Change the Climate Toward Risk

Jeff  Carter
Posted: Nov 21, 2011 12:01 AM

Inflation hawks have been predicting high inflation rates every since central banks all over the world started monetizing their debts. However, we have seen only ebbs and flows of inflation. It’s certainly not the inflation that I remember from the late 1970's. It seemed like every night you turned on the news, banks were raising their prime rates.

We had bouts of inflation in material goods like cotton for instance. But those bouts were more a result of a bad growing season and low supply with constant demand, not the actions of a central bank. Crop prices have risen, but is it the central bank, worldwide demand or really crappy ethanol policy in the US? Inflation is really hard to pin down.

However, in Europe right now we are seeing a run on interest rates. All bond prices are up. Some seem to defy gravity each day. Italian yields are close to 7%, when the rest of the developed world is close to 0%. French bond yields are edging closer to 4%. Greece….well maybe just don’t look at Greece. It’s a closed casket for their funeral.

The bond vigilantes are back! They are just sipping espresso and eating organ meat across the pond before they come over here and get us again. With each passing day, the Europeans dig a deeper hole for themselves, their governments and their banks. So far, the Euro charade has lasted longer than a Fellini movie. I think it ends like La Dolce Vita. The market’s lips move, but Europeans can’t hear what it’s saying.

We know for certain now how not to handle an economic crisis. After the examination of the 1930's, you’d have thought we would have learned our lessons. Increasing government spending, taxes, regulation and saving decrepit businesses is not the route to take. We have been trying to bail out banks and other companies worldwide since the crisis first manifested itself in August of 2007. It’s been one bad decision after another. The outcome has lead to zombie banks and frozen corporations, no growth.

There is a clear path to economic enlightenment. It starts with a decrease in government spending, and clearing room for the private sector to grow. Secondly, the beauty of economics is that it’s not only a study of money, but it’s a study of human behavior. A smaller social safety net and less government spending changes human behavior. Instead of freezing, they work and become more innovative. The risk taking climate changes.

Here is the disaster that we have set ourselves up for. The government has created do nothing banks that because of their damaged balance sheets refuse to lend money to any entity that looks like it has some risk. It’s printed money like it has gone out of style, increasing the circulation of dollars in the system and debasing the value of American currency.

We have increased the value and extended the social safety net that behavior has been influenced. Less people are looking for jobs, and more people are collecting benefits and food stamps than any time in American history. Today, fewer people are paying income taxes than at any time in our country's history. At the same time, demographic trends are pushing government entitlement systems to bankruptcy. Even Obama himself said “the math doesn’t change.”

However, it does if you decide to do something about it. Voting “present” is not an option.

Economics is calculus. If you remember the circular lines of parabola’s and hyperbola’s from your calculus class, you know that at some point in time, the curve changes in slope. Right now, we are at a point where inflation is relatively low, and interest rates are creeping up because of the risk premium attached to them.

Soon, we will hit a point of no return. Interest rates will climb quickly because the market will demand higher rates to compensate for the risk of holding the security. At the same time, entitlement programs will come due and the government will have to pay for them. The way they will do that is print even more money.

Then we will have the triple threat of doom. High unemployment, high interest rates, and rampant inflation. Unless we do something about it today.

Where is America’s Churchill? Europe is lost.