The Fed’s “One Weird Trick”

The U.S. economy has been saved time and again over the past two decades by this one weird trick:

“Bringing Demand Forward” by lowering interest rates and lending standards so Americans could continue to buy stuff they didn’t really need because the monthly payment dropped as interest rates were pushed toward zero.

Every time the economy faltered, the Federal Reserve would push interest rates down to “Bring Demand Forward” by goosing debt-based consumption: OK, so you don’t actually need a new car, but come on, the new car loan is only 1.9%, you can afford the monthly nut.

Or hey, it’s zero-percent financing for a couple years. Just go for it, get that new vehicle. Live large, you can swing it.

Flooding the economy with low-cost credit doesn’t just “Bring Demand Forward”; it also juices speculative bubbles across the entire spectrum, from cryptocurrencies to commercial real estate.

As bubbles inflate, punters feel wealthier and so they’re willing to borrow and spend more — the infamous “wealth effect.”

Nothing “Brings Demand Forward” like a speculative bubble and so inflating credit-based bubbles is all part of the plan to encourage people to buy stuff they don’t need on credit to keep GDP expanding.

“Bringing Demand Forward” with speculative bubbles is joyous until the bubble pops — and all bubbles pop. When bubbles deflate, gains are replaced by losses and the reverse wealth effect kicks in.

The solution for the past two decades has been to drop interest rates even further and expand credit even more to generate a new bubble in one asset class or another.

Now that central banks have pumped up the Everything Bubble and unleashed inflation, the weird trick of dropping interest rates/juicing liquidity no longer works. It no longer works in China, Japan, Europe, the U.S. or the developing world: Diminishing returns are systemic.

Economies that become dependent on zero interest rates juicing liquidity habituate to this constant stimulus and become dependent on speculative bubbles rather than on organic growth funded by earnings, savings and the advances of productivity.

“Bringing Demand Forward” always had an expiration date. You can’t bring demand forward forever. Eventually consumers tap out, bubbles pop, speculative gambles go bust, debt service eats up consumers’ disposable income, credit cards get maxed out and enterprises bloated by decades of bubbles and credit-funded spending implode under their fixed costs and debt loads.

The fantasy is that inflation will plummet to zero and we can all go back to “Bringing Demand Forward.”

The reality is what’s plummeting is demand. The Everything Bubble is popping, credit is tightening, stimulus that worked in the past is no longer saving stagnating economies and the higher cost of credit is drowning consumers and enterprises that have grown complacent after 20 years of continuous “saves” via zero interest rates and tsunamis of cheap credit.

Sure, those households bringing in $250,000 and up are doing just fine — if they bought houses and other assets ages ago and can reap the gains to subsidize their lifestyles. But everyone living off average earnings without the cushion of Everything Bubble gains — how much “demand” will they be able to afford after paying $300 for a couple bags of groceries?

It’s going to hurt when we hit the rocks at the bottom and unfortunately few are taking measures to reduce their risk while such measures are still within reach.

Below, I show you how “doom-loops” are forming that could devastate financial markets and the entire economy. Read on.


By Charles Hugh Smith

The shift from real to fake occurs because it serves somebody’s interests. The married couple who have fallen out of love continue the pretense of a “happy marriage” for a good reason: The facade of lovey-dovey normalcy plays well socially and in their careers.

The kids know better, of course, and so they’re told that propping up the facade presented to the outside world is “non-negotiable.” They can snark to their friends privately but must dutifully play the part in public lest their warring parents make life even more miserable than it already is.

The shift from fake to fraud is an easy one, because reality cannot be allowed to break through the artifice. The artifice is the business is doing great, but the reality is the enterprise is sliding into insolvency.

And so the partners start cutting corners: stop paying taxes and invoices, start borrowing money to cover expenses and eventually, begin defrauding others to maintain the facade of success and normalcy.

It’s a slippery slope, and it all starts when we decide that reality is unacceptable because it demands painful sacrifices and trade-offs. So we choose artifice over reality. At first it’s just a matter of omission: We leave out the unpleasant bits and hype the happy facade. Here we are on vacation, look how luxurious it is, look how happy we are.

But artifice isn’t real, it’s fake, and the costs are not just financial. Living a lie saps us of integrity and moral cohesion to the point that we can no longer distinguish between the artifice being propped up and the real world.

All that matters is sustaining the illusion of stability and success, and to do this as reality weighs on the fake facade demands ever larger servings of artifice.

