This week, the markets experienced significant volatility once again. The DOW was erratic, mimicking a fish out of water, hinting at something monumental on the horizon.
Currently, U.S. government debt has surpassed an astounding $18.1 trillion. When we include the debts of households, businesses, and state and local governments, the total U.S. debt skyrockets to a staggering $59.2 trillion. Personal debt alone, encompassing mortgages, student loans, and credit card debt, now exceeds $16.7 trillion.
These figures are not only substantial; they are mind-boggling. They reflect not just the sheer size of the numbers, but also what they signify for our economy.
These colossal debts create a facade of prosperity, generating a false sense of demand that leads to productivity that might not otherwise exist.
Every day, millions of individuals engage in jobs that owe their existence to either cheap money or inflated prices. Sometimes, it requires just one of these factors; at other times, both are necessary—think of industries like oil fracking or mortgage brokering.
Endless debt fuels this cycle: more credit leads to more demand, which increases consumption, creates jobs, and boosts productivity. But where does it all lead?
Ultimately, it leads to even more debt. The extent of this increase hinges on inflation levels.
The Absurdity of Our Economic System
The bizarro, debt-driven economy we navigate depends on some degree of price inflation to function smoothly. Even a brief period of deflation, or a mere pause in inflation, could disrupt the entire credit system.
So, what level of inflation is necessary?
The Federal Reserve posits that a 2 percent inflation rate is ideal—not too high, nor too low, but precisely calibrated.
This 2 percent target is believed to alleviate the debt burden on society without completely eroding its ethical base. At this rate, it takes approximately 34 years for a debt load to halve. While this gradual reduction may keep borrowers in check, it is just enough to stave off mass defaults.
From the Fed’s viewpoint, inflation is preferable to deflation. Unfortunately, the current debt-based financial system seems to be nearing its limits. The economy appears to be yearning for deflation, seeking to purge unsustainable debts through defaults. The Fed, however, is determined to keep stability by inflating these problem debts away with minimal price increases.
This perspective is not an endorsement of the Fed’s inflation strategies. It’s merely an attempt to clarify their approach in straightforward terms.
It’s also crucial to recognize that the Fed isn’t as in control as it professes. While a 2 percent inflation rate may be desirable, artificially creating and maintaining it by manipulating money prices is akin to trying to cure a headache by striking one’s head with a hammer.
Anticipating the Next Economic Downturn
Having engaged in extensive monetary intervention for over six years, the Fed has now reached the limits of its policy options. The federal funds rate has been nearly zero since late 2008. If credibility is to be maintained, they must start tightening their approach.
Meanwhile, the economy seems to be shifting. Following a significant drop in oil prices, gas prices are also falling. It’s increasingly evident that this is less about an oversupply and more about a decrease in demand.
Recent information revealed by the DOW transports index supports this. Decreased fuel costs typically benefit transport sectors, but this latest price drop deviates from the norm.
“To gauge the impact of lower oil prices on the economy, look at the Dow Jones Transportation Average (DJT),” notes Mark Hulbert.
“The situation doesn’t look good.”
“During the past five weeks, oil prices have plummeted by 20 percent. If this cheaper oil had a positive effect on the economy, you would expect to see it reflected in the transportation sector. Yet, during this same timeframe, the Dow Transports have actually declined by nearly 2 percent.”
Hulbert further mentions that transport metrics serve as leading indicators of economic downturns. As of now, the Fed remains unwavering.
“The Fed has shown no signs of hesitating to increase interest rates in the latter half of 2015,” reported MarketWatch on Wednesday. “The U.S. central bank remains optimistic about the economy, asserting that inflation will revert to the 2 percent target after being temporarily affected by various factors.”
Just wait until the S&P 500 dips below 1,500. At that point, the Fed might find itself in full panic mode, possibly resorting to printing money to buy stocks outright. It sounds far-fetched, but if they’re willing to print money to purchase bonds, why not stocks?
Sincerely,
MN Gordon
for Economic Prism
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