Catastrophe - Dick Morris [17]
And too much money will be chasing too few goods, leading to huge inflation.
The financial community clearly expects inflation. That is why long-term interest rates are now so much higher than short-term rates. Investors are pretty confident that inflation won’t be a problem as long as the recession rages. There’s more likely to be deflation. But once it ends, they can see inflation coming a mile away.
So even though interest rates on very-short-term Treasury bills are only one quarter of one percent, the Treasury has to pay 2.94 percent to get people to lend it money for ten years.60 And the average mortgage interest rate for a 15-year loan (at fixed rates) is 4.61 percent.61 Why? Because we expect to be hit with inflation.
Because banks aren’t lending no matter how large their reserves are, the stimulus money remains parked on the sidelines. But when the banks decide the climate is right to start lending, huge inflation will be the likely result.
As Karydakis notes, “The Fed is acutely aware of the need to start mopping up that excess liquidity, very quickly after the economy starts showing signs of making a gradual comeback.”62
But inflationary psychology can be a hard habit to kick. Once consumers see inflation, they start demanding higher salaries, even asking their bosses to put cost-of-living wage adjustments into their compensation package. Employers, desperate to meet the new demand for their company’s services, don’t have time to argue. They can’t fire their workers, because once unemployment starts dropping there’s too much risk that they’ll have to scramble to find replacements and end up falling behind their competitors in market share. So they give in—and the inflationary wage/price spiral takes over.
Karydakis mentions the need to “start mopping up that excess liquidity” as soon as the economy improves. What would probably happen in such a circumstance is that the Fed would try to buy up the extra money in circulation. To do that, however, the Federal Reserve would need to sell debt—Treasury bills—in the open market. The T-bills would soak up part of the money in circulation, keeping it from being spent and causing more inflation.
Right now, to stimulate the economy, the Fed is paying those who buy T-bills a measly one-quarter of one percent interest. Buy $100,000 in Treasury bills, and after a year you’ll see only $250 as a return on your investment. Yet despite these low rates people are flocking to buy T-bills. Why? Because the U.S. government is the strongest in the world—and therefore the safest place to park your money while the recession runs its course.
As soon as the recession eases, however, all demand will disappear for T-bills that pay such little interest. Instead people will want to spend their money, or to invest it in more profitable ventures. The Fed will have to raise T-bill rates to competitive levels to induce people to take their money out of circulation and buy T-bills with it instead. And there’s the rub: the higher interest rates climb, the more of a drag on the economy they become.
So to borrow the money to pay for Obama’s “stimulus package,” we will have to raise interest rates which will undo any good his stimulus spending may have done.
And the only way to cure an inflationary spiral, once it takes effect, is to induce a recession!
As a nation, our last experience with persistent inflation came during the 1970s, when the big deficits we ran to pay for the Vietnam War and the residue of the Great Society (all without a tax increase) led to double-digit inflation. No matter how often President Gerald Ford spoke of the need to “WIN” (Whip Inflation Now), his pathetic efforts came to naught.
The result was a period of what became known as “stagflation”: inflation continued, but economic growth lagged. Unemployment and prices rose at the same time. The only remedy, it turned out, was a new recession—this time