Of all the different elements of the economy, the direction of interest rates is most important. That’s why, as the editors of Profit Confidential, we expend a considerable amount of our time analyzing and providing guidance on interest rates. We believe that the unprecedented debt the U.S. has accumulated will eventually result in foreign investors demanding a better return on U.S. Treasuries. Too many U.S. dollars in circulation will also eventually force interest rates to rise.
Economics 101 suggests inflationary pressure builds during periods of low interest rates. The demand usually increases when people both borrow and consume more. As the price of goods and services is directly correlated with demand, it increases—resulting in inflation.
To tackle inflationary pressures, central banks increase interest rates. Why? Because once they increase interest rates, it is supposed to do the opposite of lowering the rates—forcing people to save and cut back on discretionary spending.
Following a 30-year down-cycle of interest rates in the U.S., we are on the cusp of a new 30-year up-cycle in interest rates; a move that could cripple the government and the economy. This is mainly because the government has added too much debt to its balance sheet, and the Federal Reserve has printed significant sums of money.
After phenomenal amounts of bailouts were doled out, followed by non-stop government spending, the U.S. national debt rose 76.2%—from $9.2 trillion in 2008, to $16.3 trillion in 2012. (Source: TreasuryDirect, last accessed November 27, 2012.)
It gets worse. The current administration said it would keep the budget deficit below $1.0 trillion. It hasn’t. For fiscal 2012, the federal budget deficit was $1.1 trillion, slightly below the $1.3 trillion deficit recorded in 2011. (Source: U.S. Department of the Treasury, October 12, 2012.) What’s more, 2012 marked the fourth consecutive year in which the U.S. government experienced an annual deficit above $1.0 trillion. As a percentage of gross domestic product (GDP), the U.S. government’s budget deficit for the year 2012 stands at seven percent.
Along with skyrocketing government debt, the Federal Reserve has printed $3.0 trillion. Where did the $3.0 trillion come from? It’s not backed by gold. It was simply created out of thin air. And, the presses continue to print an additional $85.0 billion a month!
Looking at an even bigger picture, between January 2000 and September 2012, the amount of U.S. money in circulation (the “M1 money supply”) has increased 112%, or $1.25 trillion. That’s a lot of money printing.
Similarly, the “M2 money supply,” which includes the M1 money supply plus savings deposits, balances in money market mutual funds, and deposits, has increased 118%. M2 is a better measure of actual money supply. Since the beginning of 2000, M2 money supply has increased more than $5.4 trillion. (Source: Federal Reserve, October 11, 2012.) Again, the printing presses have been in overdrive.
Now think of it this way; as more money is created and more debt is added to the federal government’s balance sheet, U.S. economic viability becomes questionable. What does this mean? The interest rate at which the government is currently able to borrow is being kept artificially low. With the government adding more debt and the inflationary pressure building—something has to be done.