by Don Fredrick, The Complete Obama Timeline, ©2022

(May 5, 2020) — The Dow Jones Industrial Average today declined 1,063 points over investor fears of a recession. They are not wrong to worry. The Gross Domestic Product (GDP) has declined five months in a row and, in the first quarter of 2022, was a negative 1.4 percent. The economy will “officially” be considered to be in a recession after two quarters of negative growth—and no one should bet against a second quarter decline.

The recession fears are partly the result of the Federal Reserve (the “Fed”) increasing its benchmark interest rate by 0.5 percent, as well as its suggestion that it might begin selling up to $35 billion in mortgage-backed securities (MBS) each month. The Fed has been buying those securities since the 2008 housing collapse, and it now has about $2.7 trillion in MBS assets. Those purchases helped stabilize the housing market, and the Fed’s actions to keep interest rates low stimulated that market. But both MBS purchases and the manipulation of interest rates are artificial interventions in the private economy, and they cannot continue forever without negative consequences.

Those mortgage-backed securities were not purchased with “real money.” The Fed merely created money out of thin air with accounting entries in banking system computers. In essence, the Fed printed $2.7 trillion in Monopoly money. In addition to that $2.7 trillion, the Fed created even more trillions in new money to cover the federal government’s unending budget deficits. The national debt was about $10 trillion in 2008. It is now in excess of $30 trillion. Some $20 trillion in money backed by nothing has been introduced into the economy over the last 14 years, for the sole purpose of enabling the politicians in Washington, D.C. to ignore economic reality, avoid balancing the budget, and buy votes. Those actions have always had negative consequences, and those negative consequences are now becoming more significant.

The extraordinary and unjustifiable inflation of the money supply is what has caused continuing increases in consumer prices—including home prices. In addition, keeping interest rates artificially low encourages people to buy cars and homes. The rush to buy them prompts sellers to boost prices, and bidding wars push them even higher. The politicians think that is great. More people have new cars and houses. They are fulfilling the American dream. The big box stores sell lawnmowers and string trimmers. Furniture stores cannot keep up with demand. But that demand is largely based on credit, and at some point the bubble bursts.

Keep in mind that the term “inflation” does not technically mean “rising prices.” Rather, it is the artificial expansion, or “inflation,” of the money supply, and that is what causes rising consumer prices. Why would it not? If the government were to give everyone $40,000 to buy a new car, the demand for new cars would quickly exceed the supply. If a car dealer has 100 cars on the lot and 500 customers eager to buy them, it is reasonable for the dealer to boost the prices of those cars. But the government has not given everyone $40,000 to buy a new car. It has instead dumped trillions of new dollars into the entire economy with “Covid relief” funds and other vote-getting bribes. That money has not been directed solely toward the purchase of new cars, of course. It has been directed at the purchase of everything in the economy—including groceries. It is generally that new money that caused the rising prices, not supermarket managers or Vladimir Putin. (The Biden administration’s preposterous efforts to “go green” have obviously made matters worse. Its attacks on the oil and gas industry have certainly contributed to the rising prices.)

Looming on the horizon is the possibility that the Biden administration may (in time for the November mind-term elections, of course) “forgive” some or all student loan debt. The total amount of outstanding debt is reportedly $1.6 trillion. Imagine the ramifications of such an action. Canceling student debt is tantamount to the Fed expanding the money supply. Telling Americans they no longer have to pay off their student loans is essentially introducing $1.6 trillion into the economy. Instead of the government being paid $1.6 trillion by the debtors, students and former students will be able to spend that money on something else. If, for example, a young worker had been paying $500 per month on his student loan and he is now “excused” from writing that check to the government, he will suddenly find himself with an additional $500 per month to spend elsewhere. The total amount of additional money spent in the private economy will likely be in the tens of billions of dollars each month. That will lead to an increased demand for goods and services and result in prices going up even more. That $1.6 trillion would certainly not be “canceled.” The burden will simply be shifted from the students to the taxpayers. But Congress will not dare raise taxes by $1.6 trillion to cover the debt forgiveness. The Fed will simply create an additional $1.6 trillion out of thin air. (Students could not pump the entire $1.6 trillion into the economy immediately, of course. A student with $50,000 in student loans would not have $50,000 to immediately spend. But over several years he will end up spending that $50,000 on goods and services for himself, rather than paying back the taxpayers who loaned it to him.)

In general, politicians love inflating the money supply to cover deficit spending. That inflation is essentially a hidden tax that enables government to spend money it does not have. Consumers notice rising prices, of course, but unless they rise too rapidly it never occurs to them to blame the real culprits: government and the Fed. Instead, they blame the businesses that had to raise prices. Rising incomes tend to further shield the government and the Fed from blame. A person who, for example, used to earn $40,000 per year and now earns $80,000 per year believes he is twice as well off. In fact, he is no better off at all if consumer prices have doubled in the same time period his salary doubled. He may even be worse off—if prices have risen faster than his income. Currently, few Americans are receiving wage and salary increases that are anywhere near enough to cover rising prices. That means anger is not being directed solely at businesses. It is being aimed at Washington, D.C.—as the approval ratings of Joe Biden and Congress demonstrate.

The “official” inflation rate is allegedly 8.5 percent, but the actual year-over-year increase in prices is probably closer to 15 percent—and almost every consumer knows that.( is a source of information that is far more accurate than what is calculated by the Bureau of Labor Statistics.) It is no surprise that the federal government intentionally manipulates the consumer price index, because it uses that data to determine things like the annual cost of living increases in Social Security checks. Needless to say, the government does not want to give every retiree a 15 percent boost in payments in January 2023, because that would increase the budget deficit even more. That, in turn, would force the Fed to print still more money, boosting prices higher and causing the process to be repeated the following year.

