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.
Not too long ago, I reported that Italy, the third-biggest economy in the eurozone, had fallen back into recession.
Now Germany’s economy is pulling back. In the second quarter of 2014, the largest economy in the eurozone witnessed a decline in its gross domestic product (GDP)—the first decline in Germany’s GDP since the first quarter of 2013. (Source: Destatis, August 14, 2014.)
And more difficult times could lie ahead…
In August, the ZEW Indicator of Economic Sentiment, a survey that asks analysts and investors where the German economy will go, posted a massive decline. The index collapsed 18.5 points to sit at 8.6 points. This indicator has been declining for eight consecutive months and now sits at its lowest level since December of 2012. (Source: ZEW, August 12, 2014.)
Not only does the ZEW indicator provide an idea about the business cycle in Germany, it also gives us an idea of where the eurozone will go, since Germany is the biggest economic hub in the region.
But there’s more…
France, the second-biggest economy in the eurozone, is also in a precarious position—and a recession may not be too far away for France.
After seeing its GDP grow by only 0.4% in 2013, France’s GDP came in at zero for the first two quarters of 2014. (Source: France’s National Institute of Statistics and Economic Studies, August 14, 2014.)
France’s problems don’t end there. This major eurozone country is experiencing rampant unemployment, which has remained elevated for a very long time.
While I understand North Americans may not be interested in knowing much about the economic slowdown in the eurozone, we … Read More
The U.S. dollar is still regarded as the reserve currency of the world. The majority of international transactions are settled in U.S. dollars and most central banks around the word hold it in their foreign exchange reserves.
But since the Credit Crisis of 2008, and the multi-trillion-dollar printing program by the Federal Reserve, the supremacy of the U.S. dollar as the “world’s currency” has been challenged.
The BRICS countries (Brazil, Russia, India, China, and South Africa) have agreed on starting a new development bank that will compete with the International Monetary Fund (IMF) and the World Bank. (Source: Washington Times, August 5, 2014.) Both the IMF and World Bank are “U.S. dollar”-based.
Since the year 2000, the U.S. dollar composed about 56% of all reserves at central banks. But after the Credit Crisis, that percentage started to decline. In 2013, the greenback made up only 32.43% of all foreign exchange reserves at foreign central banks. (Source: International Monetary Fund COFER data, last accessed August 11, 2014.)
Yes, the $3.5 trillion in new money the Federal Reserve has created out of thin air has made other central banks nervous about holding U.S. dollars in their vaults. After all, if you were a foreign central bank with U.S. dollars as your reserve currency, how good would you feel to know the U.S. just printed more dollars as it needed them without any backing of gold?
But it’s not just the money printing. It’s the massive debt the U.S. government has accumulated…currently at $17.6 trillion and soon to be $20.0 trillion.
In the short-run, the U.S. dollar is still considered a safe … Read More
Remember Alan Greenspan? He was the chairman of the Federal Reserve from 1987 to 2006. Several media sources, including this one, blamed the sub-prime mortgage fiasco that led to the Credit Crisis of 2008 on the easy money policies under the leadership of Greenspan.
But the Credit Crisis aside, it is ironic but true that Greenspan has had a knack for calling stock market bubbles correctly.
For example, in December of 1996, while chairman of the Federal Reserve, Greenspan grew wary about the stock market. In a now famous speech called the “Challenge of Central Banking in a Democratic Society,” along with other observations on the value of stocks, Greenspan essentially argued that the rise in the stock market at that time wasn’t reflective of the poor economic conditions that prevailed.
Within two years of that speech, the stock market started to decline and stocks did not recover until 2006.
In an interview with Bloomberg a few days ago, Greenspan said, “the stock market has recovered so sharply for so long, you have to assume somewhere along the line we will get a significant correction.” (Source: “Greenspan Says Stocks to See ‘Significant Correction,’” Bloomberg, July 30, 2014.)
In the interview, Greenspan says long-term capital isn’t growing and as a result, productivity and the economic recovery will be in jeopardy.
Greenspan is out of the Federal Reserve. But the leader of the Fed today, Janet Yellen, also has reservations about the value of certain stocks. As I wrote on July 16, Yellen had been quoted saying tech stocks were priced “high relative to historical norms.” (See “How Many Warnings Can … Read More
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