, una Argentina fuerte, una Argentina potencia.”)

What exactly does it mean to have a big, strong, and powerful Argentina?

With these words, Milei is not talking about increasing the power and prosperity of the private sector. He doesn’t mention that in his speech. Rather, he means more power for the regime, and that means a lot more government spending. In the speech, Milei brags about buying 24 F-16 fighter jets, and modernization of the TAM tanks. Milei wants higher salaries for government bureaucrats (i.e., military personnel) and he insists that these government employees “deserve” more “respect and recognition.”

Given that Argentina has not been involved in any significant international conflict since the nineteenth century—and faces no real international threats on its land or maritime borders—one might wonder what the regime could possibly need new tanks for. Milei hints at this moments later when he reminds the audience he wants to “join NATO as a global partner.”

(In fairness, it should be noted that Milei’s position is just a continuation of the status quo. In this aspect of his policy agenda, Milei does not appear to be any more pro-NATO than his predecessors of the past 25 years. Indeed, Argentina has been one of the more pro-US regimes in South America for decades.)

Where we do find an alarming new direction, however, is in Milei’s apparent intent to use his intended strong and powerful military against domestic “threats.” According to Milei:

Until now, the Armed Forces have been entrusted with the task of purely and exclusively protecting against potential external threats. … [I]t is imperative that we rethink these old paradigms. Argentina cannot be oblivious to this new reality; it is time to modernize and adapt to these new threats. That is why we are modifying the Internal Security Law so that the Armed Forces can support the Security Forces in exceptional situations, without having to resort to the extreme option of declaring a state of siege.

That last sentence is the most ominous: “we are modifying the Internal Security Law so that the Armed Forces can support the Security Forces in exceptional situations.”

Were an American president to say such a thing, it would be a signal that the regime is going all-in on embracing a police state. In a civilized country, there are legal barriers against the use of the military against the domestic population. The US has many such legal barriers, the chief example of which is the Posse Comitatus act. The US regime frequently ignores these limitations, of course. Washington now routinely uses its military-intelligence apparatus to spy on Americans, and worse. Yet, it’s better to have the legal pretense of limitations on domestic military operations than nothing at all.

In Argentina, Milei says he wants to break down these barriers in his quest to fight domestic enemies. This plan is, essentially, the “Argentina edition” of the Patriot Act, and the Department of Homeland Security.

Militarism within the Argentinian Context

It is important, however, to not excessively compare the US situation with the Argentinian one. To this day, much of the public’s view of the military in Argentina is influenced by the human rights abuses of the military dictatorship during the so-called Dirty War from 1974 to 1983. During this period, with the help of the American CIA, the regime in Argentina “disappeared” and tortured thousands of dissidents.

Since then, the Argentinian military establishment has suffered from a notable lack of prestige among much of the Argentinian public. Public views of the military are not uniform among members of the public, however. In Argentina, skepticism of military power is generally associated with “the Left” while support for the military establishment is seen as “rightist.”

Milei seems to now be doubling down on this political framing. For example, in his speech last month, Milei claimed the military is being “emptied out” (”vaciamiento”) and “for decades” has been relegated to an “undeserved” low-status position.

When he says “for decades” this is likely a reference to the last forty years during which military spending in Argentina has been well below what it was in the days of the dictatorship. According to SIPRI’s database on military expenditures, military spending increased sharply when the junta came to power, and declined sharpy after the junta was deposed.

Since 1990, however, military spending (in constant 2022 dollars) has been largely unchanged, although it tends to fall below average levels when the Argentinian economy enters one of its many financial crises. The military in Argentina is hardly withering away, but even if it were, we can’t say it has suffered any more than the average Argentinian household. Indeed, because it has access to taxpayers’ dollars, military personnel have done well for themselves compared to the long-suffering private sector.

(In nominal terms, military spending is higher now than during the 1990s, although the incessant devaluing of the peso has meant military spending has fallen in real terms.)

Milei’s framing of how the military has not been treated with proper respect suggests he thinks the military has somehow been treated unfairly since the days of the dictatorship. This is likely to create a closer association—in the public’s eyes—between Milei and the old Argentinian Right which tends to agree that the Left in Argentina is inordinately obsessed with rehashing the old crimes of the military 45 years ago.

This latter position among Rightists is not entirely unwarranted, but Milei’s apparent decision to commit himself to a larger, more powerful and more costly military risks reviving and confirming the Latin American Left’s position that libertarian or free-market candidates are on the side of militarism and human-rights abuses. This association has dogged Chilean “classical” liberals for decades after Augusto Pinochet—quite by accident and against his personal ideological leanings—ended up supporting a turn toward economic freedom as a way to escape Chile’s inflationary downward spiral. Ever since then, the Left in South America—which loathes free markets, of course—has insisted that any candidate that supports free markets is a secret Pinochet clone who wants to bring back the juntas of the bad old days.

Unfortunately, Milei seems to be playing right into the Left’s hands on this. All his rhetoric about overpaid government bureaucrats is conveniently forgotten when he speaks of military officers, and his talk about cutting back military spending apparently does not apply to funding new efforts to waging war on domestic enemies.

With this latest policy turn, the evidence continues to mount that Milei is more a typical conservative or “rightist” than he is a free-market libertarian in any meaningful sense. It’s the usual conservative formula: “government spending is bad unless it’s for my friends at military headquarters.” America has suffered under this bait-and-switch brand of conservative politics since 1945. Milei may be the latest example abroad.

Originally Posted at https://mises.org/

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