It should be obvious by now to everyone that increasing interest rates to slow the economy is not resulting in lower inflation. It is obvious to the Federal Reserve, who nevertheless continues to increase rates to kill the patient to make the procedure successful.

The reason increasing interest rate increases are not working is inflation now is the result of a far different landscape than previous economies. Just one example: only about ten percent of new mortgages are variable rate which increases with an increase in prevailing interest rates. A decade ago, the number was forty percent. Having a fixed rate mortgage in this environment makes you immune from the effects of rising mortgages, unless you choose to move.

The overall savings rate is higher, due in part to the stimulus payments but more to the changing demographics of the country. About twenty percent of the population is 65 or older. In 2005, the figure was closer to twelve percent. This is a group that is living off its capital by expending it. In effect the older retirees are acting collectively as a privatized version of the government stimulus program.

At the same time, there remains 1.5-2.0 job openings for every person looking for work. The Fed has looked high and low for the supposed missing workers who disappeared after covid. It would be a safe bet at this point they are not coming back. Whether long covid, death, other disabilities, personal capital to live off, or whatever, the workers the Fed assumes can be enticed back to the work force does not seem to exist.

Finally, there is another reality: the wages increases that have been paid through price increases to date have not put most people ahead of inflation. This implies that wage increases are set to accelerate unless more workers can be found.

Workers can be found if the immigration system can be reformed to accommodate them. One proposal is for a worker visa for five years, subject to renewal. They would be distributed based on skills needed by domestic employers. Employers can interview workers in their home countries or otherwise outside the US. Smaller employers can have this done on a pooled basis by the Department of Employment Security in their state. If a person has a skill set in demand in the US for which there is a job vacancy, they can be hired by a domestic employer. They would be given a social security number; their wages would be taxed, and they would be required to contribute to Medicare and Social Security.

As they would not have full citizenship, they could not apply for either retirement or retiree medical benefits. They would be covered by workers’ compensation. They would be paid at least the minimum wage. Any employer attempting to pay less than the minimum wage for employees would be faced with imprisonment. Should the worker be granted citizenship, trust fund contributions would be claimed retroactively. Any worker convicted of a crime would result in immediate deportation.

Such a program could have several salutary effects. It could increase the labor force in a way that would be immediate and accretive. By increasing labor supply, it should reduce wage inflation. Additional workers could themselves be a source of economic growth. The workers would have the option of returning to their home country or becoming a US citizen after a period of time. Since only those who have skills in demand would be permitted to migrate, the issue of unemployed or unemployable migrants is addressed.

Without this approach or something like it, the country’s economic fortunes likely set to dwindle. The population of the US is contracting. Consumer spending is slanted sixty percent towards services, which are far more labor-intensive than goods. Healthcare facilities are already experiencing profound shortages of personnel.

Raising interest rates likely not address a worker shortage. Only more workers can do so. Thus, the economy may need less from the Federal Reserve and more from the Legislative and Executive Branches of government. Elected officials have shown a reluctance to take on an issue that may aggravate those whose vote they court. Perhaps if the issue were reframed as an economic one it might get more support.

The Economy

The economy grinds on, doing better than most expect and the Federal Reserve wants. Fourth quarter GDP has been revised to up one percent. This is almost five times more than previous readings.

Even with a stronger number, there are indications that profit margins are narrowing for some companies. Strong wage growth must be paid regardless of revenue increases. The result is a squeeze in profits.

This has been especially pronounced in very high paying jobs like technology, law, accounting, and consulting. Some are even saying this could be the first white collar recession as workers in these jobs are cut back due to lower sales growth and less generous venture capital funding.


Inflation is becoming harder to explain away. Energy, the original engine of inflation this cycle, has been subdued at least for now. Food prices are now out of control as bird flu causes egg prices to increase seventy percent and any manner of produce is impacted by weather irregularities. Recently some countries have banned exports of onions. When food becomes scarce, people initially hoard it, aggravating the efforts to match up supply with demand.

Interest Rates

Any plausible scenario of interest rates declining has been shot down by the strong labor markets. Rates are headed higher and likely be high for longer than most previously envisioned.

One interesting observation is those who are advocating the purchase of bonds. To make such a recommendation, one must assume that interest rates are peaking, inflation will go back to one to two percent per annum in short order and yields will decline in tandem.

There is nothing on the horizon that seems to supports such a scenario. So far as an “inverted” yield curve being touted by many as predicting a recession and lower yields. (This is when short-term rates are higher than long-term rates.) A yield curve can also reassert a normal pattern by having long- term rates going significantly higher and short-term rates be unchanged.

The Stock Market

The gains recorded by the market so far this year seem to be a case of euphoria getting the better of fundamentals. While there are some industries that should do well this year like the airlines, in general there are several industries that would seem to be on thin ice. Tech firms have been rife with revenue disappointments.

Electric utilities have been considered very conservative investments. However, most utilities have significant amounts of debt on their balance sheets that will be rolled over at sharply higher interest rates as time goes on. Couple this with the demand to fund new generating and transporting capacity to accommodate electric vehicles, most utilities could soon be petitioning for significant rate increases. At that point, electric rates become very political. Which is to say, not financially predictable.

Warren M. Barnett, CFA

February 28, 2023

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