Source: Shutterstock

    In our last post we discussed two ugly realities that savers and investors must be aware of if they hope to avoid retirement penury: Reality Number One: the insidious effects of price inflation, and Reality Number Two: the ongoing debasement of our currencies. To demonstrate their corrosive effects we included two graphs. We include them again. The first shows that an eventual reduction in the rate of inflation never returns us to pre-inflationary lower prices. That is because the effects of price inflation are cumulative. A new lower rate of inflation merely means that existing high prices will increase at a slower pace.  The first chart shows that prices (in blue) remain painfully high even after the rate of inflation falls from 8% to 2%. So the Fed's trumpeted goal of returning the rate of inflation to 2% is no solution for these higher prices. 

The second graph reveals the stunning loss of purchasing power of currencies.  While this chart looks at the falling dollar, all fiat currencies have suffered significant losses of purchasing power - meaning that your savings are being relentlessly stripped of value. 

      Source: Federal Reserve Bank of St. Louis

    These two government-created evils attack us from multiple fronts. First, if our income growth does not meet or exceed the rate of price inflation, we continually fall ever farther behind financially. We are forced either to go further into debt to maintain our current consumption levels (e.g., US credit card debt just reached $1 trillion for the first time), or we must lower our standard of living to meet our now reduced real (net of inflation) income. Second, if our income rises equal with the rate of price inflation, we still lose because we will pay more in taxes on the higher nominal income even though that higher income does not equate to any real increase in wealth. This is because taxes are not indexed for inflation. Third, our larger nominal income may push us into a higher tax rate bracket causing us to lose yet more money. Price inflation and loss of purchasing power are deadly threats to our current and future well-being. They are the direct results of our governments' misguided monetary and fiscal policies. The critical point is that neither of these two threats is going away. The dollar has been continually debased over the last 110 years. If you believe that this trend will soon end or that Congress will finally get its financial house in order, you will pay a dear price for your naiveté. 

    As bad as this is, there is a third evil that threatens our wellbeing and it too gets precious little media attention: monumental government debt that grows at an alarming rate. At some point this debt will crash down on us as in Katsushika Hokusai's famous painting, The Great Wave Off Kanagawa. We keep harping on the debt issue because it will lead to a disaster - to nearly everyone's great surprise. 

    In Hemingway's The Sun Also Rises, a character named Bill asks his friend Mike, "How do you go bankrupt?" Mike responds, "Two ways. Gradually and then suddenly." And so it is with all unpayable debt. A canary in the financial coal mine is Yellow Corp, a huge US trucking company that was allegedly worth $5 billion a short time ago. It just collapsed into bankruptcy leaving taxpayers on the hook for the $700 million dollar pandemic relief loan improvidently provided by the US government. The relevant fact is that Yellow had been going broke "gradually" for some time. It accumulated $1.47 billion of debt that was due to be repaid next year. Then it was "suddenly" unable to either pay it off or refinance it, leaving its customers, 22,000 employees, shareholders, bond holders, bank creditors and US taxpayers in the lurch. It also leaves the Central States Pension Fund, (a multi-employer union pension fund that the US government bailed out just last December), with one fewer contributor, thus shifting Yellows' pension funding burden onto the remaining employers. The predictable outcome is further government bailouts of the fund, socializing this private cost onto the public (taxpayers).

    Yellow's financial problems are typical of thousands of other "zombie" US businesses. They accumulated massive debts during the Fed's era of absurdly low interest rates. Now, with rapidly rising current rates, they are unable to pay them off or roll them over. Expect a flurry of corporate bankruptcies. However, in the larger context, Yellow's problems are a trifle. Let us turn our attention to the biggest debtor in world history, the US government. 

     Source: Federal Reserve Bank of St. Louis

In Q1 1990, US debt was $3 trillion - a staggering sum to be sure. By 2000 that debt had nearly doubled to $5.77 trillion. In eight years it nearly doubled again to $9.44 trillion and in just two years grew $3 trillion more to $12.77 trillion. By 2020 it had nearly doubled again to $23.22 trillion. In the last three years it soared nearly 50%, approaching $33 trillion. What comes next? The Congressional Budget Office predicts US debt will reach $50 trillion by 2033. 

