[slide 1]Spending, Printing, and Debt are all interrelated. As I illustrated in part one, poor fiscal policy can lead to a inflation and even hyperinflation. I will briefly review this again.
[slide 2] Everybody knows that the more our government spends, the more indebted it becomes. This is because tax revenue doesn't come close to our spending. [slide 3] What most people don't know however, is that some of the fiscal shortfall is paid for by printing money. The government does not do this directly, as I will explain later, [slide 4]however the net effect is identical, and that is inflation.
[slide 5] Inflation decreases the value of currency, including the currency loaned out by lenders. [slide 6] The interest on bonds and loans then increase to entice the lenders back into lending. [slide 7] Higher interest rates mean higher service must be paid on any future debt. Since government bonds are mostly short term nowadays, this effects spending within a matter of months.
[slide 8] More spending leads to more debt, [slide 9] more debt leads to more interest payments, and [slide 10] you can see we're trapped in a vicious cycle.
[slide 11]You're probably wondering why, if this is going on, are we seeing some of the lowest interest rates ever.
[slide 12]Interest rates are determined by 3 things: The supply of loans, demand for loans, and inflation.
[slide 13] In an effort to stabilize the economy, The Federal Reserve is currently printing trillions of dollars and pumping it directly into the banks. [slide 14] In the short term, this will reduce interest rates. [slide 15] In the long term, however, all this newly printed money will lead to MASSIVE inflation. Eventually, interest rates will rise to an equilibrium with infaltion. At this point, we will be in a state of stagflation. [slide 16] The only way to get us out of [slide 17]it will be to do what we did the last time,[slide 18] and that's to stop printing money. This will lead to a record increase in interest rates, far greater than those we saw in the 1980's.
[slide 19] The high interest rates will lead initially to fewer people being able to take out loans to buy homes and cars. This will lead to a sharp and dramatic fall in home prices--possibly the lowest home prices ever. Since banks have tens of thousands of homes on their balance sheet, this will lead to massive mark-to-market losses. This, combined with the inability to loan money, will lead to massive bank failures and recession.
In addition, the government will be forced to raise interest rates on treasury bonds. You should know where it goes from here: The more debt service, the more spending, and therefore the more borrowing and printing. This will lead to a viscous cycle further exacerbating the situation.
[slide 20]To give you some perspective on the fiscal situation, the debt service for 2009 will be under $300 billion. The deficit will be about $2 thousand-billions. Keep in mind the current deficits include defense, social security, medicare, those enormous bailouts, as well as lots of other things.
After 2009 ends, the national debt will be at around $13 thousand-billion.
Interest rates will easily reach 15% at some point within the next few years, but let's be optimistic and say it happens in 2010. 15% of 13 trillion dollars is nearly $2 thousand-billion. Keep in mind, the deficit for 2010 would have to include all the other fiscal shortfalls we had in 2009.
[slide 11] Because of the nature of the relationship between these forces, many believe that a high rate of inflation and maybe even hyperinflation could occur quickly and without much warning from the economic numbers.
[slide 12] Unlike the stagflation that occurred during the late 1970's and early 1980's, we will not be able to escape from the inflation by borrowing money instead of printing it. Instead, the only option will be to do what many have suggested for years and just [slide 13]cut spending.
[slide 14a] As I explained in part 2, cutting spending has always been unpopular, which is why the government budget rarely does anything but grow. Americans overwhelmingly agree that they want to keep expanding [slide 14a-ss]social security, [slide 14a-med]medicare, and [slide 14a-sd]a strong defense--all while paying low taxes.[slide 14b] It is undeniable that this situation is unsustainable. What's scary is imagining what it will take for this cycle to meet its end.
[slide 15] During the Great Depression, many unusual laws and regulations were enacted in an attempt to restore our economy. This is likely to be repeated in our current crisis, however, like then it will be disastrous.
[slide 16]In the 1930's under presidents Hoover and Roosevelt, government grew enormous and struggled to find revenue. [slide 18a - US import tax w/hoover face] Herbert Hoover enacted record tax increases on income and imports. The Smoot-Hawley Tariff passed in 1930 was the largest peacetime tax increase on imports in American history. [slide 18b - foreign import tax] This lead to a retaliation in the form of import taxes in other countries and therefore ultimately meant a reduction in US exports. In 1932, Hoover doubled the income tax, raising the tax rate on the wealthy especially.
[slide 17a-'it all started with tires'] Already, we can see that our current president is following the historical example set by Hoover. Obama has increased income taxes on those he deems 'wealthy' and recently, he sparked an international trade dispute by placing a 35% import tax on tires. [slide 17b-retaliation] Like the Smoot-Hawley tariff, this assault on free trade was met with threats of reciprocation in tariffs. If these countries follow through, this would have a devastating effect on our already vulnerable economy.
[slide 18] When FDR took office in 1933, he continued to increase taxes and spending, but not before he issued an executive order to confiscate all privately owned Gold. In total, 500 tons of gold were taken from private United States citizens.
[slide 19] Based on these facts, it's logical to assume that when facing a severe enough recession, government may again attempt to seize property in order to fund the ever-expanding government without having to inflate the currency.
[slide 20] Historically, countries that have attempted to seize the wealth from the wealthy end up experiencing what is referred to as "capital flight." This is where rich people lead a mass-exodus out of the country in an attempt to evade persecution. [slide 21] To prevent the wealthy from simply leaving, laws may be enacted to keep their fortunes here, and possibly to prevent the sale of certain types of property like large homes and to forestall high-volume stock trades.
------------------------- [slide 23] It should be noted, however, that our current crisis is very different from the one in the 1930's. Back then, the dollar was still on the Gold standard and therefore the government was limited in its ability to print money, that is no longer the case today.
[slide 25]I believe that eventually the rate and cause of inflation will be recognized by the media, political candidates, and most importantly, the American people.[slide 26] As Reagan identified the stagflation in the 1970's and ran on a platform to shrink government and curtail inflation, I believe that so too will the candidates of 2012 or 2016.
[slide 27]Of course, the sacrifice endured by people participating in the 1980's economy will pale in comparison to the sacrifices of our generation. [slide 28] In the 1980's, Reagan's government was cowardly and irresponsible. Instead of cutting spending and suffering the consequences, he was able to issue a record amount of debt to therefore defer his fiscal crisis to another generation. [slide 29] Unlike the 1980's, our current government will not have the credit rating to issue as many bonds.
[slide 31]Unfortunately, the elderly who rely on the government for support will suffer the most during this transition. After decades of politicians telling them not to save for retirement, America will finally wake up one morning to find no government check in the mail box. This will be devastating for these retirees who are no longer able to earn a decent wage. If we acted today on a campaign to taper-off the citizenry from these programs before they disappear, it would drastically reduce the suffering of these people. [slide 32] I do not, however, feel this is possible under the current mindset.
[slide 30]Regardless of our history, I think it will be politically possible for the necessary spending cuts to take place after we slam into the tip of the inflation iceberg. (182,148)
Occupation: Daniel is Medical Resident from the southwest US. Prior to medicine, he worked in IT as a consultant, programmer, web designer/developer, and technician.
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