By Jason Arvak
The New York Times reports on growing signs of rising interest rates on everything from cars and houses to government debt. This is the leading edge of a tsunami of inflationary pressures that is the necessary cost of a trillion-dollar economic bailout program and the chosen cost of an endlessly expanding set of government entitlements.
The bailout for the banks politically stinks to high heaven, but it wasn’t really a choice. Allowing large banks like Citibank and Chase to go under may have been tempting in an emotional “let them get what they deserve” indulgence of populism, but the actual consequence would almost certainly have been a chain-reaction that would have collapsed the entire American (and global) financial system and made the Great Depression look like mild stagnation. To prevent this, the Fed bought up billions in mortgage-backed securities, which had the effect of thawing frozen credit markets and, for a time, suppressing interest rates. The lesson learned — that mortgages can and do go bad and that it is not possible to wave a magic wand of derivatives to remove risk from those investments — will have the consequence of higher interest rates on homes in the long term. This will be reflected in credit card interest rates as well.
More seriously, it will also lead to a rise in interest rates on government debt. Contrary to the assumptions of most politicians in both parties, there is a finite pool of available investment capital in the world (and that pool is substantially smaller than it was a few years ago), and the federal government has to compete with other options to attract buyers for its bonds. The growing economic recovery will soon strip away the ironic “honeymoon period” where massive new federal spending could be supported by the flight of investment capital to the “save haven” of U.S. sovereign debt at near-zero interest rates. With the stock market and corporate debt now offering plausible promises of decent returns at reasonable risk again, interest rates on government debt will have to increase. Furthermore, the government’s continuing profligate ways raise questions about whether or not U.S. fiscal health is sustainable — and investors will insist on higher interest rates as a hedge against the inability of the United States to perpetually spend without bothering to figure out how to pay for it.
While a rise in interest rates normally coincides with a decrease in inflation, that will not be the result this time around. The massive injection of new money into the economy that the Federal Reserve called “quantitative easing” was necessary to fend off the devastation of a deflationary spiral into a depression. But after the economy rebounds, all that newly-created money continues to exist, creating pressures for inflation after consumer demand rebounds as well. Furthermore, T-Bills are, in essence, a kind of cash these days, traded between banks and other institutions just like cash is traded among individuals. The massive creation of T-Bills adds to inflationary pressures by basically inflating the overall money supply.
In short, profligate and once-necessary but now-irresponsible government spending in the absence of counter-balancing revenue creates costs on everyday people in three ways. First, it raises everyone’s interest rates. Second, it raises current inflation as the natural cycle of “soaking up” the injection of capital into the markets takes hold. And third, the longer policymakers pretend the problem does not exist, it raises the prospect of much more serious inflation as government eventually has no option to repay its debts except to devalue them by devaluing the currency.
But don’t rely on the current government or the media to pay attention to the signs of looming trouble. The only real cure is large spending decreases (intolerable to Democrats) combined with substantial tax increases (intolerable to Republicans). And most voters remain trapped in the “let’s get stuff from the government and have someone else pay for it” mindset that perpetuates the political cycle. The combined bill for decades of economic profligacy has combined with the bill for preventing an imminent disaster. And thus far, no one is willing to step up and actually do what needs to be done to pay it.
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A law student today, Jason is a former professor of international relations. In his research and writing, he focuses on international law, military strategy, civil-military relations — and sometimes, on other topics. Prior to graduate school, he served for 15 years in the United States Air Force. Comments are welcomed at [email protected].