Racing Towards Stagflation

Right From the Start

Tuesday’s Wall Street Journal carried an article by Jon Hilsenrath describing a push by Eric Rosengren, president of the Federal Reserve Bank of Boston for a third, but unlimited, round of quantitative easing – a euphemism for monetizing the debt. Fortunately Mr. Rosengren is not a voting member of the federal reserve presidents who pass on monetary policy for the Federal Reserve Board.

In its simplest terms monetizing the debt means increasing the money supply (printing more money) in order to purchase additional government debt. Most responsible economists agree that such a practice increases the likelihood and depth of an inflationary cycle. There is a simple reason – increasing the money supply without increasing the underlying gross domestic output simply means there are more dollars to buy fewer products thus inflating the price for the products.

It is for that very reason that Federal Reserve Board Chairman Ben Bernanke, during testimony before the House Financial Services Committee stated categorically:

“We are not going to monetize the debt.”

But in Washington political “guarantees” have the half-life of a “quark.” Mr. Bernanke and his fellow monetary meddlers have twice led the Federal Reserve Board into “quantitative easing” – his term – or “monetizing the debt” – my translation. In the first instance, in 2009, as noted by Mr. Hilsenrath, the Federal Reserve increased the money supply in order to purchase $1.25 Trillion worth of mortgage backed securities (including sub-prime debt that was already failing), $300 Billion of U.S. Treasury securities and $175 Billion of debt issued by Fannie Mae and Freddie Mac – the champions of sub-prime mortgages to people who could not or would not repay them. That was followed by another round in 2010 and 2011 when the Federal Reserve purchased an additional $600 Billion of U.S. Treasury securities.

Mr. Bernanke justifies this practice as an effort to stimulate the economy. In theory by purchasing additional government debt, the Federal Reserve Board represses the cost of debt and discourages investors from “idling” their cash in low yield federal securities. The theory continues that by doing so that it will encourage investment in the private sector thus stimulating economic growth. But here’s where academic supposition meets market reality.

Quantitative easing is not working. Despite the pitiful returns on investment in government securities, private investors and businesses are not rushing to increase investment in the private sector. In fact, major business such as Microsoft, Google, General Electric, and others are estimated to be holding $1.7 Trillion in cash and that is after a substantial amount of cash has been spent by private business to reduce debt incurred when interest rates were higher.

And the reason that it is not working is that no amount of low cost debt can overcome economic policies that repress business growth. Investors and business simply will not risk capital investment for creation or expansion of business when government actively imposes additional burdens through regulation, and new programs such as Obamacare. As in most things involving politics, perception is king. President Barack Obama’s administration has earned the reputation of being the most hostile administration since President Richard Nixon sought to impose wage and price controls and President Jimmy Carter followed with simple ignorance. It is as much the known policies as the uncertainty of the next policies that have caused business to hunker down.

The quantitative easing policies have not only not worked but they have increased the risk of a vicious inflationary cycle coupled with low economic growth. For those with memories as short as Mr. Bernanke’s, they may want to reread the brief history of Mr. Carter’s “stagflation” in the 1970’s.

It is for that reason that I think the attention of the country’s politicians is misplaced. Both parties are talking about how to stimulate the economy. The Democrats want to raise taxes and increase government spending. Those Democrats, led by Mr. Obama have already demonstrated that such a “stimulus program” did nothing for economic growth and was used primarily to reward Democrat constituencies (public employee unions, community activists, and investors in “green energy” project that have failed or will fail without continuing government subsidies.) The Republicans champion reduced government spending and tax reductions in hopes that we can grow our way out of the economic doldrums and our massive federal debt.

But neither party provides focus on the biggest problem facing stabilization of the economy – the $15.9 Trillion debt which is projected to grow to the $16.4 Trillion debt ceiling by the end of November – some six to nine months before its anticipated date. Mr. Obama has no plan for dealing with the debt and, in fact, his proposed tax increase will all be used for increased government spending. The Republican plan can slow the growth of the debt but it will continue to increase until there is an aggressive attack on federal entitlement programs – welfare, Social Security, Medicare and Medicaid. (For a “teachable moment” you may want to visit a Social Security office and note the ratio of elderly to those requesting and receiving other benefits.)

I have noted previously that the existence of federal debt is not necessarily a detrimental thing. Most families and business maintain a level of debt – for families it usually represents a mortgage, automobile financing, and credit card, while for business it usually represent capital investment, inventory financing and working cash to smooth out seasonal fluctuations. But when debt exceeds the resources to repay the debt you are in trouble. For families and businesses that usually signals bankruptcy. For the federal government that reflects today’s reality where additional debt is accumulated to pay the interest on the existing debt. Today’s federal debt exceeds the Gross Domestic Product. Even with historical lows in interest rates, the interest on the national debt has been rising at an alarming rate over the half dozen years with a spiking in the last three and one-half years under Mr. Obama.

