Economic analyst David Rosenberg from Gluskin-Sheff warns of an impending recession, attributing the looming crisis to rising food and energy prices. He expresses skepticism about consumers’ ability to navigate through these challenges.
Through historical analysis, Rosenberg highlights a significant metric: the ratio of crude oil to core Consumer Price Index (CPI). Recently, this ratio has exceeded the 40x mark for only the third time in history. The previous instances occurred in November 1979 and October 2007, both of which preceded severe recessions within two months. Even earlier breaches of the 20x threshold were precursors to the recessions of 1973-75, 1990-91, and 2001.
At Economic Prism, we consider it highly probable that another recession may begin in the coming months. In addition to the elevated oil to core CPI ratio, another historic event is approaching: the conclusion of QE2, which is set to end at the close of June.
“When QE2 ends, a significant source of stimulus will vanish,” warns Robert Arnott, chairman of Research Affiliates. “If QE2 is not succeeded by QE3, its cessation could trigger a recession and a downturn in risk markets.”
Unconventional Debt Default
The practice of quantitative easing—essentially creating money and lending it to the Treasury—is fraught with risks. With oil prices exceeding $100 per barrel and soaring food costs, further quantitative easing could prove disastrous. Yet, it remains a possibility, as the Federal Reserve may have few alternatives.
Notably, the world’s largest bond fund manager, Bill Gross of PIMCO, has indicated that he is selling Treasuries, citing their diminishing value against a $75 trillion debt backdrop.
“Unless entitlements undergo significant reform,” Gross contends, “I am confident that this country will default on its debt—not through traditional means, but by stealthily undermining savings via various historically validated policies—inflation, currency devaluation, and low to negative real interest rates.”
In fact, a form of unconventional debt default by the U.S. Government through inflation, currency devaluation, and negative real interest rates is already in progress.
- Inflation, when accounting for food and energy, is currently running at 6% annually.
- The dollar index has fallen to 75.82, a 36% decline over the past nine years.
- The Federal Funds rate remains near zero, significantly below the inflation rate.
Washington’s Budget Cut Farce
Even amid the threat of unconventional debt default, the U.S. government struggles to implement budget cuts. As the 2011 fiscal year is halfway complete, Congress is still without a budget. As a result, they must approve an emergency spending bill to keep operations running.
For those following the situation, the proposed spending cuts are hardly noteworthy—they resemble a farce.
House Democrats are only willing to reduce spending by $32 billion, which amounts to less than 2% of the expected $1.645 trillion deficit and under 1% of total expenditures. On the other hand, House Republicans are aiming for $61 billion in cuts, bringing total reductions to $100 billion. However, even a $100 billion reduction only addresses slightly over 6% of the projected deficit and 2.6% of overall spending.
This year, the U.S. Government will allocate $205 billion to interest on existing debt. According to the Obama administration’s forecasts, interest payments are predicted to reach $928 billion by 2021. This starkly illustrates that even if Congress manages to cut $100 billion in spending, it would only cover 10.7% of interest obligations over the next decade.
Moreover, this scenario underscores that Washington is not genuinely committed to controlling spending. They may act as though they are serious, but in reality, they prioritize their re-election over fiscal responsibility.
The public desires immediate benefits, and politicians promise to deliver them. For years, this has led to a cycle of borrowing from the future. However, reality eventually catches up, resulting in disillusionment and financial decline.
Sincerely,
MN Gordon
for Economic Prism