In the latest edition of Economic Prism, we posited that, amid the prevailing financial uncertainty, the U.S. economy is showing signs of improvement. This assertion took many of our readers by surprise, prompting us to elaborate further on this viewpoint. Allow us to clarify our perspective.
First, it’s important to acknowledge that we still view the economic landscape as precarious. With government debt surpassing 100 percent of Gross Domestic Product (GDP), this situation serves as a significant barrier to economic growth, undermining monetary stability. The debt crisis isn’t going away; it will ultimately constrain economic activity and could lead to either government default or rampant inflation as the Federal Reserve prints more money to alleviate the debt load.
However, economic trajectories are rarely linear. They are often marked by cyclical rallies that can deceive both believers and skeptics. Presently, we believe the economy is on a temporary detour, diverging from its long-term trends.
The financial challenges we face today have deep-rooted origins. They didn’t arise with the 2008 financial crisis but trace back nearly a century, starting with the establishment of the Federal Reserve. The real tipping point came in 1971 when President Nixon severed the dollar’s final ties to gold. Since then, the proliferation of debt-driven money has skyrocketed.
Despite extensive government intervention, real economic growth has been achieved over the past century. However, this growth has often been accompanied by an illusion crafted from an excess of debt. Recognizing that we inhabit a world filled with both tangible and illusory components is crucial for making sound decisions regarding your savings and family assets.
Pushing on a Wire
Today, the effects of years of government manipulation of money’s value have distorted our understanding of genuine economic growth versus its illusion. At times, the distinction is stark, especially when parallel historical patterns emerge, such as the dot-com bubble of the late ’90s and the housing bubble of the mid-2000s. Currently, some suspect we may be observing a similar trend with Treasury bonds. More often than not, however, distinguishing between reality and illusion can be quite challenging.
Yet, there is a noticeable uptick in economic activity, although much of it is built on a shaky foundation of debt sustained by a seemingly ceaseless flow of paper currency. As mentioned last Friday, key economic indicators—including manufacturing, housing, and consumer spending—are on the rise.
Whether this represents legitimate economic growth or merely the appearance of it, something significant is happening. Notably, consumer spending has increased, and here’s why it matters.
The Federal Reserve expanded its monetary base from $900 billion in late 2007 to around $3 trillion today. Interestingly, despite this tripling, the new money largely failed to circulate within the economy. Following the housing market collapse, heightened fear and tightened lending standards meant that the influx of new money remained dormant, largely sitting on bank balance sheets or being utilized to purchase Treasuries.
This phenomenon—where increased money supply fails to stimulate the economy—is often referred to in central banking terms as “pushing on a string.” In this context, while the Federal Reserve attempts to stimulate growth by increasing the money supply, the other end of the string does not move, leaving the economy unaffected. Recently, however, the Fed noted a significant rise in consumer debt—the most substantial increase in a decade. This suggests that the string of monetary policy is now taut, allowing credit to flow into the economy once more, marking a change we haven’t witnessed since mid-2008. Where might this lead?
The Money Must Go Somewhere
In the short term, this is undoubtedly beneficial for the economy, utilizing the Fed’s monetary stimulus that has lingered unused on bank balance sheets for the past three years. Moreover, this influx is likely to be inflationary. The speed at which this new money circulates and its velocity will be crucial in determining how much consumer prices rise.
The latest Consumer Price Index (CPI) report showed no change in prices for November. Anticipation builds for the December CPI report later this week, where holiday discounts may offset the recent uptick in consumer spending. However, it’s inevitable that this new money will need to find its way into the market in some form.
Will it be funneled into consumer goods? Could it inflate stock, gold, and oil prices? It seems probable that this new capital will permeate various sectors, potentially causing disruptive inflationary pressures. It will also likely stimulate business activity, enhance employment, and, unfortunately, foster misallocation of resources.
The uncertainty lies in whether this will result in a brief boost lasting just a few months or evolve into a more prolonged uplift over two to three years. Regardless, this won’t address the underlying long-term debt issues. In fact, it may exacerbate them, encouraging consumers to take on additional debt only to face another setback when the temporary momentum fades.
In the meantime, we will continue to observe these developments and keep you updated. Thank you for your attention.
Sincerely,
MN Gordon
for Economic Prism