An increase of just one-quarter of one percent in the cost of the current debt will increase the cost by nearly $40 Billion dollars annually – one-half percent $80 Billion and $160 Billion for a one percent increase. Even a modest increase in interest rates could result in a cost in excess of $1 Trillion annually to service the debt. To put that in perspective, Mr. Obama’s most recent budget proposal recommended $3.8 Trillion of spending – nearly $500 Billion of that to service the current debt at current interest rates.

The current national debt exceeds the Gross Domestic Product. Until such time as we can reduce that debt load to the historical norms of one-half of GDP the country and its economy remains at substantial risk. Recessions and recovery are natural and recurring events for the economy. If the federal government will simply get out of the way – repeal Obamacare and roll back regulation to 2008 – the economy will recover rapidly and on its own. The same is not true for the mounting national debt. Additional increases in the debt ceiling will only exacerbate an already dangerous situation. A program of capping the national debt at the current level coupled with a dedicated stream of revenue to reduce the principle amount of the national debt until it reaches one-half of GDP (and thereafter reducing the cap by the principle payments) will do more to stimulate the economy than any amount of quantitative easing or government stimulus.

Short of that Washington’s politicians are simply whistling up a dark alley.

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Posted by at 05:00 | Posted in Economy, Federal Budget, President Obama | 15 Comments |Email This Post Email This Post |Print This Post Print This Post
  • Bob Clark

    I agree Obama’s economic policies keep us stuck in a low economic growth trajectory. Very importantly, tax policies have become a series of short term extensions for the last three or more years, and both sides are just talking about another one year extension. This alone discourages private sector investment because it is impossible to calculate an intermediate and long term rate of return.
    The economy could be much stronger than it is currently as Obama is actually strongly benefitting from a technological revolution in the natural gas and oil drilling industry. This technology which has nothing to do with Obama has been under painstaking development since the 1980s, involving huge private sector investment. Most all of the increase in domestic oil and natural gas supply is occuring on private lands. The U.S could literally get back to complete independence on natural gas if the federal government would establish a longer term plan for providing an inventory of federal natural gas resources; and it could cut oil imports by another 10% by revitalizing Alaskan federal oil resource availability, instead of letting it slip into steady decline as now.
    Of course, total energy could get real cheap if Obama and the Democrat party would back off of killing the coal power industry. It is questionable natural gas can completely replace coal without causing a major spike in natural gas prices longterm.
    I am not so worried about easy money policies currently as actually the Federal Reserve is buying much of the new federal issued debt, helping in a specious way to keep federal debt more internalized (as to oppose to borrowing much more from like China than currently is the case). A supply side approach can offset a large portion of the inflationary effects of easy money currently. Unfortunately, we are not going to get a supply side policy with Obama, and Romney is so undefined (gummy bear like) who knows how much supply side you get out of Romney.
    Obama waisted the stimulus monies helping pad the compensation of existing public union and auto union workers, mostly; instead of dedicating it to hiring new workers (while lowering prevailing wage limitations which reduce the amount of government infrastructure that can be had for a given government dollar). He also spent a whole year working on the 2,700 page blob known as ObamaCare, which needs wholesale reworking if we are not to lose a rather sizeable amount of doctors and other practioners.
    Obama’s foreign policy is hard to judge because it is hard to figure if it doesn’t put America in a weaker position over the intermediate to longterm period. By comparison, George W. ignored British history in going into Iraq; but who knows maybe it works out much better in the future. Obama didn’t just run from the wars once in office but is orchestrating a graceful like exit. I guess he should get positive reviews for this. But longer term we are only as strong as our underlying economy, and this is definitely slipping towards the European basket case model under Obama’s food stamp/welfare model.
    I am hoping Romney and crew can get a more definitive brand real soon and start to swamp Obama over the airwaves. But maybe more important for the GOP is to hold the House, and stretch to retake the Senate; then you’ve a real lameduck president if Obama; and the threat of impeachment can be waved if he continues to usurp power away from Congress and the courts.

  • Rupert in Springfield

    Look – Let’s be real on what is going on in the economy. Most jobs are created in small business and most small business started the Obama administration worried about hiring because we were in a recession, not so much because of Obama himself.

    The second half of the Obama administration has been different. After Obamacare was passed, after Keystone, after Boeing, and in Oregon after measure 67, one thing became clear – a business friendly environment this was not. Absent some key fault of an economic foundation, say excessive interest rates, a poor growth rate such as we have is due to mood. Obama, his policies and staff affect that mood in a profound manner. For small business there have been a few too many gaffs for them not to
    add up to “you know what, this guy just doesn’t like people like me very
    much”. Couple that with Obamas incredible bias towards big business, he
    loves them and has been largely financed by them, and small business is
    truly in no mood to hire.

    So now it’s a waiting game. Business isn’t going to do boo until the election is resolved. Both sides are well aware of this. If Romney is elected, I think many expect an uptick in the economy. This would not be due to anything fantastic Romney has planned, but more due to relief that Obama’s stifling policies may be coming to an end.