The Fed now finds it necessary to “combat inflation” to keep it from spiraling out of control. Its typical “solution” is to increase interest rates to “slow down” the “overheated economy.” An increase will certainly do that. Even the recent 0.5 percent increase in the benchmark rate will probably boost lending rates for mortgages to 5 or 6 percent. A higher interest rate means a higher monthly loan payment. Higher monthly payments mean a reduced demand for housing purchases. Reduced demand means lower housing prices. The Goldilocks problem the Fed faces is finding the interest rate that is “just right.” Raising the interest rate too little means consumer prices will continue to rise. Raising the interest rate too much means a recession. No one should expect the Fed to “get it right.”

As consumer prices continue to increase (rising diesel fuel prices are not going to make truck deliveries of products any cheaper), the Fed will be forced to raise interest rates again. Mortgage interest rates of 7 or 8 percent might be seen by the end of 2022. Will that cause another housing collapse? That remains to be seen. But, at the very least, higher interest rates will cause both housing sales and housing prices to fall. Homeowners with adjustable-rate interest loans may find themselves unable to make their mortgage payments. Depressed housing prices will lessen the ability of getting a home equity loan. Foreclosures will depress the market even more. Falling real estate prices will result in fewer people fleeing to Florida and Texas—because they will not be able to get the price they thought they would get for the sale of their California or New York properties. (Anyone who wants to sell his New York house and retire to Florida might want to find a buyer soon—before the market changes drastically. A person who times his actions well may be able to sell high and then buy low after the bubble bursts, but that is a risky endeavor.)

The likelihood is that the Fed will be reluctant to raise interest rates enough to drastically slow consumer price increases, but the rate it does target will slow down the economy enough to cause a recession. The result will be “stagflation,” the combination of a stagnant economy and rising consumer prices. (Ask anyone who lived during the presidency of Jimmy Carter for a description of what that looks like.) A recession now seems almost impossible to avoid. The more a family spends on groceries and gas, the less it has to spend on the purchase of other products and services. A family cannot stop eating or using gasoline, so it must find other ways to reduce its expenses. That might mean eating less often in restaurants, not going to movies or concerts or theme parks, canceling Netflix or Disney+, postponing the purchase of a new car, or repairing the washing machine instead of replacing it. All such decisions reduce employment, and as more people lose their jobs the problem is compounded.

The lunacy of the process is mind-boggling. The government spends money it does not have in order to buy votes and to satisfy lobbyists who give them campaign donations. It cannot raise taxes enough to cover the spending without causing a recession or a revolution. The Fed then covers the deficits by printing money. The new money pushes consumer prices higher. Rising prices threaten the people in power. The Fed tries to protect them by increasing interest rates to “combat inflation.” But inflation is never controlled. It cannot end unless the government balances the budget. With a balanced budget there are no deficits. With no deficits, there is no need to inflate the money supply. If the money supply is not inflated, consumer prices stabilize—and can even decline, as employers and employees work more efficiently, in order to lower prices and attract new customers.

Balancing the budget eliminates inflation*. But the government cannot balance the budget without raising taxes or cutting spending. Raising taxes enough to balance the budget results in a recession, because too much money taken out of the private economy causes it to decline as workers become less productive. Economist Arthur Laffer described that with his “Laffer Curve.” At lower levels of taxation, an increased tax rate generates more tax revenue for the government. But as the rate increases, it discourages both investment and work and actually results in reduced tax revenue. Obviously, no one would work if his tax rate were 100 percent, but a tax rate of zero yields no tax revenue. Laffer’s curve suggests there is a “sweet spot” for a tax rate, beyond which tax increases are counterproductive. (In general, problems arise once the federal government’s taxation and spending exceed 18 percent of GDP.)

The federal budget can also be balanced by slashing spending, but the politicians will not do that because it requires the end of programs, subsidies, and benefits demanded by the taxpayers, the unions, lobbyists, and defense contractors. Few legislators would vote to eliminate the Department of Education, for example, even though the nation would be better off without it and its demise would save the taxpayers more than $65 billion per year. Closing military bases is also next-to-impossible, partly because of deals between members of Congress. (“I’ll agree to vote to keep your California Army base open if you vote to keep my North Carolina Naval base open.”)

The sad reality is that the government monster has become so large and so many people have become dependent on it that it cannot be controlled. The budget will never be balanced, the deficit spending will go on, the national debt will keep growing, the money-printing will continue unabated, and the government and the economy will someday collapse in a manner that will astound the world. But do not think that other nations will escape the same fate. They, too, are spending far more than they collect in taxes, and they also have central banks inflating their money supplies to cover the difference.

At some point, dollars and euros will not be worth the paper they are printed on. It already costs the government seven cents to make a nickel, and the candy bar that used to cost a nickel now costs more than a dollar not because the candy bar is worth more, but because the dollar is worth less. Inflation is one of several factors that are likely to return control of the House and the Senate to the Republicans. But unless they are willing to slash spending, the devastating consequences of inflating the money supply will continue.

* Balancing the budget would indeed eliminate inflation. That is, there would be no need to print money to cover deficits if there were no deficits. But that does not mean no prices would ever increase. For example, a frost in Florida could destroy orange crops, and that would cause the price of oranges and orange juice to increase. But that is not a widespread price increase on most goods and services across the nation, as is caused by inflating the money supply. It is merely higher prices for a few products: oranges and orange juice. A frost in Florida would obviously not cause an increase in the price of California lettuce, or corn from Iowa, or cars from Detroit. It is important to differentiate between inflation of the money supply and rising prices. Rising prices can be caused by inflation. But they can also be caused by weather, war, natural disasters, labor union strikes, shortages of parts needed for manufacturing, and any number of other circumstances.

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