Inflating Away America's Future

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Americans are suffering from a lack of adequate savings to fund a comfortable retirement. Our growing debt burdens virtually assure us that the lofty living standards of today will soon be nothing more than a long forgotten memory.

Those ideas are now becoming more promulgated.

But what is less known is that our government will likely seek a panacea that will lead to perdition, not only for our retirees, and soon-to-be retirees, but our entire economy and country as well.

Consumers - especially those who are about to retire - are currently experiencing a barrage of economic hardships. The value of their real estate holdings is back to the level it was in 2002. Stock prices are back to the same level they were at the end of the last millennium. Real incomes continue to fall, while the unemployment rate remains near double digits. Household debt as a percentage of income and gross domestic product (GDP) is near record levels. Many public pension plans are insolvent and our entitlement programs have scores of trillions of dollars in red ink.

Given all the headwinds that have plagued consumers over the course of the past decade, it is no surprise that their balance sheets are in a state of massive disrepair. In fact, household net worth fell from the 2007 peak to the 2009 valley by a total of $17.5 trillion, or 25.5%, and is still nearly $10 trillion away from its all-time high.

But unlike what occurred during the Great Depression, prices at the retail level are rising sharply instead of falling. The consumer price index (CPI) is up 3.6%, imported goods are up 12.5% and commodity prices are up 35% year-over-year. So our current and prospective retirees are forced to deal with the worst of all combinations: a negative real return on savings, rising consumer prices, and deflating asset prices.

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It should also come as no surprise that the U.S. Federal Reserve and our government believe the best answer to all of our retirement problems can be found in the printing press.

Why?

Because the U.S. economy has devolved from a manufacturing economy into one that predicates economic growth on consumption and asset bubbles.

Back in 1953, the percentage of the economy devoted to manufacturing was over 28%. Today that all-important sector of the economy has sadly dwindled down to just 11.7%. Since we have progressively over the last 50 years decided to eschew manufacturing jobs - mostly by abusing the status of the U.S. dollar as the world's reserve currency - Americans have increasingly come to rely on the building and servicing of equity and real estate bubbles for economic growth and retirement savings.

The engineering of our bubble-economy used a tried-and-true formula. All we needed was a fiat currency and the temerity to borrow a ton of money that is printed by the Fed. A parade of Fed chairmen starting with Arthur Burns paved a smooth road to perdition (the exception being Paul Volcker) and current Federal Reserve Chairman Ben S. Bernanke was an excellent protégé.

Fed Chairman Bernanke printed money with alacrity, especially after the credit crisis ensued. Within just a few years time, Bernanke expanded the Fed's balance sheet by nearly $2 trillion in order to fight what would otherwise be the healing process of deflation and the paring down of debt.

Our government's "recovery plan" has enabled us to perpetuate our artificial economy and to postpone the eventual pain. The goal of this doomed strategy is to circumvent the market forces that demand the economy enter into a period of deleveraging. Sooner rather than later, however, debt levels will become far too onerous just as inflation erodes the economy by destroying the middle class and those living on a fixed income (retirees).

Indeed, that day may have already arrived.

Today, the American economy has $14.4 trillion in gross debt, while our publicly traded debt has soared 90% in the last four years. Annual deficits have grown from a couple of billion dollars during the pre-crisis era to $1.5 trillion and 10% of GDP today.

If the U.S. desires to take a peek into the crystal ball, all we need to look at is Greece.

Athens followed a similar economic model of borrowing money to boost current consumption. But it didn't take long before Greek debt exploded to $481 billion (340 billion euros). Government debt as a percentage of GDP went from 105% in 2007 to 158% today. And according to the European Commission (EC), that debt figure will reach 166% of GDP by 2012.

It's now game over for that once-proud nation as its total revenue soon won't be able to cover its interest expense. The only remedy is a massive restructuring of public debt, which will likely entail duration, principal and interest rate adjustments. Once that occurs, its credit rating is sunk and future borrowing costs will be prohibitive. In addition, the hit to creditors (mostly European banks) will have dire consequences for the entire European economy.

How would you like to be a Greek citizen who has planned to retire this year?

But here is where the United States also makes a critical error. Our government blames the problem in Greece on not having an independent central bank that has the ability to print an ever-increasing amount of money to pay off its creditors. We believe our advantage is the capability to inflate the debt away by dramatically lowering the value of the dollar.

However, that will only lead to an American version of a Greek tragedy. And as an added bonus, the U.S. foolishly thinks we will get a boost to GDP through the increased exports generated by a weakening currency.

But not only does a falling currency fail to balance a trade deficit - it actually causes the debt-to-GDP ratio to increase. It is true that monetizing debt can make the value of existing debt fall, but that is only true if those debt service expenses are fixed and long-term in nature.

Greek interest rates exploded to 30% on the two-year note from just the low single digits back in 2007. Imagine how high those Greek bond yields would eventually become if Athens were able to inflate its own currency!

Compare that Greek note to our own two-year issue trading with a yield of just 0.37%. But the U.S. has already made the mistake of rolling over our debt to the short end of the yield curve. The average maturity of our debt is only about five years. And our publicly traded debt is projected to be near 100% of GDP by the end of this decade - and even that lofty number is only achieved by using rosy assumptions of GDP and interest rates.

Once debt reaches that level we will become Greece. Only the U.S. seems determined to use the printing press as our preferred form of default. However, bond yields are determined by credit, currency, and inflation risk. Yields on U.S. debt could skyrocket in a very short period of time to a level much higher than what Greece is experiencing today if we continue to use inflation as the solution to every economic problem. That will be especially true if the dollar loses its status as the world's reserve currency.

The consequences for the future economy are clear: Living standards are set to decline dramatically, especially for those who have the least time to prepare. We must balance our budget, boost the value of the dollar, lower inflation, cut taxes, reduce regulations and introduce competition back into our educational system. That is the best hope for America's future. Since the bond vigilantes are currently busy over in Europe, the U.S. may have a little bit of time remaining.

The peak of the Greek empire crested in circa 300 B.C. It would be a catastrophic mistake to fritter away our last opportunity to ensure that this current generation doesn't mark the peak of our great American civilization.

[Bio Note: Michael Pento is a senior economist at Euro Pacific Capital, Inc.

Pento brings 18 years of industry experience to Euro Pacific Capital, where he serves as a senior economist and vice president of its managed products division. His economic and market commentaries are regularly featured on that Website and newsletter. In addition, Pento heads up an external sales division that markets managed products to outside broker-dealers and registered investment advisors.]
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