    This is the Democrats worst nightmare if it happens. Both sides are aware it is a distinct possibility.

    Romney is no savior, he doesn’t have to be. All he has to do is get elected and get out of the way. Unless I miss my guess, that will be the single biggest boost to the economy in the past four years.

    • Marvin McConoughey

      Its true that small business creates many jobs. But the importance can be overstated. Small business is also responsible for many job losses and business failures. Simply put, the staying power of small firms is less robust than for larger firms. As you would expect, individual exceptions often exist without, however, being the norm.

      • Rupert in Springfield

        Actually if you go by net job gains, which obviously includes job losses, a good rule of thumb is small business accounts for about 60% of job growth.

    • valley person

      Unless you miss your guess? Well…yeah. On so many levels.

      To cite just one, your “guess’ was that Oregon’s economy would tank after M 67passed. Yet we have grown faster than ost otehr states, and have added jobs faster. THis does not complute, so you pretend it didn’t actually happen, and what actually happened was we must have done worse with our business unfriendly environment.

      Well why not…I’ll hand you another. Keystone. Didn’t get built, and energy prices have come down, and domestic production has gone up. Care to explain?

      Small business…any business… hires when they have more demand than they can meet with current staff…period. Hardly anyone walks away from increasing their sales out of uncertainty, or regulations, or anything else. Those that do ignore increased sales value small over more, and good for them.

      • ADF

        You have either never run a business, or you ran a business in a specialized or very static environment.
        Businesses make decisions about growth ALL THE TIME and they don’t just allow “demand” to drive that growth. They look at:
        profit (non-scalable businesses can’t just expand when they have more customers),
        liability (if every customer increases liability, they be unable to expand, or may not want to add that risk for the trade-off in profit),
        capital requirements (they may need capital to expand, and if they can’t afford that, no matter the demand, they will NOT expand),
        taxes (if expansion will increase their tax liabilities progressively they will NOT expand since the increased sales are offset by increased taxes),
        cash-flow (if the business requires a high amount of cash-flow to operate, it may not be possible for the business to expand if they can’t increase their cash-flow adequately), as well as staffing, space, regulation, etc.

        Allow me to offer just one example, this one pertains to taxes (one of the most onerous reasons for non-expansion). A dentist I know started his practice and built it to a 3-day a week practice, he sat down with his accountant in anticipation of expanding to 5-days a week (the “demand” was there to support this). His accountant did the math and advised the dentist that while he would be increasing his income and his profits, the extra income would move him into the AMT (alternative-minimum-tax) bracket. This would consume nearly *all* his increased profit. The dentist looked at the meager amount of increased income (it was around 2-4% for an extra 66% of work; 3 days to 5 days) and made the WISE choice to NOT expand to 5-days; he would rather spend those extra 2 days with his family (I don’t blame him!). That decision caused him NOT to create 2 dental hygienist jobs, 3 dental assistant jobs, and an increase of staff time from 3 to 5 days for 2 staff. That decision was made because our gov’t “tax” system in not a system designed for “revenue generation” but is a behavioral modification system that is designed to *punish* success and growth. I could give dozens of stories *exactly* like this.
        So don’t tell me that “small business” lives in a one-track world of blindly responding to “demand”; there are many more factors at play. Stating otherwise, just shows your ignorance.

        • 3H

          But, I’ll bet either a new dentist started a business with that extra demand, or a different dentist expanded their hours, and hired those exact same people.

          • ardbeg

            ADF might be onto something-three day work weeks.

        • valley person

          I ran my own business for 19 years, grew up in a small business family, and recently started another small business with a group of investors. Most small business people I know, including self and family, are in business doing something they (we) like to do. I should have prefaced my statement by stating a caveat that many small businesses do not expand for market share because they have personal reasons to just stay small.

          In the case of your dentist friend, he or she made a choice that balanced several factors, including additional earnings versus additional time spent working. Time is a precious commodity, and many of us, including myself, concluded that an extra 10 or 20 or even 50% income isn’t worth the time.

          But leaving market share on the table for others does not hurt professionals, or food cart operators, or other limited scale service businesses. It can hurt manufacturers or chain restaurants of other more generic operations. In any case, if there is market share to be had someone will scoop it up and new “jobs” will be created.

        • Rupert in Springfield

          ADF – It’s pretty simple, Dean thinks increasing the uncertainty economically does not affect business decisions. Obviously that’s an idiotic premise. Probably not much point in discussing things further with him.

          • valley person

            Hey, life is one uncertainty after another. If you want to sit around and wait to be certain about something you would never accomplish anything in life.

      • Rupert in Springfield

        >To cite just one, your “guess’ was that Oregon’s economy would tank after M 67passed.

        Since I never claimed that not much point in reading further.

        • valley person

          You never claimed that? Only about 10,000 times in the Catalyst archives.

  • mike

    But look at all the success O has had with the green energy investments!!
    That should count for something.

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