Interest rates and inflation

I have written several times about our crazy monetary policies and how perpetual deficit spending is not wise.

Today's Wall Street Journal reports an uptick in inflation, most likely a sign that the economy is picking up, the money in circulation is starting to bid up prices, and thus people have to pay more to buy the things they want.

It has been crazy that with the printing presses running 24/7 over the past eight years and longer, we haven't seen inflation taking off. The economists have been scratching their heads as they advise our political leaders to keep doing it, and more of it is even better. So we keep deficit-spending, we keep printing money (or the equivalent, we just add some zeros onto the end of our electronic funds), and we hope that people don't all start to freak out that our dollars are no longer tethered to anything of intrinsic value and their perceived value and usefulness is solely based on trust.

Let's say inflation goes up to 5% a year. Now people start to think that they should buy the things they want now, because in a while, those things will be more expensive. There is a cost for waiting. So guess what? The economy starts to heat up, people are selling stuff like crazy, and there is more pressure on prices to rise. Merchants have more dollars and more business so they raise prices. Consumers have more money so they are willing to spend more.

Currently interest rates are still very low, because the Fed has made them so. So let's say that interest rates stay at 3% with inflation at 5%. What happens?

If you have $10,000 to invest, are you going to accept a 3% rate of return and effectively lose 2% per year to inflation? No. If your money is not "earning" anything, you will find something else to do with it. Most likely, you will spend it. Maybe try to buy things that go up with inflation. So for the banks to make money, they need to raise their interest rates along with inflation. And we've seen that in the last eight years. We've had inflation at around zero and interest rates around 3%. So if inflation goes to 5%, perhaps interest rates will go to 8%.

Our federal debt is around $20 trillion and rising. Interest rates are now say 3% so our annual interest cost is about $600 Billion. I assume we have some cash assets which help offset that (say social security trust funds) so maybe we actually pay like $400-500 Billion. I just looked it up and my estimate is on the money, so to speak. Here is the link: https://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm

The good news is that our interest payments have been steadily rising for the last 20 years. We did not experience a huge shock based on our "quantitative easing" program. The bad news is that under our previous administration, the debt has ballooned. It has doubled in less than 10 years. Interest costs have not spiked because they were kept low by the government. Everyone knows that can't last forever and now let's contemplate what happens when the gravy train comes to a halt.

If interest rates normalize to 8% because inflation goes up to 5%, our calculated annual interest payment would be at least $1.6 Trillion. If you read the government website I cited, previous years' interest includes other borrowings, which we are still certainly doing. So maybe total interest costs will be $2 Trillion a year, given that our annual deficits continue and maybe inflation will hit 6% instead of 5%.

This means roughly half of our federal budget will need to be spent on interest. Or not. We can default instead, or we can jack up taxes, or we can fudge the books to increase the money supply and not let the public know. Maybe the Treasury can issue trillions of dollars in bonds, and then the federal reserve can "buy" them, and then auction them off and use the proceeds to pay off the previous bonds. Who can follow all that? Nobody but Charles Ponzi.

Now let's throw one more log on the fire. Our political leaders are not just spending us into oblivion, they are also promising future benefits to some of our workers into oblivion. Our unfunded pension and other liabilities are in the trillions as well. According to Google, Massachusetts unfunded liabilities alone are $115 billion. Here is a 2014 Forbes story which estimates the total U.S. unfunded liabilities at $127 Trillion. (One-hundred twenty-seven Trillion dollars.) https://www.forbes.com/sites/realspin/2014/01/17/you-think-the-deficit-is-bad-federal-unfunded-liabilities-exceed-127-trillion/

Oops, my bad. The 2017 article updates that figure to $210 Trillion. But what's another $80 Trillion and change among friends? See https://www.forbes.com/sites/johnmauldin/2017/10/10/your-pension-is-a-lie-theres-210-trillion-of-liabilities-our-government-cant-fulfill/

These unfunded liabilities are future obligations which are not necessarily guaranteed. What happens when people (mostly tens of millions of former government workers) realize that the promises made to them are going to have to be broken?

My best guess is that to avoid a financial calamity, the government will turn to taxation of assets, rather than cutting spending. Other than your house, most assets are not taxed, just the income earned from them. People do pay excise taxes on the "luxury" of owning a car. But these are mere crumbs. When the government goes after assets in earnest, anyone with accumulated assets will really feel pain.

When we start taxing assets, we are going to see a lot of new behaviors, many of them unpleasant. A huge consequence of this will be a loss of feeling in this country that we are all Americans and we are all "in this together" and "on the same team." Talk about income inequity and inequality. The "haves" will really become pariahs and as they hide their assets (or just dump them), the "have-nots" will decry that they aren't paying their "fair share." If you think Senator Warren is shrill now, just wait.

Do you remember John Kerry, who married Teresa Heinz? Kerry, our former Secretary of State, will go down in infamy as the guy who allowed Iran to develop nuclear weapons and paying them hundreds of billions of dollars to fund terrorists worldwide. Kerry and his wife are worth hundreds of millions, yet he illegally registered his yacht in Rhode Island to avoid the luxury tax. If the Heinz-Kerrys do it, do you think the Smiths and Jones' will do it?

Everyone with money will have to convert to cash (which the government might even outlaw, to prevent the hiding of assets), and we could have hyper inflation as a result. Or not. Maybe the economy will just collapse and we will go back to a barter system.

This hasn't started yet, not even close, but the push to charge a "millionaires" tax may be seen as the beginning. When high incomes are punitively taxed, what will those people do? Just pay it, or will some of them look to reduce their taxes by moving to another state, or taking compensation in other forms? Will the government be able to close every available loophole, and then what? The Left will argue that all workers work for the society (the state) and we will have full communism. Avoiding taxes is now called unpatriotic by the Left. It is just a matter of time before trying to minimize your taxes will be illegal.

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