Photo by Jason Leung

This past week, the Federal Reserve raised its benchmark short term interest (Federal Funds) rate a minimal quarter point, .25, from 3.75% to 4.00%. Expectations are strong for yet another .25 hike before the end of 2026.

Goods and services inflation in the US has recently begun to accelerate and the conventional wisdom in the mainstream media is that the Fed is raising rates in order to dampen inflation.

But is that the case? Or is there something else behind the rate hikes?

As the argument goes, Interest rate hikes dampen Consumer and Business demand for loans and thus consumption and investment in turn. Higher rates mean less spending by consumers on mortgages and big ticket items like cars; higher rates dampen business borrowing demand, so the theory goes.

It’s Supply Stupid

But the current inflation surge is not due to excess Demand. It’s a Supply problem. The Fed has little influence over supply, especially if it involves the global economy. And that’s exactly what’s driving up prices: the escalation of global oil and energy prices, which translate into higher costs of gasoline for consumers, diesel for truckers and railroads, aviation fuel for airlines and much of electricity and natural gas services throughout the economy. And those prices eventually bleed into higher food prices with a lag.

To repeat: the higher energy prices driving US domestic inflation are a consequence of rising global energy prices—and those global prices in turn are the result of Trump war policies in the now-spreading Middle East wars, Trump sanctions policy and tariff wars.

The Fed raising rates to dampen Demand has no effect on rising energy prices due to Supply and US war and related policies.

Current rising US inflation is a Supply problem that the Fed can do little about by raising rates and targeting Demand. Demand-driven inflation are actually receding for months in the US, as real wages for households decline and unemployment rises in the Tech and now other industries. US job growth in 2026 has all but collapsed. In addition, as costs of borrowing rise—and in turn interest on credit cards, auto loans, student loans, mortgages, etc.—household Demand has slowed further.

Interest on that $18.5 trillion household debt load is a drag on household consumption. So too is the $23.7 trillion corporate and non-corporate business debt on investment. And that’s not counting the additional $43.8 total government debt, federal and state and local or the additional Federal Reserve balance sheet debt of $6.8 trillion. That’s a total combined debt of $106.2 trillion.

All that is money paid to wealthy capitalist investors that otherwise might be spent or invested on goods and services, to create jobs, and generate income for the many instead of the few. Assuming an average interest rate from all sources, that’s $7 trillion a year accruing to investors from interest alone. Interest payment on the Federal national debt alone is now more than $1.2 trillion a year.

Summing up: the problem of rising prices in the US today therefore is not excess Demand. And Fed price hikes, targeting Demand, will have no effect on inflation driven by Supply of global energy and other commodities caused largely by Trump policies.

On the other hand, the higher rates will have an added negative economic impact—as interest rates in general suck up and divert money capital from consumers, government and even some businesses to the super-wealthy investor class minority.

Fed Rates vs. Capitalism’s Financial & Global Restructuring

There’s more. Even if one assumes Fed higher interest rates will dampen consumer-business demand and thereby slow inflation, changes in the US and global economy the past quarter century show that Fed rate hikes have had a declining impact on dampening inflation. Conversely as well, Fed rate cuts have a declining impact on stimulating consumption and business investment.

In economists’ parlance: interest rates have become increasingly inelastic, stimulating as well as slowing the economy. Why is this so?

The ultimate causes for interest rates (i.e., monetary policy) growing relative ineffectiveness have to do with the growing financialization and globalization of the US and international economies since the 1990s. This phenomenon is addressed in more detail in my just-released book, ‘The Twilight of American Imperialism’, Clarity Press, September 2026.

But to summarize in brief: lowering interest rates have been having a declining effect on stimulating economic growth because most of the rate cuts get redirected to investing in the expanding financial asset markets in 21st century capitalism in the US and the general Empire abroad. It is more profitable for businesses and investors to borrow money from the Fed’s affiliated banks (at lower rates) and reinvest that borrowed money in financial asset markets (in US and globally), rather than to invest in real assets in the US that produce goods and services (and in turn jobs and incomes). There are of course exceptions to the rule. But the exceptions represent a declining share of the real economy. Capitalism is changing and monetary policy has been declining in effectiveness as a result.  Fed rate hikes (or cuts) have had less effect in stabilizing the US economy.

For example: the Fed reduced interest rates to 0.11 to 0.40% from 2009 through 2016 and additionally injected $4 trillion in Federal Reserve bond buying into the economy. What happened to US GDP real growth? Annual growth rates averaged 1.43% from 2008 through 2016. One cannot argue therefore than lowering rates stimulated the real economy. They didn’t. But they subsidized a lot of investors with low-cost money and made them richer.

