Friday, March 23, 2012

Federal Reserve & National Debt Have Set Stage For Soaring Inflation

In 2011, the U.S. inflation rate averaged 3.2 percent. So far in 2012, the rate is still averaging roughly 3 percent. Yet, Americans are seeing even more significant increases whenever they buy food or gasoline.

The concern among many economists and analysts is that the U.S. could be headed for a much higher inflation rate in the not too distant future.

From 1914 until 2010, the average inflation rate in United States was 3.38 percent. It's reasonable to ask, What's behind this?

Most people associate inflation with rising prices. However, rising prices are merely a symptom of inflation, not the cause.

In reality, rising prices are the result of money losing its value — its buying power. Money is driven by the same laws of supply and demand that affect almost everything else. The more rare something is, the more valuable it is. Conversely, the more readily available something is, the less valuable it is.

Money is constantly being created by the world's central banks, including the Federal Reserve Bank. When the supply of money exceeds the supply of goods and services in an economy, it devalues the currency — meaning the currency loses buying power.

The Fed is allowed to create money out of nothing. Yes, as incredible as it seems, the Federal Reserve is legally entitled to create something of value out of absolutely nothing. All of the world's central banks do this. All paper money is fiat money, meaning it is simply assigned a value by government decree. Yet, paper money has no intrinsic value. It's just paper with ink, backed by nothing of value.

However, only about three percent of the world's money is in the form of bills and coins. The other 97 percent is just numbers typed into bank databases and shown on computer screens.

Most troublingly, all money is loaned into existence. But the interest portion of all loaned money is never created; only the principle is created. So, the system is always out of balance, right from the start. The only way for the interest on debts to be paid off is by creating even more money. In essence, money is created as debt.

So, by design, our monetary system must constantly create new money, or new debt. And price inflation is the end result every time a central bank creates new money. It's the money supply that is being inflated, and all of this new money continually devalues the existing supply of money.

What is really worrisome is that the creation of money has been happening at an alarming rate.

The U.S. monetary base (the supply of money) nearly doubled between 1994 and 2006. Then it doubled twice more, increasing by an additional 221% from 2006 to 2011. That's simply staggering. In fact, it's alarming.

The result has been a devalued dollar, manifested in the form of rising prices, which is affecting all Americans. This process will continue to play out in the coming years, but the consequences are likely to become considerably worse over time. If you don't understand this, just think supply and demand.

The U.S. government has created so much debt for decades that the Federal Reserve would have to manufacture about five times more dollars than exist today merely for the Treasury to meet its obligations. The U.S. government's unfunded liabilities currently amount to $70 trillion.

Yes, you read that correctly. The U.S. government has $70 trillion in future obligations and it doesn't have the funds to pay them.

Due to its fears of deflation and persistently high unemployment, the Federal Reserve has bought trillions in mortgage-backed securities and Treasury bonds over the past couple of years, all with freshly created money. The funds from those purchases have flooded the economy with inflation-fueling liquidity, pumping up the stock market in the process.

Much of the excess liquidity has also ended up in commodities markets, which has sent crude oil and food prices into an upward trajectory.

All of that liquidity flowing through the economy has enabled the government to continue producing annual trillion dollar deficits. Whatever funding the Treasury cannot raise in the bond market, the Fed simply prints.

But the Fed isn't acting alone. The European Central Bank, the Bank of England, the Bank of Japan and the Chinese Central Bank have all been printing like mad, pumping absolutely massive amounts of liquidity into global markets.

The end result will be skyrocketing inflation.

There are limits to everything. This level of debt creation cannot go on indefinitely.

As Dr. Chris Martenson has astutely observed, beginning in January 1970, total credit market debt doubled five times by 2010. This includes all debt — financial sector debt, government debt (federal, state, local), household debt, and corporate debt.

In order for the 2010 decade to mirror, match, or in any way resemble the prior four decades, credit market debt will need to double again from $52 trillion to $104 trillion.

Does this seem reasonable or even possible to you? How can the current amount of debt ever be repaid, much less another doubling?

What is clear is that no matter how this all ends, it will not end well.

The dollar has already lost over 95 percent of its buying power since the creation of the Federal Reserve in 1913. And there is no let up in sight to all of this unrestrained money printing. Once foreign governments and sovereign wealth funds stop buying Treasuries — out of fear that the U.S. already has too much debt to ever be repaid — the only option will be for the Fed to super charge its already rampant money creation.

As it stands, the national debt already exceeds the gross domestic product. That's troubling because when public debt reaches 90 percent of the GDP, research suggests that economic growth slows by about 2%. And slow growth can pile on even more debt.

In their book, "This Time It's Different: Eight Centuries of Financial Folly," Carmen Reinhart, a University of Maryland economist, and Harvard professor Kenneth Rogoff find that a 90 percent ratio of government debt to GDP is a tipping point in economic growth. Beyond that, developed economies have growth rates two percentage points lower, on average, than economies that have not yet crossed the line.

History indicates that the U.S. will not be able to grow its way out of debt. And the long term trends for the debt and dollar are frightening.

Under the CBO’s rosiest estimates, total Federal Debt is projected to rise to at least $21.7 trillion by 2022. However, the debt could also be as high as $29.2 trillion by that time.

The end result will be an even more devalued dollar with even less buying power.

The inflation of our currency is already leading to inflated prices throughout the economy, Yet, the current inflation rate is merely a hint of the explosion that is yet to come.

The inflation rate hit a historical high of 23.70 percent in June of 1920 and got as high as 13.5 percent as recently as 1980. It shouldn't be a surprise to anyone when inflation rises to a level somewhere between those two points in the coming years.

Then we'll all sound like our grandparents, reminiscing about how cheap things used to be back in 2012.

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