As the graph shows, the CBO estimates that government debt will increase by $5.2 billion every single day for the next ten years. While that is appalling, we believe it seriously under estimates the problem because its projection does not contemplate any health, military, financial or monetary crisis occurring over those ten years. Jim Richards recaps the two year period from the spring of 2020 to the spring of 2022.

From February 2020 through April 2022 the Fed pumped a mind-boggling 6.5 trillion new dollars into the economy, increasing the money supply by a whopping 42 percent.  Like an increase in the supply of all other goods and services, this explosive increase of the supply of money caused the “price” of money in terms of its purchasing power over goods to plummet. 

What is certain is that there will be more of the same when the next "crisis" arrives. This ensures more debt and renewed price inflation. We know this is true because when the Fed opens its tool box there is just one tool inside: a printing press that can be used to falsified interest rates, recalling the adage that, "When all you have is a hammer, every problem looks like a nail." 

The Tottering Tower of US Debt

    Annual interest payments on the growing mountain of US government debt will trigger a crisis at some point. Will that happen at $43 trillion of debt? $53 trillion? $73 trillion? We do not know and neither does the Fed. But it does not take a clairvoyant to see the crisis coming. If the US government ends up paying an average interest rate of 4% on its current outstanding $33 trillion of debt, annual interest payments will  be $1.32 trillion - over 25% of current revenues - leaving less for defense, Social Security, Medicare, government pensions and everything else. Annual interest payments soar to $2.12 trillion on $53 trillion of debt - consuming 43% of current revenues

    What would it take for the US government to repay its debt to avoid disaster? The answer to that question reveals Ugly Reality Number 3: the debt will never be repaid. It will not be repaid because it cannot be repaid. In fiscal year 2022, the US Government spent $6.27 trillion. However, its revenue was just $4.9 trillion.  Step One in paying off the debt requires the government to stop increasing the debt - i.e., no more deficits. Step Two requires setting aside revenue each year to pay down the debt. Assume that the US decides to pay off its debt over thirty-three years. That means it must first cut its current annual expenses by $1.37 trillion - just to keep the debt from getting larger - and then cut expenses another $1 trillion annually to apply to paying down the debt. 

    What are the chances that the US Congress will willingly cut $2.37 trillion of expenses from the budget every year for the next thirty-three years? The obvious answer is "Zero." All the vested interests (those receiving government benefits) would march on Washington with pitch forks and torches and vote into office anyone promising not to make cuts in benefits. So, the national debt will continue to soar until the system collapses at some unknown tipping point in the future. Why will that happen? History tells us so. It happened to the great Roman and Ottoman empires. It happened to the Spanish empire. It happened to the German and Russian empires. It happened to the British empire. Each and every one of them became overextended and succumbed to hubris and incompetence. The US has trod this path for the last thirty years and there is no political will to stop.  

    What might trigger the crisis? It could be many things but it may be a bond-buyer's strike. That means, at some point no one will step up to buy the US Treasury's ever-larger bond offerings fearing that rising inflation will cause the bonds to rapidly lose value. That precipitated the recent implosion of SVB Bank, Signature Bank, First Republic Bank and others. The bonds they had bought when rates were low dropped markedly in value when rates rose. What happens then? The Fed will be forced to print many trillions of dollars to buy the orphan bonds in a desperate effort to keep the failing system from imploding. That could trigger hyper-inflation - and more pitch forks and torches. The Fed's vast inventory of government bonds previously purchased will drop in value as there will be no buyers for them. At bottom, the US government is Yellow Corp. on steroids. 

    Ray Dalio, renown manager of Bridgewater Associates, recently opined on this issue of spiraling government debt.

Does it matter that the central governments and central banks have such bad balance sheets and income statements if the real economy is in pretty good shape? Of course it does! As with people and companies, governments that borrow have debt service payments and eventually have to pay back principal, which is painful. The only differences in their finances are that governments can confiscate wealth through taxes and print money via the central bank (so that’s what we should expect to happen). 


Over the long term, from looking at history and penciling out what is likely, it is virtually certain that central governments’ deficits will be large, and it is highly probable that they will grow at an increasing rate as the increasing debt service costs plus increasing other budget costs compound upward, and, as they increase, governments will need to sell more debt, so there will be a self-reinforcing debt spiral that will lead to market-imposed debt limits while central banks will be forced to print more money and buy more debt as they experience losses and deteriorating balance sheets. 


