Let us set our reference value to 100 in January 2007 (one year before the big financial crisis of 2008 began in the USA), for the following three variables: the U.S. nominal GDP, the debt issued by the U.S. government in the past and, finally, the U.S. monetary base (the money of the central bank) and see where we are today.
- The nominal GDP has gone from 100 to 157, i.e. an average annual growth rate, since 2007, of 3.25%.
- The debt issued by the federal government has gone from 100 to 401, i.e. an average annual growth rate of 10.5% per year.
- As for the Fed’s balance sheet, it has gone from 100 to 741, which corresponds to an average annual growth rate of 14% per year.
These figures illustrate a reality: the reader must understand that since 2008 at least, we have been living through a monetary experience that is without precedent in modern history. The Eurozone has been following similar monetary and budgetary policies since 2012. In fact, the two foremost global economic powerhouses, the United States and Europe, decided at the same time to allow their central banks to finance the budget deficits of states, on a massive scale, by buying the bonds issued by these same states.
This monetary and budgetary drift occurred in two phases:
- The first phase was between 2008 and 2014
- The second phase, attributable to Covid, began in 2020.
An observer arriving from the planet Mars would have expected a strong inflationary surge in these zones, because inflation, as Jacques Rueff used to say, "consists of subsidizing expenditures that give no returns with money that does not exist” and that is what the central banks are doing.
Well, that wasn’t the case at all.
The U.S. GDP deflator (the price index) rose prudently by 1.5% per year throughout this entire period, leaving observers of a monetarist tendency (such as myself) somewhat surprised, and, of course, arousing the enthusiasm of the Keynesians, who are constantly telling us that we can therefore put the money printing machines into overdrive to finance all state spending - even the zaniest aspects of it - without this having the slightest consequence on the hike in prices.
Keynes was right, then, and Milton Friedman was wrong.
But perhaps we’re jumping the gun a little.
- First of all, in the USA and the rest of the world, we have had formidable inflation in the price of assets of the real estate kind in the big cities, or in the stock prices of successful companies on the stock exchange. If you were to tell a young couple seeking to become homeowners that there has been no inflation in the real estate market, they really would think you were taking the piss. This inflation has not been taken into account in the inflation indices but it sure as hell took place, and in a big way!
- Then, between 2008 and 2020, the price of petrol came crashing to the ground, going from $130 /bbl to...a negative value, at its lowest, something that had a very beneficial effect on the retail prices indices. That is over now, though, for the price of petrol is back above $70 /bbl.
- And finally, globalization was still in full swing, meaning that Europe and the USA were able to buy at a good price in Asia, because there was no inflation over there.
All that has come to an end and we definitely appear to have entered a period of lasting inflation, as attested to by the following chart - though, admittedly, it requires a few clarifications.
- Where areas are shaded blue, this means that I’m certain, statistically, that the inflation has been accelerating for at least a year. Since January 2021, this has been the case.
- For the retail prices index, the rise in the last 12 months has reached 5.37%, its highest level since 1990, and the wholesale prices index, which just came out Friday, is up by 8.3%, a fact that does not augur well for the CPI indices in the future.
- The index I refer to as the ‘yellow vests’ index, which covers purely food, housing and energy costs, which constitute almost 100% of the spending of the poorest households, is up by almost 10% in the last 12 months, meaning that all over the world, it is the poorest that are going to be the hardest hit. This ought to lead to a tumultuous fall in southern Europe, and plenty of political unrest, particularly in Africa. Levels of migration from Africa are going to accelerate, that’s for sure.
- Covid and the new ‘Cold War’ between China and the USA have caused production to be shut down in numerous industrial sectors due to a shortage of spare parts virtually all over the world, and if you order a Ford, a Toyota, or a Peugeot, you’ll be lucky if your new car is delivered any earlier than in 15 months’ time. And the same is true for most products. And so the people who can produce goods, or who have stocks, raise their prices, as one would normally expect.
- What’s more, China, the world’s factory, can quietly control its export prices by adroitly reducing its supply, and anyone who can’t or won’t pay, or indeed anyone whose governments have upset the Chinese Communist Party in some way, will have no access to the spare parts they need and will therefore have to stay closed. The quantity of products therefore goes down, whereas the supply of money increases; this generally results in a hike in prices.