The end-point of artifice is the emperor has no clothes: Those propping up the facade insist a risibly obvious lie is the truth. Since those propping up the facade have invested everything they have in the artifice, they’re now totally dependent on everyone accepting the fantasy as if it were real.

In other words, once everyone accepts the artifice as if it were real, it becomes real. But this too is artifice. Reality is not a matter of public opinion or approval. We don’t decide what’s real and what’s fake/fraud by opinion polls. Real is real, artifice is fake.

You already know I’m talking about the U.S. economy, and indeed, the global economy because like the onlookers suppressing their mirth at the naked emperor’s supposed finery, we all know the “growth” and “prosperity” are functions of artificial stimulus, the ever-greater conjuring of “money” out of thin air, pushing interest rates underwater and fiddling with statistics.

We all know it’s as fake as the luxurious lifestyles posted on social media by youths struggling to pay rent. The craving for artifice over reality has infected the entire culture and economy. What’s real no longer matters; all that matters is the public facade is maintained at all costs.

The problem is those clinging to a world of artifice lose the ability to deal with the real world. They believe that maintaining their fake facade is a substitute for dealing with reality, and so they lose the practice of dealing with the real world via difficult solutions that demand sacrifices and trade-offs.

Unfortunately for all those beavering away at maintaining their world of artifice, reality is implacable, and it manifests as doom-loops, which feed on artifice and become stronger until they break through the facade and the artificial construct collapses.

A current example of a doom-loop is the collapse of commercial real estate in downtowns emptied by remote work. The loop is the decline of the commuting workforce that feeds the decline of demand for office space and the decline of small business that served the workforce and paid rent.

As the area decays, fewer people seek office space or are willing to start a new business. The decay feeds on itself.

The facade of artifice demands a happy-story solution, which is to convert all those empty office towers into luxury apartments and condos that will be inhabited by free-spending folks who will spark a renaissance with their wealth.

The problem is that it’s not cheap or easy to convert office space to dwellings. It’s horrendously costly and therefore risky. And since the downtown has already decayed, there is no certainty in the assumption that high-income people will flock to a barren cityscape of homeless encampments and vehicles with smashed windows.

The irony here is the doom-loops are generated by our refusal to deal with reality. We want artificial solutions that cost us nothing and require no sacrifices, fake fixes that maintain the facade we value more than our ability to function in the real world.

Doom-loops don’t occur in isolation: They interact with each other, reinforcing each other. Attempts to suppress one doom-loop by papering over the unwelcome reality accelerate other doom-loops.

There is a structure to our artifice: Those benefiting the most have the most to lose should the facade crumble. Those at the top of the heap are thus fanatically devoted to propping up the illusion of stability and “growth,” regardless of the damage being done behind the happy-story facade.

There is no master plan in the desperate machinations to keep the facade intact. There is only the day-to-day plugging of holes that reality is leaking through.

And so the fraudulent farce continues: The social media facade of luxury behind the five roommates crammed into one flat struggling to pay rent, the “stability” of the banking sector, the permanence of “growth,” the tired joke that “debt doesn’t matter because we can always conjure more money” and the absurd confidence that speculation is a substitute for a functioning economy that doesn’t depend on financial trickery for its survival.

A desire to restore our collective ability to deal with reality gets one labeled a bitter doom-and-gloomer, because this would require the collapse of artifice. And that, of course, is non-negotiable to those who have confused their artificial world with the real world.

The era of 2023–2030 will be a titanic struggle between the forces of artifice and the multiplying doom-loops generated by artifice. Artifice has been the official policy since the Vietnam War era, and the conventional view holds that the past 50 years are proof that artifice can be successfully maintained forever.

This confidence can only be maintained by refusing to look at the doom-loops gathering momentum behind the facade. The effort required to keep the facade intact increases geometrically, and eventually the system can no longer keep it all glued together.

At that point reality intrudes and we’ll have to regain our ability to deal with a world stripped of financial trickery and fraud. That won’t be easy because we’ve spent 50 years in a world of artifice.

Those who find this hard to swallow, answer this: What would happen if the Federal Reserve ceased to exist and the federal government could only borrow 1% of its revenues for additional deficit spending? What if all the trillions in stimulus, borrowing and trickery went away tomorrow?

Does anyone seriously believe the economy would chug along, unperturbed, rock-solid and stable? This is the difference between artifice and reality. If you prefer reality to artifice, oh, you wretched doom-and-gloomer. Just look at our social media feed, that’s what’s real. Hungry and can’t eat an iPhone?

No problem, just have AI conjure up an image of a banquet and post that on your public-perception feed.

The Daily Reckoning