By Victor Sperandeo
From 2008-2018, U.S. debt virtually doubled while the M2 money supply compounded at 6%. This should have caused rapid inflation. It didn’t. In fact, inflation decreased to 56-year lows during the period from 2009 to 2017.
The Federal Reserve and leading economists say they don’t know why. Here’s the explanation.
To have inflation, commodity prices must perform better. Commodities are non-correlated to stocks and bonds while they are highly correlated to inflation, volatile interest rates, and high or rising GDP growth rates. All of these were at historic U.S. 240-year lows over the last nine years. Using the CPI to represent inflation, inflation made continuous new lows ending in 2017 at a compounded rate of 1.61% on a 10-year rolling annual basis. The five-year rolling annual rate also made new lows but has since recovered by 7 basis points. Since 1961 the five-year low was 1.36% (2012-2016), but now from 2013-2017 is 1.43%.
The reasons for the decline in these economic barometers were the policies of President Obama.
The “change” brought to the nation included increased regulations (Todd-Frank), higher taxes for everyone (the end of the Bush tax cuts in 2012), and the creation of Obamacare. The ACA was effectively a huge tax on the middle class disguised as an insurance policy, which was then redistributed to the lower class, who got healthcare insurance policies at way below the market prices, by subsidizing the insurance companies. As a consequence, Obama transformed America into a virtual Corporatist/quasi-Socialist State.
Today the U.S. is essentially an oligarchy of party leaders and federal judges, who are controlled and heavily influenced by multinational corporations and outside special interests. They operate much like cartels. In short, we now have government similar to that of a banana republic.
Therefore, with 0% nominal Fed Funds rates for seven years and three large Quantitative Easing (QE) programs, combined with an increase in the Federal Reserve Balance sheet from $800 billion to $4.5 trillion, why isn’t inflation at least approaching historic compounded levels of 3.10% that were seen between 1913 and 2017?
The primary reason is: when you execute extraordinary amounts of printing of paper money via QE, i.e. buying government debt, and other assets, such as mortgages, the cash created “out of thin air” goes only to the very few investors who own those assets in large quantities. No inflation occurs, as those investors don’t spend that money, but rather invest it in assets such as equities, real estate, other debt and art. Prices for these assets rose to historic levels as a consequence.
This is called “wealth creation” instead of inflation. This Fed monetary and tax policy is also encouraging corporate stock buyback programs, which caused the velocity (or turnover) of money (via M2) to decline to the lowest level in 60 years, or 1.4 times. This, coupled with a lack of investment in new plant and equipment — causing capital expenditures to decline — resulted in a major decline in productivity to 0.7. That in turn led to stagnant medium incomes over the last 20 years. (This doesn’t take into account the Free Trade thinking that caused the 19.8 million manufacturing jobs to decline to 11 million since NAFTA was enacted.)
If the bulk of people don’t get the money, they can’t spend beyond their revolving credit card limits. Household non-revolving credit debt (house equity and auto loans) is at record highs as of January 2018. Total household debt is $13.2 trillion, also a new record. Credit card interest rates average 19.9% and range from 9.9% (often only as a promotional rate) to 29%.
Contrast this to corporate debt which despite being at record levels costs around 3% to 3.25% on seven-year term debt. This is the rate corporations are paying to borrow money to buy back stock. Inequality exponentially increases while the middle-class standard of living steadily declines; meanwhile low but steady inflation still takes its toll (for which nobody blames the Federal Reserve?).
Since 2008, “financial repression” has been in effect with interest rates below inflation. This is why stocks go up but no major actual inflation occurs. In effect, it is a method of government theft of individual savings; inflation is a stealth tax. So, people hoard more as they earn less and their savings decline. For example, the 90-day Treasury Bill yield at the end of March was 1.71%, while the CPI was 2.36% year over year.
This makes government and corporate borrowing virtually free. Historically (since 1926) T-Bills have traded at a compounded rate of 70 bps above CPI, not 75 to 50 bps below CPI. This is what is meant by “Government is created to serve the rich, while enslaving the poor.”
Moreover, these increases in government debt are not sustainable.
This is an existential threat to our Constitutional Republic’s political structure. Normally a nation with a printing press never defaults by bankruptcy, but rather by hyperinflation. This in turn historically has led to authoritarian dictatorships (see Napoleon and Nazi Germany). I should also mention schemes of “Universal Basic Income” such as Facebook CEO Mark Zuckerberg is proposing would most likely cause hyperinflation, as people would get free money estimated at $36,000 a year per family, and certainly they would spend it.
In June 2017 the CBO projected that total stated debt would grow to $30.7 trillion in 2028 (up from the current $21 trillion). However, in March 2018 that estimate was increased to $33.2 trillion, or an additional $254 billion per year. Interestingly, they also raised their revenue estimate over the same period by over $1 trillion (even after the latest tax cuts). So, these higher debt projections already take into account increasing revenue! This assumes no recession during the period, which I estimate would increase debt by additional $12 trillion (making U.S. debt $45 trillion). Not to mention our unfunded liabilities which could be anywhere from $100 trillion to $220 trillion in 10 years going forward.
It should be noted that the longest recovery since 1854 — when the NBER began to keep track of such statistics — was 120 months. We would reach 121 months in our current recovery in July 2019. To think (via the CBO projections) the U.S. can go 10 more years in recovery (for a total of 227 consecutive months) is like assuming the U.S. will win the lottery; it may not be impossible, but it is highly unlikely. That is, unless you’re a politician (or the CBO) who lies for a living.
Certainly, the borrowed times we live in will not be the future we assume we know.
At the bottom line are two fallacies. The first is the idea that paper money wealth will protect you, and what you see in asset prices around the world is accurate. Interest rates are manipulated by governments to the extremes in the history of civilization. Therefore, we come to the second fallacy: the belief that prices are real — based on a real foundations.
How is this mindset allowed to persist, and why is this growing danger consistently ignored? This kind of thinking is based on “perception policy” to keep the sham going. The situation was best described by Ayn Rand in her novel The Fountainhead: “The hardest thing to explain is the glaringly evident, which everybody has decided not to see.
Victor Sperandeo serves as the President and CEO of Alpha Financial Technologies, LLC (AFT), is a founding partner of EAM Partners L.P. (EAM), and serves as the President and CEO of its general partner, EAM Corporation. Sperandeo is a trader, index developer, and financial commentator based in Dallas, Texas. He has over 45 years’ Wall Street experience trading both independently and for many notable investors. He is widely regarded as an expert in commodities, particularly in the energy and metals sectors. His market crash prediction in a September 1987 Barron’s interview earned him great recognition and highlighted his deep understanding of financial markets. Author of several books detailing his philosophy: Trader Vic — Methods of a Wall Street Master; Trader Vic II — Principles of Professional Speculation, and Trader Vic on Commodities: What’s Unknown, Misunderstood, and Too Good To Be True. He was a 2008 Inductee into the Trader Hall of Fame by Trader Magazine and included on Ziad Adelnour’s list of top 100 Wall Streeters.