The same applies vice versa: the historical record in the US since 2016 shows raising rates do little to dampen inflation. What that record does show, however, is that when Federal Reserve long-term bond rates hit 5.5%-6%, they provoke a financial crash. That happened in 2000 just before the dotcom bust, in 2007 before the subprime mortgage-derivatives crash, in 2019 when the Repo market threatened to implode, and in 2023 when the regional banks in the US began to go belly up. Those long-term US bond rates are now about 5.4% and rising!

Rising rates make the rich richer and destabilize the financial system, while doing little to nothing to dampen global supply-side inflation driven by US policies.

Fed Rates vs. Trump’s War, Trade & Sanctions

Today in 2026, another global development is rendering Fed interest rate policy ineffective: Trump’s Middle East wars, sanctions and trade policies, and the consequent decline of the US dollar, are all responsible for driving up global energy and commodity prices. It has nothing to do with domestic Demand.

While the US domestic economy is essentially self-sufficient in oil and energy, the global economy is not. That’s especially true for Europe and Northeast Asia (Japan, South Korea).

Trump’s war in Iran, now spreading throughout the Middle East region, has resulted in a serious shortage of energy (oil and natural gas) in Europe in particular. The US initially exported large quantities of US (and Venezuelan) oil and gas to Europe when the Iran war began. Much of the US release of its Strategic Petroleum Reserve (SPR) was exported to Europe. However, now the SPR reserve release is running low and Europe’s oil supply from US exports is in trouble. Global oil and gas prices have therefore begun accelerating again, and US prices in turn, as US oil companies price their sales on global prices, not domestic supply.

US sanctions policy—in particular on Russia and Iran—is also driving up global energy prices. So is Trump’s tariff wars, raising import prices. And the devaluation of the US dollar is doing the same.

But if the Federal Reserve’s raising rates has no effect on US and global energy supply and thus no effect on US domestic inflation, why is the Fed raising rates nonetheless?

US Inflation & US Treasury Market Crisis

The US Treasury and its agent selling Treasury bonds, the Federal Reserve, need to raise interest rates. Why? To offer higher returns to buyers of US Treasuries and thereby provide an incentive to buy more US Treasuries.

So why do the Fed and US Treasury have to sell more bonds and securities?

Because the sale of Treasuries to domestic (2/3s) and foreign (1/3) buyers are the primary means by which the US covers its annual budget deficit. This year, the 2026 deficit will exceed $2 trillion. It has done so since 2020. Total US defense and war spending is the largest cost element in the annual US budget deficit. Pentagon spending is already over $1 trillion and Trump has requested $1.5 trillion in 2027 to cover the continuing cost of wars, replenish exhausted US weapons supplies, and to fund new weapons systems like drones, hypersonic missiles, autonomous weapons, etc. Interest rates on past Treasury sales now cost the US more than $1.2 trillion a year and are rising as the US national debt escalates past $40 trillion.

 In short, the US must now sell even more Treasuries in order to cover the rising budget deficit driven by ever higher defense and war spending. (Either that or Congress must raise taxes on the rich, which it won’t do).

But in order to sell more Treasuries, the Fed needs to raise interest rates it pays borrowers (buyers) of the Treasury securities.

One may argue that the Federal Reserve knows it must raise rates not so much to dampen inflation (which higher rates won’t do), but to sell more Treasuries to pay for US war-driven escalating budget deficits and accelerating interest payments on the national debt.

There’s yet another twist to the Federal Reserve’s rate dilemma: Not only must it sell more Treasuries to cover the rising budget deficit and debt, but it faces a growing challenge to even maintain current levels of Treasury sales.

Forces are developing that indicate that key groups of foreign buyers of Treasuries (1/3 of all buyers) are retreating from purchasing US Treasuries.

The Fed must raise rates not only to cover a rising budget deficit. It must raise rates to attract more domestic US buyers of Treasuries as foreign buyers of Treasuries retreat.

The retreat from holding Treasuries has been underway for some time by China. Once having held $1.2 trillion in US securities just a decade ago, latest data show China holds only $.63 trillion. It continues to steadily divest itself of Treasuries, not buying new and allowing old to mature and roll off. Other economies of the global south are beginning to do the same. Blame US sanctions and trade war policies for much of this development. They are replacing Treasuries with gold, and soon digital currencies as well.

