The economy is split. Investors and asset owners are thriving, which skews aggregate data upward. However, the average person is struggling with low confidence and financial pressure. Policy based on the top half's experience is dangerously disconnected from the majority's reality, creating a massive blind spot.
Economic activity like spending, borrowing, and investing is ultimately dictated by how people feel about their future. Positive economic data becomes irrelevant if the prevailing consumer sentiment is fear and uncertainty, a lesson powerfully demonstrated by Japan's multi-decade stagnation despite immense monetary stimulus.
The headline unemployment rate appears strong only because it doesn't count the growing number of people who have dropped out of the labor force. This statistical quirk conceals a significant economic weakness, particularly among young people, presenting a dangerously optimistic and distorted view of the labor market.
Raising interest rates is a tool to cool an over-exuberant economy. It is completely ineffective against inflation driven by external supply shocks, such as an energy crisis caused by war. No amount of rate hikes can solve a geopolitical problem, meaning central banks are using the wrong tool for the job.
Japan’s failure to spark growth for decades, despite flooding its system with cheap money, shows that population psychology trumps policy. If people are driven by fear and pessimism, they will refuse to borrow or invest, regardless of how low interest rates go, rendering traditional stimulus useless.
While officials cite resilient economic data, consumer surveys show confidence at recessionary lows. The fact that a majority of Americans report feeling as if they are in a recession is a more potent and timely predictor of economic reality than lagging government metrics or official declarations from the NBER.
The U.S. has accumulated so much debt that the only viable path to solvency is to outgrow it, similar to the post-WWII boom. This high-stakes strategy is now entirely dependent on Artificial Intelligence delivering unprecedented and sustained productivity gains. If AI's economic impact is delayed, a debt crisis is almost inevitable.
The 10-year Treasury yield, a benchmark for the global economy, is rising despite the Fed's actions. This indicates that investors do not believe the current policy will successfully combat inflation, likely because the economy lacks the foundational growth needed to support higher rates. It's a vote of no confidence.
If cash-strapped consumers stop spending, retailers will slash prices to survive, causing deflation. Policymakers may misinterpret this as a sign that their rate hikes worked. In reality, it would be a symptom of economic decay, not successful policy, leading them to continue a harmful course of action.