Long/Short Equity, Value, Macro
Contributor Since 2012
In the aftermath of the dot.com bubble bursting in 2000 the U.S. federal government has consistently been run with annual deficits since 2002. Cumulatively the deficits for the period 2002 to 2011 add up to almost USD 6.14 trillion based on data published by the Federal Bank of St. Louis. At the end of 2011 the Federal Government Debt in the U.S. stood at USD 15.223 trillion (USD 15.582 trillion at the end of Q1-2012 and USD 15.962 trillion as of 17 August 2012). This means that 40.3% of the Federal Government Debt was generated during the 2002 to 2011 period. The biggest Federal Surplus in history was USD 236.241 billion in 2000. The current debt is therefore 64.44 times higher than the biggest surplus in U.S. history (or about 49 times if the surplus is inflation adjusted assuming a 2.5% inflation during the period).
The "Bank Credit at all Commercial Banks" reported by the Federal Reserve Bank of St. Louis also increased substantially during the 2002 to 2011 period (as it has done since 1949), although it decreased on a yearly basis during 2009 and 2010.
After reaching 5.1% in June 2007 the interest rate as measured by the 10-year Treasury Constant Maturity Rate (GS10) declined to 1.53% in July 2012.
Since the onset of the debt crisis in 2007/2008 the Federal Reserve, in addition to lowering interest rates, has printed money on an astronomical scale. The Adjusted Monetary Base (base money) increased from a base of USD 846.2 billion at the end of 2007 to USD 2,702.7 billion in August 2012, more than tripling the monetary base.
M1 and M2 Money Supply (or Stock) also increased during the 2007 to 2012 period, but at a lower pace than base money, 1.7 and 1.3 times, respectively. The M1 Money Multiplier decreased by 50% during the same period, which explains (together with a decline in the M2/M1) ratio why money supply increased considerably less than base money during the period.
Where does all this leave the U.S. economy then? Interest rates can't go down much further than they already are (see here), the monetary base has been pumped up to such atmospheric levels that it now can't be increased any further as massive future inflation now seems inevitable when the M1 Money Multiplier again start to increase (see here). For example, if the M1 Money Multiplier reverts from its current 0.851 to its historical average of 2.120, M1 would increase from its current USD 2,292.7 billion to USD 5,729.442 billion or an increase of 150%. All else remaining the same, M2 would also increase by 150% to USD 25,056.91 billion (from USD 10,026.8 billion). The Quantity Theory of Money holds that a change in the money supply will cause a proportional change in the price level because velocity and real output are unaffected by the quantity of money. But it might take some time before it results in inflation, but in the long run the major consequence of money growth is inflation if the theory holds. And its important to remember that inflation is a tax. The Fed could naturally reduce the monetary base by selling U.S. treasuries, but that would lead to a corresponding increase in the yield on those securities (unless they are manipulated in some cunning way) and reduce the excess reserves for banks, leaving them even more vulnerable (would they even buy the treasuries in due course?). The Federal Government Debt is at such a high level that even the record surplus generated in 2000 is not high enough to pay the interest on that debt so that any down payments would need to be financed through new debt issues or higher taxes. The latter is not as easy to implement as the former.
It is really extraordinary to see how the U.S. through unsustainable deficit spending and credit expansion has, during a relatively short period of time (2007-2012), set the country back many years and has put itself in an almost impossible economic position. Economic trickery by the Federal Reserve cannot remove the debt other than to shift it from one pocket to another (e.g. from banks to taxpayers, from taxpayers to the government etc) and without someone paying for it. How its resolved remains to be seen, but inflation, default or some combination seem inevitable in due course. Best position yourself to be an early receiver of newly printed fiat money in an inflationary environment as quickly as possible. Bank executives are already in that position of course, a long time ago.
See also here to see what Gary North has to say on the subject of hyperinflation and the U.S. federal debt.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.