For example, recent events in Japan indicate Japan, once a stalwart purchaser of US Treasuries, may be about to join China and reduce its Treasury holdings. A constant holder of more than $1 trillion, the largest foreign buyer of Treasuries, Japan began to slow its purchasing in 2026. The reason? Japan’s own government bond rates are rising for the first time in more than a decade. Japan’s currency value was formerly zero. Its investors, and global investors, used to buy Japan Yen cheap and use it to buy US dollars and in turn, US Treasuries. That was called the carrying trade. That is ending. Japan’s bonds are rising above 3%. Its Yen is also rising. With the government bond rate differential between Japan and US Treasuries narrowing, global investors are now buying Japanese bonds instead of US Treasuries. That is why US Treasury Secretary Bessent last month entered the Yen market to buy Yen (with Euros, by the way, saving US dollars for other purchases). He did that to prop up the Yen, keep Japan bonds from rising further, and ensure foreign investors continue buying US Treasuries.

However, events in September thus far show Bessent has failed. Japan may therefore buy fewer Treasuries—i.e. at a time that China is buying less and the US needs to sell even more Treasuries to cover its accelerating annual budget deficit!

There’s a third reason why foreign Treasury sales may be entering a crisis. In recent years, as China reduced its buying and Japan didn’t increase its purchases, Europe stepped in to fill the gap, accelerate its buying of US Treasuries, and to help the US cover its US budget deficits as US war spending accelerated after 2021.

European countries in many cases more than doubled their purchases of US Treasuries from 2021 through 2026: Britain increased its holdings of Treasuries from $412 billion in 2020 to $865 billion in 2025; Belgium from $135 billion to $466 billion. Luxembourg from $197 to $431 billion; France from $49 billion to $376 billion and so forth.

One may argue Europe did so in exchange for continuing US military support for NATO in Europe and for Europe-NATO’s war in Ukraine. But with Trump’s decline of support for NATO funding and Ukraine war spending, Europe now has to fund the Ukraine war itself. To that end, it has thus far raised or committed $176 billion in Euro bonds. Will it—indeed can it—continue to buy US Treasuries at the same rate as before? Not likely for several reasons.

First, it’s less likely given that Trump and Europe are feuding over Greenland; Trump is attacking Europe with tariffs; And Trump is angry with Europe’s lack of support for his war in Iran. Europe has a number of incentives, therefore, to reduce its prior level of purchases of US Treasuries.

Evidence is beginning to appear that Europe plans not to continue purchasing US Treasuries at past rates. France, Belgium, Britain and other European countries in recent weeks have begun moving their physical gold stocks from the US back to Europe. That likely means it plans to substitute gold in lieu of buying US Treasuries. More outright shifts are also occurring. The huge Norwegian Sovereign Wealth Fund has reportedly begun selling its Treasuries.

A countervailing force, however, is that Europe has nowhere to go for oil and natural gas other than the US. Oil and energy from the Middle East to Europe continues to decline. The US has backfilled much of Europe’s oil needs in the first half of 2026 with SPR exports. With SPR now running low, that export may slow. In turn, Europe’s energy prices have begun to escalate even further.

In parallel to Europe, Canada has begun orienting toward Europe as a result of a deep trade dispute with Trump. It has become an associate member of the EU. Like Europe, Canada previously increased is buying of US Treasuries from $69 billion in 2020 to $475 billion in 2025. And like Europe, it is unlikely it will continue to do so as the trade dispute between Canada and Trump further deteriorates.

The point of this preceding analysis is that a crisis in the US Treasury market is brewing. Foreign purchases of Treasuries are likely to slow across the board—at a time when the US needs to sell even more to foreign buyers to cover its further escalating war-cost-driven budget deficits.

That means the US Treasury needs to sell even more to US domestic buyers of Treasuries. For that, it needs to raise the rates it pays buyers of US bonds and other securities to entice them to buy even more and not just at prior rates.

The Treasury Market and Accelerating Decline of Empire

This is where financial instability in the massive Treasury market comes in. The US has to sell more Treasuries to domestic buyers in particular. But who are those buyers? In recent years, they have been the increasingly unstable US financial institutions like hedge funds and other so-called and unregulated ‘shadow banks’.

Should the US real economy slow—or worse, the AI investment bubble go bust—hedge funds and their ilk may begin to retreat from the Treasury market. The result could be the eruption of a major crisis in the Treasury market, which would reverberate across all financial markets rapidly. One may argue that’s perhaps why Bessent also recently began to provide an extra $8 billion a week to Treasury investors.

A crisis in the Treasury markets would drive Fed rates even higher—perhaps beyond that 6% long bond rate that history shows since 2000 is a tipping point for precipitating a general financial crash.  Should that occur, a deep contraction of the US real economy would be certain. That contraction would then exacerbate even further the ability of the US empire to fund its projected war spending.

The Empire would have to accelerate its geopolitical retreat, already underway, as its funding collapses. Empires and their military cannot sustain themselves without sufficient funding. Slowing US Treasury sales and a contracting real economy and a deep recession ensure the US Empire would have to retreat and consolidate—to the western hemisphere and central Pacific at minimum.