“If something can’t go on forever, it must stop.”
In February 2019 we asked, “Where is inflation?”, and discussed the many wrong forecasts over the prior decade touting its re-emergence. We also discussed some of the reasons it had remained so tame over the prior two decades. But heeding Milton Friedman’s dictum that “inflation is everywhere and always a monetary phenomenon” predicted that continued expansion of the money supply would eventually saturate the market and the excess would drive inflation up. Well, the Fed has finally found that limit and proposals now before Congress threaten to speed us past it. Recently, the Labor Department reported inflation over the prior 12 months of 6.8%, the highest in 39 years.
We have further discussed in the past the “need” for the Government to boost inflation in order to ease the massive debt burden it has incurred. The $29 trillion national debt now exceeds GDP by 25%, only the second time in history that the debt-to-GDP ratio has been over 100%. The other time was right at the end of World War II. Over the succeeding 35 years, that figure was reduced to 40% by persistent inflation, especially during the late 1970s and early 80s. We can never “grow” our way out of such vast debt and defaulting is simply not an option, so inflation is the only arrow left in the quiver.
The potential of inflation-driven higher bond yields is, however, the booby trap in this scenario. The interest on the Federal debt is approaching $600 billion per annum, even at current historically low interest rates. Even a modest rise in rates, combined with continued deficits, would push this over a trillion dollars very quickly (that’s $114 million in interest every hour!). That said, the 10-year U.S. Treasury Bond yield actually fell a few basis points on last week’s announcement to 1.47%.
The current high-inflation, low-rates status quo seems unstable – how long will investors buy bonds with sub-2% yields in a 6% inflationary environment? As “Stein’s Law” predicts, it’s got to stop. So, what will give? Will the recent inflation prove to be transitory and resolve the conflict with rates, but thus exacerbate the debt problem, or will rates rise, exacerbating the debt-service problem? We don’t make predictions here (“Bohr’s Law”), but it seems the market could force rates up with less resistance than Congress getting spending under control and slowing monetary growth. We’ll see.
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