Rather than dealing with the destruction from the artificial booms in the 1990s and 2000s, our politicians and the Fed are now trying to keep the artificial booms propped up with stimulus. We should have had a deep and severe economic crisis in the early 2000s as a result of the 1990s artificial boom. However, the Fed lowered interest rates to hold off the crisis and another artificial booIm ensued in the 2000s. We should have had an even deeper and more severe crisis after the crash in 2008, but the Fed further reduced interest rates. Now we have an economy that is hardly growing while the Fed is holding the Funds rate below 1% (see Funds rate graph above). Our current stagnate economy is the new artificial boom!
All that the stimulus does is push our economy into deeper debt and further deplete our limited resources of savings, capital, and labor. The stimulus can temporarily hold off the liquidation but it weakens the foundation of the economy and ascertains a more severe crash down the road. Think of a sleep deprived person. A person naturally needs sleep to function. Sleeping is the time when the body stores up and replenishes energy aka its savings. If a person chooses to not sleep, he eventually takes some stimulant to stay alert. As the person tries to avoid sleep even further, the person will need more and more stimulus to keep going. Eventually the body is beyond exhausted, no longer responds to the stimulants, and collapses.
After decades of stimulus, our economy has reached the point where it is no longer responding to stimulus. We are broke. It’s taking a massive amount of money just to keep the economy from collapsing on its debt. In fact, our economy is now so dependent on stimulus that the Fed has been forced to take extraordinary actions known as quantitative easing, or QE. Simply holding down interest rates is no longer enough to hold off a collapse. Before the 2008 crisis, the Fed held roughly $700 billion of Treasury notes. In November of 2008, the Fed started its first round of QE by buying $600 billion in mortgage-backed securities (“MBS”). By June of 2010, the Fed was holding over $2 trillion in MBS and treasury notes. In November of 2010, the Fed was forced to start another round of QE and bought $600 billion in treasury securities. Still not enough, on September 13, 2012, the Fed announced a third round of QE, an open-ended purchase of $40 billion MBS a month. Even more, on December 12, 2012, the Fed announced that it would increase its monthly purchase to $85 billion a month.
As a result, the actual amount of money created by the Fed out of thin air since the 2008 crisis has been enormous.
Most of that newly created money remains in excess bank reserves because the Fed is actually paying banks interest to hold onto the cash. However, the money supply is slowly starting to circulate into the economy. The biggest impact by the money creation is a third bubble in the stock market (see the S&P 500 price index above). The newly created money is also resulting in rising housing prices, higher gas prices, climbing farmland prices, record banking profits, and improving job numbers in service and construction sectors. Moreover, the growing money supply is leading to higher government revenues. In fact, just like during the 2000s artificial boom, Ohio has misinterpreted its growing revenues as a sign of an improving economy and, as a result, has recently passed a budget that increases spending by 6%!
The Fed is now stuck between a rock and hard place. Our economy is not just completely dependent on the stimulus and artificially low interest rates. The stimulus and artificially low interest rates have allowed the structural imbalances in our economy to grow in size. The banks that were bailed out thanks to TARP are now even bigger. Since our politicians and the Fed have prevented the necessary liquidation for decades, our financial problems have only increased.
If the Fed ends the stimulus, interest rates will rise and the market will crash again. In fact, stocks slid and bond yields spiked back in June just under the fear that the Fed would start tapering back its bond purchases. Once the market crashes again, the economic collapse must be more severe than 2008 because the low interest rates and stimulus have allowed our debt and financial imbalances to escalate even further. TARP was not a “mud sandwich” that our politicians were forced to eat to avoid economic destruction (see video here). TARP was merely a gutless bipartisan effort to kick a larger economic collapse down the road.
