We face many issues as a nation, but nothing is more critical in the 2024 election than our fight with inflation and spiraling debt. These two issues are locked in a deadly embrace that cannot be separated. To fix either, we must fix both. The importance of this is local and global. We see it every day at the supermarket, but as the world’s reserve currency, we have exported our fiscal stupidity to the rest of the world. What our Congress has done to the world will create long-term animosity toward the United States and take decades to resolve.
Just Not That Difficult to Understand
Governments intentionally make the discussions about deficits and inflation both confusing and inconsistent. Pick your network show, and they will have “knowledgeable” guests back-to-back who give views of the economy that are diametrically opposed. Always remind yourself that these people have a product to sell, and convincing the public investor that their product contributes to the solution is their motive. We cannot look to economists or government experts for help; they are no better than television pundits when forecasting the direction or issues with our economy.
Your and my understanding of what is happening and what is likely to occur is better because we live in the real world, where we have purchased a gallon of gas and a dozen eggs. Unlike television hosts, we are not sitting in five-star restaurants discussing the theory of how ordinary citizens deal with these issues. We are ordinary people dealing with these daily, and we are voters.
Understanding what has happened and how it has hurt us is easy. It is a cure that is complex and painful. But the most important thing is voting for electable people who understand financial issues and who can correct things over time. Our politicians put us in such a hole that there are no quick fixes.
Inflation
If you are a person who believes that our inflation is “transitory,” then there is a government job waiting for you with your unique expertise and insight. To believe what you hear daily, you must confuse slowing inflation with deflation. Television hosts talk about slowing inflation as if it were a victory, some imaginary world where you pay less today than you did yesterday. That world is deflation, and we are not there and probably will never be there in the long run without meaningful change in Washington.
The FED and television economists believe that if you paid 10% more for bread last year and only 3% more this year, then inflation is moderating. We all know that the reality is that 10% last year and another 3% this year are still higher numbers. The growth rate is slowing, but that 13% is now baked into your everyday cost of living forever. Slowing inflation is good, but it is not a cure unto itself.
Unless your wages increase faster than inflation, your standard of living is going down; that is where we feel it most. For retirees, the challenge can be worse. Most have savings and income set at retirement, and that figure has not improved with time. The FED has also held interest rates artificially low for decades. This hurts those living on fixed incomes the most. When it corrects, it must rise fast and move further; this is precisely where we find ourselves today.
What is also apparent about Congress is too few members understand basic economics. They passed out trillions of dollars during and after the pandemic, which created the exact conditions that always result in inflation. Government handouts and supply chain issues created by the pandemic set today’s conditions. Politicians understand the relationship between free money and votes, which became apparent during the pandemic.
There are many ways of analyzing and defining inflation. A clear connection to the money supply (the number of dollars in circulation here in the United States) is best. The chart above clearly shows that as you increase the number of dollars in circulation (green line), inflation follows (red line), and the reverse is also true. This measure fits the historical definition of what we all learned in school.
“There are too many people with too much money chasing too few goods.”
With artificially suppressed interest rates, individuals and governments are deluded into borrowing more money than is wise under normal conditions. Politicians cannot stop spending when they believe the debt is affordable, a perception set up by holding rates low. Washington bureaucrats set up this environment, and it helped them maintain power and control from 2008 until 2023. The FED had other alternatives to help slow the economy and, unfortunately, chose the worst option.
Historically, the FED has had three quite diverse ways to speed up or slow our economy, and a combination of these three has worked best. The three are moral suasion, interest rates, and reserve requirements. Using these wisely and in tandem works; picking just one and pushing it does not work, and unfortunately, that is what the FED has done.
Moral Suasion
We would call this tool merely talking about the economy and what must be done to guide it in desirable ways. This tool has often been used to help people understand the dangers of behavior, especially in Congress. In recent years, the FED has made their discussions complex and vague. Especially bad is their unwillingness to explain to Congress and the American people that the FED cannot function correctly with uncontrolled Congressional spending. They hint at the problem but cannot say it. They are empowered to be an independent financial control, but the past two FED chairmen have politicized their position.
There was a change in the Obama era that has continued today. Historically, only the FED Chairman spoke to the press and the public about the economy and their actions. This gave them a clear, concise, and unified way to communicate. Today, regional FED presidents hold one or more press conferences, go on talk shows, and use their web presence to push narratives that fit their views. The FED Chairman needs to shut down all voices but his until our economy is on firmer footing. In times of financial stress, you need clarity, not confusion. We throw into the mix Janet Yellen, who oddly agrees or disagrees with the FED and rating agencies in unpredictable ways rather than staying quiet.
Interest Rates
The FED can change the rates they pay on debt and, in doing so, influence market rates. This is one of the primary tools for slowing down or speeding up the economy. Banks, consumers, markets, and corporations react quickly to changes in loan and deposit rates. The FED has only tried to slow the economy through rates in this economic cycle. This push for higher rates has also hurt the banks and driven the national debt to new unsustainable levels. This single focus continues to be a big mistake, just as holding rates artificially low for too long was also a mistake. The unknown big problem from the interest rate hike is the unrecognized bond losses on the books of our largest banks, the FED, foreign banks, and foreign Central Banks. By waiting to raise rates, all banks now have massive bond losses on their books, creating further distaste for Treasuries and making the dollar less appealing.
We now have a record national debt, credit card debt, home mortgages, student loans, automobile loans, and commercial real estate debt. The sum of this is not sustainable by the banks, governments, corporations, or consumers. Soon, we will have record defaults in several sectors of the economy because the government artificially created an environment encouraging people to borrow money they cannot repay. Worst of all, this culture has been exported with worldwide dollar usage, so the world now has similar issues. By allowing inflation here, we have forced inflation everywhere. All banks that use the dollar as a reserve currency now have the same bond losses and weakened banking conditions. This mistake is one more arrow in the quiver of the BRICS consortium and reinforces the need for either a different or more than one reserve currency.