The concerning scenario that could occur if deficits compound so that there is more supply of government bonds than there is demand is that either interest rates will rise or central banks will have to buy more to try to hold them down, but in either case central banks’ losses and their negative net worths reach magnitudes that could have adverse effects on monetary policies directly (because they have to monetize their own and the central governments’ losses) and/or indirectly (because such losses could become political issues). 

Inflation Is Falling - Problem Solved, Right?

    Governments around the world hope to convince voters that inflation is falling and all is well again. But they carefully ignore three big issues: the continuing debasement of the currency, surging debt and the inflation rate is not what the governments say it is. Government agencies create the reports about the rate of inflation that are widely circulated by a non-inquisitive main stream media. An obvious motive to understate the real rate of inflation is to maintain the illusion that those in power are in control of the situation when they are not

   The US government's touted inflation figure is a fiction. By way of just one example, housing costs consume anywhere from 30-40% of the typical worker's income. If the government grossly understates the cost of housing then its overall CPI number is a fraud. The Bureau of Labor Statistics has concocted a statistical confection called "Owner's Equivalent Rent" to report housing costs. Here is a chart showing that OER number (green line) compared to data published by Zillow (red line) that is based on actual published asking rents. You be the judge of the credibility of the government's housing cost figure. 


The Real Rate of Inflation and Wage Growth 

    Government agencies routinely manipulate collected data by employing "hedonic adjustments" and other contrivances. Unsurprisingly, these adjustments always have the effect of lowering the reported rate of inflation., utilizing original government formulas, calculates that inflation is actually running at nearly 8% (1990 based) or over 12% (1980 based). From this we can conclude that the BLS inflation data is a gross distortion (political propaganda). Is it important to know the truth about the real rate of inflation? Only if you are a business owner, worker, retiree, saver, investor or voter. The blue line is inflation calculated by ShadowStats and the red line comes from the government.


Here is another chart produced by a government agency, the St. Louis Fed. It reports workers' inflation- adjusted hourly earnings.  As you can see wage earners have been on the losing end of inflation for a long time. As bad as this looks, the actual loss to workers is greater than depicted because real inflation is far worse than reported by the government.

The Fed Continues To Supply Cheap Money 

    The economy will never return to "normal" so long as the Fed continues to manipulate (falsify) interest rates. A free market should set rates by the natural supply and demand for funds. The chart below shows the Federal Fund Rate, net of the Fed's favored "16% trimmed mean" inflation rate. Hence, it is still supplying the market with money at a cost of less than the real inflation rate. Using Shadowstats 8% inflation figure, the true Fed Fund rate is deeply negative and therefore very "accommodative" (meaning "loose").  Distorted interest rates distort the economy for which there is always a later price to be paid.

The next chart shows the government calculated, inflation adjusted yield on a 10-year Treasury which is the foundational rate for most of the US economy. It is still negative compared to the real inflation and much more negative (-4%) with the actual 8% rate of inflation. Bond holders continue to lose money even with nominal bond rates over 4%. The Federal Reserve Act created the Fed and assigned it the task of providing financially sound banks with temporary loans at "penalty interest rates" during periods of illiquidity. It never tasked the Fed with being the US economy's ring master. Yet that is the role the Fed has assumed. (Recall the quip about why you should not "assume" anything). 

    Americans are repeatedly told by their elected (Biden) and unelected (Janet Yellen) officials that the US economy is "strong" and GDP is growing. Again we look to ShadowStats to assess the truth of those representations. The red line reports the government's assertion of 5% GDP growth and the blue line refutes it showing real negative growth. 


Secretary of the Treasury Yellen also assures us that US banks are in good health. Review the next chart reporting on banks' asset values to assess the truth of her statement.

     Source: Nomi Prins

How Fares The World Economy?