Keeping interest rates artificially low is not as easy, however, as merely maintaining the same amount of stimulus. As the growing money supply seeps into the economy, interest rates are bid up in the market in response to rising nominal profits and fears of price inflation. When the Fed announced on December 12, 2012 that it would increase its monthly purchase to $85 billion a month, the Fed stated that the increased purchases “should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.” Yet, since the December 12, 2012 announcement, mortgage rates have skyrocketed.
Thus, on July 17, 2013, Bernanke told Congress that tapering was not on a “preset course.” In fact, he stated,
“[i]ndeed, if needed, the Committee would be prepared to employ all of its tools, including an increase [in] the pace of purchases for a time, to promote a return to maximum employment in a context of price stability” (emphasis added).
(Of course, Bernanke has never been very good at forecasting economic conditions).
If the Fed wants to keep the economy from crashing, it must continue to increase the size of the monetary stimulus. However, such a reckless policy cannot continue indefinitely. Eventually, all the money creation will result in prices getting out control. In fact, according to the Consumer Price Index, prices rose .5% in June. If that rate continues for a year, it would equal an inflation rate of 6%, which is already significantly higher than the Fed’s stated CPI goal of 2%. In fact, parents will notice this month that prices of back-to-school supplies are up 7% from last year. Eventually the Fed would create so many dollars that we would have hyperinflation. The dollar would be rejected as a currency and the economy would collapse anyways.
When the market collapses this time, there will be no bailouts from the Congress, either. Thanks to artificially low interest rates maintained by the Fed, the Congress has managed to balloon the size of the government debt to $16.7 trillion. Of course, some economists believe that the real national debt is near $70 trillion. Nevertheless, a federal debt of a mere $16.7 trillion will be unsustainable when interest rates starting rising. Thanks to low interest rates being maintained by the Fed, the government is currently paying about $250 billion in interest. We were paying the same amount of interest in the 1980s when interest rates were in the teens. On May 17, 2013, Treasury Secretary Lew announced that he will run out of “extraordinary measures” sometime after Labor Day and the debt ceiling will need to be raised to avoid a government default. For math simplicity, let’s assume the federal debt reaches $20 trillion by the time interest rates start rising. With even a modest increase in the interest rate to 5%, the government would have to pay $1 trillion in interest alone! Where is the government going to get that type of money? Crushing taxes would to have to be placed on the middle class in hopes of raising revenue during the middle of an economic crisis. Alternatively, there would have to be deep and painful cuts in entitlement programs as well as in defense spending, potentially leaving military communities like Dayton, Ohio decimated. In short, when the market collapses, the government will default.
A severe economic collapse is coming no matter what actions are taken by the Fed or our politicians. The longer the Fed delays the collapse, the greater its severity. It is simply impossible to predict when the collapse will start. It could happen as early as 2014 or 2015 or the Fed could push it off for a decade. The Fed, however, has no incentive to ruin the dollar with endless monetary stimulus. After all, Fed employees are paid with dollars, too. Thus, the Fed is likely to pull away the stimulus sooner than later. For a while, the Fed will continue to fudge the CPI numbers to hide rising prices. Moreover, the Fed will lie and tell us that rising prices are a sign of economic growth. Eventually prices will start to get out of control and the Fed and our politicians will begin conducting witch hunts to blame the rising prices on corporate greed and speculation. However, ultimately the Fed will be forced to protect its own self-interest and end the stimulus. The market will collapse and the Fed will let the chips fall where they may.
Critics will describe these warnings as just being pessimistic and cynical. Such characterizations could not be further from the truth. A painful economic collapse is indeed in our future. However, these warnings are made with the hope that people will primarily make preparations to protect their family and friends and, secondarily, demand action from our leaders.
The destructive ideology that prosperity can come from a printing press and endless spending must be rejected. After the collapse comes, we must rebuild our economy on a foundation of savings, sound money, and liberty. I believe that We the People will triumph.
John Langenderfer is a practicing attorney with a focus in consumer and commercial law. He can also be reached on his Facebook page.
All opinions expressed belong solely to their authors and may not be construed as the opinions of other writers or of OCR staff.
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