Reserve Requirements
This tool is one of the least understood by the public and has an immediate and powerful effect on economic and bank behavior. Few realize the actions taken by the FED during the pandemic and the mistakes made since then. When the pandemic hit, there was concern about the public availability of money and loans. So, the FED lowered the reserve requirements for banks to 0%. This opened the door for banks to make as many loans as possible without having regulatory constraints. Time will tell if this was a wise temporary policy, but it was an unusual time and an equally unusual move by the FED. The mistake came late last year when it was time to reinstate the reserve requirements. The FED decided to leave the Reserve Requirement rate at 0%. Why?
The reserve requirement is also tied to the money supply. The lower the reserve requirement, the more money there is in circulation. This keeps people borrowing and spending temporarily. Pulling away that money would have unpredictable effects on the economy. But the FED has painted itself in a corner. There is a strong linkage between the reserve requirements, the money supply, and inflation. By leaving the reserve requirement at 0%, the FED began working against itself in its quest to tame inflation. You cannot control inflation when banks can infinitely increase the money supply unpredictably and perhaps immeasurably.
The FED will have counterarguments about the reserve requirements and how other constraints on banks serve the same function. They are wrong. Reserve requirements become a bank-by-bank constraint on lending and force every bank to behave responsibly. With reserve requirements in place, we are not dealing with macro-compliance but micro-compliance to sound banking practices. With reserve requirements in place, there are fewer economic surprises and shocks from bad bank behavior and failures.
Our National Debt
Last week, our national debt hit a new but foreseeable “brick wall” when there were insufficient purchasers for 30-Year Treasuries. With Japan, China, Russia, and some BRICS nations reducing or eliminating their dollar debt holdings, there are not enough purchasers of our debt at current rates. To solve this issue, the Treasury had to raise the interest rates it pays to find buyers. It is not that the rate finally offered was out of any historical range; the lack of interest from purchasers is concerning.
This ominous development signals that our national debt will rise even faster as we must pay higher rates and borrow more to continue supporting our debt. It is a debt-death spiral created by Congresses, Presidents, and bureaucrats. To make matters worse, Moody’s Rating Service has warned that they will downgrade our debt again unless Washington controls spending. Whether you believe Moody’s warning is relevant or not, it signals directionally that we are behaving irresponsibly as a nation with finances.
This chart shows our total debt at just over $32 trillion and the quarterly change. The FED reports this information with a quarterly delay, but we should take no solace in the delayed reporting. In the last few months, our debt has soared from $32 Trillion to almost $34 trillion. This is entirely unsustainable and plays right into the plan of the BRICS group to destabilize the dollar and replace it as the world’s reserve currency.
We all know the source of our problems and the fix, but do we have the political will to solve them? This is not a Democratic or Republican problem but an American one. The past four Presidents and Congresses have spent money as if there were no limit to our resources. To correct this, we must address Entitlements and Taxation. It will be like simultaneously placing your hand on the third rail of politics and expecting to live through the experience. We will either address these or suffer through default and have the solutions imposed on us.
Entitlements
So far, no one has dared to tackle entitlement spending because doing so will anger voters and remove many from power. To address the issues, we need someone willing to be a one-term President because addressing these will almost ensure no reelection.
Having kicked this can down the road for decades, we now have our backs against the wall, and all of us will need to do our part. It is just math, not politics. Politics surround the issues of implementation. Social Security, Medicare, Medicaid, and Unemployment are the four extensive entitlement programs.
Our entitlement spending is out of control and needs to be completely revamped. In 2022, the total spending was $13,717 per citizen, up from $6,268 in 2012, a 118% increase. These programs are unsustainable as currently constructed and administered. Their use exploded during the pandemic and has never returned to pre-pandemic levels. The extension of these benefits to illegal immigrants is bankrupting many cities and perhaps states.
Taxation
Another topic that no one in Washington wants to touch on is taxation. Conservatives want to keep tax rates low for several reasons, not the least of which is explained in the Entitlement spending. Give irresponsible politicians more money, and they are guaranteed to spend it irresponsibly.
To dig out of our hole, tax rates must go up now before they must go up significantly later. Every citizen (and illegal immigrant) needs to play a part in the solution, and all need to pay income taxes. Only half of our population now pays income taxes, creating animosity between groups that politicians can exploit. Even if minor, everyone must pay into the system to feel like they are part of the solution.
Corporations are also going to need to pay more to dig us out. In 2022, individuals paid about $2.6 trillion in taxes, while corporations paid $425 billion. There is no way to judge “fairness” because corporations pay matching taxes on part of a person’s income and provide jobs. But it does not take a rocket scientist to realize that we must all help, and corporations do have the capacity to help.
The challenge with taxation is not where the money is or whether we can pay more into the system. The problem is politicians, their greed once they see new tax revenue, and their lack of understanding of financial and monetary issues. Someone will need to tie their hands so that new revenue can only pay down the debt and balance the budget annually. We will get there either through action or default.
Our 2024 Election
We must arm ourselves with as much information as possible leading into the next Presidential election cycle. In my mind, nothing is more important than the financial soundness of our nation since all other decisions depend on the world’s opinion of our fiscal management. We are on the wrong path and need new leadership with a more understandable, positive vision to help everyone understand the need for change.
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DISCLOSURE: This commentary is being communicated as general information and observations only and should not be taken as investment advice. It is not investment research or a research recommendation, as it does not constitute material research or analysis. The actions that you take as a result of the information contained in this document are ultimately your responsibility.
