15 September 2012

NOT-S0-HIDDEN INFLATION



The Federal Reserve has now compounded the inflationary scenario discussed previously by printing yet more money, in order to buy $40 billion of mortgage securities per month. This was a political decision, not an economically sound one. As a result our credit rating is starting to be downgraded and the price of commodities- everything from gasoline to food, is increasing. But while prices are already rising the increase is nothing compared to what is to come. 
At the same time interest rates are being driven down to nothing by the government printing press, so savers are actually losing money. The illusion of economic improvement in recent stock market gains is misleading in that it just means more money is going into stocks because interest rates have such a low yield, even though there is significantly greater risk. At this point the “medicine” of the “Quantitative Easing” is becoming poison that will produce galloping inflation down the road unless there is a sharp turn in policy, and even then the challenges are daunting. 
The federal government is currently taking in about $2 trillion in taxes, while spending over $3 trillion a year. This deficit gets added to an ever-increasing debt load that presumably is going to be paid by future generations. Numbers like a trillion are beyond comprehension, but anyone can understand the simple math of the consequences of spending three of something when you only have two. The rising  debt is held by the public and foreign countries like China, which goes along because it finances the export of goods to this and other countries, enabling its economy to continue growing.  
But given that the government is now effectively cheating by debasing the value of the currency, sooner or later lenders will stop lending. However, long before that, interest rates will rise to levels not seen since the 1970s, as lenders must protect themselves against the shrinking value of the currency. Worse, these rates are not being factored in to government projections so that future debt will be larger than anticipated. When there is a 300% increase in the money supply there are bound to be consequences. As rates rise the cost of borrowing will also increase, with disastrous results. First, the interest cost to the government to cover all this debt will become unbearable, given that much of it is short-term borrowing that constantly has to be refinanced at the rate prevailing at the time.  Second, the real estate market will crash even further as the cost of mortgage interest becomes impossibly high. Third, foreign investors will pull their money out as the value of the dollar plummets in relation to other currencies. 
The only way the government will be able to sustain itself is by printing more money, so that the money it pays back is worth less than the funds it borrowed. But if the dollar is worth less, it can only mean that things will cost more and more and incomes will not keep pace with the surging rate of inflation. I’m not even talking about a hyper-inflationary doomsday scenario or total collapse, for even an increase of interest rates to a moderate level of say, 7% will leave the government in dire straits, in terms of maintaining payments of the debt load it is carrying forward.  Furthermore, none of this includes additional state and local debt. On a personal level, the only way you can stay ahead of this turmoil with your own funds is by putting them in appreciable assets that provide an inflation hedge.
These things will become obvious by next year, and will accelerate in the years ahead, unless there is a drastic change of direction in Washington. It will require an iron political will to correct, as the necessary steps are bound to be painful and highly unpopular, across the board. It will require deep cuts in spending, reform of entitlement programs, and revision of the tax code. There may be a steep political price paid for acting responsibly, at least in the short term. But that is the only way to save this country, and for that matter the world, at this point. Hopefully we will have the leadership and political courage to ameliorate this situation while it is still possible.  Think about this when you vote in November. 

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