    China's economy is still struggling following its Draconian lockdown of the economy during Covid. The Chinese central bank is starting to lower rates and inject more "liquidity" (newly printed money) into the stalled economy. More debt (and it is already bountiful) may be a short term panacea but it comes, as we are learning, with long term negative consequences. China's stupendous growth sprang from the rapid industrialization of what was an agrarian economy following Deng Xiaoping's about-face declaration that "To get rich is glorious." Millions of workers streamed from the countryside to the cities to work in the booming factories. Exports exploded and the country became rapidly wealthy because its labor costs were well below those in developed economies making its products cheaper. Then real estate development became a government focus. The problem is there is a finite amount of urban housing needed because the population is now shrinking due to the former "one-child" policy. A related problem is the population is getting older, non-productive and becoming a bigger social expense burden. Two of the biggest real estate developers, China Evergrande (with $300B in debt) and Country Garden, have missed payments on their debts. The former just filed for bankruptcy protection in the US. To add to the pain, real estate prices are now falling causing great fear among tens of millions of Chinese who invested most of their savings (70%) in housing. Lending is also shrinking exacerbating the economic contraction. This is similar to what happened in the US in 2008-10 and Japan in the early 1990's.  Retail sales are also falling as workers revert to saving cash rather than spending it. Urban unemployment is up to 5.3% (based on Chinese government figures). 

    Centrally planned authoritarian economies are always at risk of social chaos because the people do not have the means to replace officials with new ones when things get really bad. Hong Kong's stock market is in bear territory caused in large part by China's ruthless repression of political dissent. That prompted many highly educated and high earners to leave with their assets in hand. Another telling development is China's decision to suppress economic data that is unfavorable. It no longer publishes the youth unemployment rate (last reported in excess of 20%). This may reduce political embarrassment on the international scene but the tens of millions of unemployed and underemployed college graduates are keenly aware of their plight. Xi Jinping's advice to them to "Eat bitterness" and take a low paying job is not being well-received. Strict state control of the internet may slow their organization and expressions of dissent but it will not stop them.

    Russia is dealing with a falling ruble (now 100 to the dollar) prompting the central bank to boost interest rates to 12%. That will have predictable adverse consequences for the economy. Like China, Russia must keep its people reasonably content or risk an involuntary "regime change."  The cost of the war with Ukraine is weighing heavily on the Russian economy as all wars do. However, Russia has been able to offset many of the West's Ukraine war sanctions by selling more of its oil, gas and other exports to China and India.

    The UK economy also struggles to recover from Covid shutdowns and its fight to control inflation with higher interest rates. Some economists fear that the Bank of England's continued high rates will suffocate the economy and  rates should be reduced. However, reducing rates prematurely risks re-igniting inflation as the US sadly learned during the Volker era. That is the risk a central bank takes on when it convinces itself that it is competent to manage a vast, complex and multi-layered economy. Britain is beset with illegal immigration as are the US and EU. There is inadequate housing for the immigrants and insufficient government funds to feed, house, clothe, educate and provide medical care for them. The vast majority of these immigrants flow through France and arrive in England in small boats across the English Channel. France is unwilling to take responsibility for them or stem their flow. It is far easier and cheaper to make them England's problem. Britain's government debt has surged 15% (from 85.5% of GDP in the last three months of 2019 to 100.5% in the first quarter of this year). UK wage growth is rising at 8.2% virtually ensuring higher retail prices as businesses must push off at least some of that cost onto the public to keep from closing their doors and laying off their staff. Government spending has reached such a high percent of GDP that it is starting to suck the life of the UK economy. Here are two charts reporting on the rising "services" CPI and "core" CPI. Rising prices for core expenses means there is less money available for discretionary expenses - and in some case even essential expenses such as housing and energy. The Brits face some ponderous problems.


   The German economy is in technical recession (two consecutive quarters of declining GDP growth) and continues to search for a solution to the loss of cheap Russian natural gas that fueled its industry, heated its homes and generated its electricity. Overall the French economy is not in much better shape because government spending continues to consume far too much of GDP. This inevitably leads to less business investment meaning lower future growth - a vicious cycle that is hard to break. The one thing France has going for it is its abundance of nuclear generated electrical power. It did not make the same foolish mistake as Germany that closed its nuclear power plants causing it to rely frequently on back-up coal for power. France is an energy exporter.   


    What we learn from history is that governments learn nothing from history. Politicians keep making the same foolish mistakes in order to "live for today" (get elected and stay in office) and let tomorrow take care of itself (when they are no longer in office). Knowing this, business owners, workers, savers, retirees and investors need to become students of history if they hope to avoid the pain governments repeatedly inflict on their citizens. 


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