Everyone knows that Government spending today will mean higher taxes tomorrow. Far fewer realize that the huge budget deficits being created now will almost certainly bring us high inflation, even hyperinflation, and a significantly devalued dollar. This year the Government will need to borrow at least $2 Trillion, and if the Obama Administration has its way, trillions more will be needed during the next several years. However, regardless of Mr. Obama’s appetite for spending, the magnitude of U.S. public debt and its size as a percentage of our gross domestic output are projected to grow at astounding rates during the next several decades.
How will we pay it all back? Historically, the Government raised money by issuing debt that Americans and foreigners alike eagerly held as investments. Currently, Americans, including our Government, and foreigners each own half of our public debt. According to a recent report by Fox News, China alone owns a quarter of our debt and is seen as the most likely buyer going forward, given its rapidly expanding appetite for our debt in recent years. But China too has its own economic problems and is getting serious reservations about increasing its exposure going forward. The other method of repaying debt is to raise taxes, but doing so in any meaningful way during this recession would be ill-advised. So where will the money come from?
The Government will likely have no choice but to print the extraordinary amount of money it needs, which will be highly- if not hyper- inflationary. (There is no agreement on a definition of hyperinflation but suffice it to say that if you quote monthly, rather than annual, inflation rates you’re probably there.) Checking inflation won’t be easy either. Normally, during periods of high inflation, especially inflation induced by expansionary monetary policy, the Government raises interest rates to choke off inflation. But this time its hands would be tied by a seriously debt overburdened American public that would suffocate from the proportionately greater impact that higher interest rates would have on its household finances; finances dominated by high levels of mortgage, auto and consumer credit. Consequently, the Government is unlikely to curb our prospective high inflation by potentially pushing our economy into another Great Depression.
Needless to say, deficit-spending-induced high inflation will devastate our currency. The likely combination of high inflation and a weak dollar will further diminish the purchasing power of all Americans, especially retirees living on fixed incomes. Many economists believe that a good proxy for an economy’s stability and strength is the stability and strength of its currency, so a weak and unstable dollar will likely tarnish America’s star status in the world economy. America will also be seen as a riskier place to invest and cause many investors to flee our capital markets; effects that will further raise our interest rates and weaken our dollar.
I am hopeful none of this will happen, but many believe it will, at least to some degree, if we don’t change our spending habits. Given the risk of this scenario playing out, it would not be surprising to see investors favor inflation-hedges such as gold and other commodities and U.S. companies with significant exports abroad. Investors will also probably shy away from dollar-denominated investments in general by diversifying globally. The implications for our policy makers should be crystal clear: be extremely careful when spending our money, especially money we don’t have and need to borrow.
U.S. Public Debt, Wikipedia
The Yin and Yang of U.S. Debt, Yale Global Online
Fox News Sunday, March 15, 2009, Fox News