- In the USA and in Europe, a curious phenomenon to which I will no doubt have an opportunity to return later is currently happening. Since the arrival of Covid, many people have made more in various forms of compensation than they used to make by working in the past. What’s more, they aren’t looking for work. And employers are being forced to increase their salaries to tempt them back, and/or to keep the ones who do want to work. This is going to lead to them having to increase their prices to preserve their profit margins...
- A vast number of new regulations have just been introduced everywhere, which make human travel and the transportation of goods far more difficult than before. This rise in costs is bound to have a knock-on effect on the price indices, mark my words.
- And finally, the millenarialist follies of our environmentalist friends and the taxes and regulations they have attached to fossil fuels (the carbon tax, etc.) mean that no-one has invested in oil and gas exploration for years and, on top of that, the energy shortage is escalating. The prices of gasoline, but above all those of natural gas, are skyrocketing, in parallel to that of electricity, which is also climbing as if to outdo the others, to finance wind turbines and solar panels. This is bound to have a profound impact on the ‘yellow vests’ all over the world.
In short, all the indications are that we are hurtling at breakneck speed into a new inflationary period. And, as is often the case, we are doing so with real interest rates (i.e. with inflation deducted) at their lowest since the ’70s, as shown by the second chart I have included in this article.
As I keep on explaining, the Keynesians think that in order for an economy to function well, it is necessary to bring about the “euthanasia of the rentier” - in other words, the ruin of savers. With nominal interest rates at 1.35% and inflation at 5.37%, putting real rates at -4.05%, that is precisely what is well on the way to happening. The problem is that if you guarantee to the saver that he is going to lose 4% of his capital per annum, he will stop saving or save elsewhere, and the national savings ratio will collapse. And since, in the long term, savings are always equal to investment, investment will collapse too, as will productivity and therefore economic growth, followed by people’s standards of living and, finally, the Democrats’ chances of being re-elected in a year’s time.
And to top it all off, Mr. Biden and the U.S. central bank are in an impossible situation:
- Either they don’t raise interest rates and keep the printing press running, and inflation really takes off, like it did in the ’70s, with the price of petrol doubling or tripling and the dollar collapsing, a scenario that would lead to Mr. Trump and his troops marching triumphantly back into power in a year’s time. That is what we might describe as the ‘Carter solution’, after the unfortunate U.S. President from the ’70s.
- Or, alternatively, they raise the rates and stop printing money, thereby making it impossible to finance the budget deficit and the past debt, and then we would see the collapse of the stock market, but also, and more significantly, of the bonds market and the real estate market. That is what we might call the ‘Volcker’ solution, after the man who led the Fed between 1977 and 1987 and managed to do what was necessary to re-establish the US currency’s credibility back then.
The problem is that the amount of stored up debt to be refinanced has increased so much since 2007 that any rise in the rates would immediately lead to a genuine catastrophe - first a financial one, then an economic one - in the USA.
The Biden administration thus finds itself in a situation that could quickly become very difficult. While the central bank was able to make the markets believe there was no inflation, everything was fine and the said central bank was able to keep rates extraordinarily low, and this made it possible to maintain the illusion.
With the violent rise in inflation, this solution no longer exists, and a choice will have to be made between accepting a collapse of the dollar and therefore a massive drop in Americans’ standards of living, with the U.S. public no longer able to pay for their imported goods, or, in order to save the dollar, increasing the rates and making the price of U.S. assets collapse, so that foreigners can buy them cheaply.
Seeing this dilemma, there is one man who must be very glad he didn’t get elected in the last presidential election, and that’s Mr. Trump, whose supporters might crush not only the Democrats but also his eternal enemies within the Republican Party, the famous ‘RINOs’ or ‘Republicans in name only’. He may well hit the jackpot come next November...
The next 12 months look set to be very tough indeed for Mr. Biden.
All this appears to be very somber. To prevent readers from feeling completely dejected, there is a third solution that should also be mentioned.
The USA has the largest official holdings of gold in the world. They could decide to devalue the dollar massively in relation to gold (gold would have to be at $5000 an ounce, at least, in order for the ratio between the government’s stock of debts and the stock of gold to be the same as it was in 1950...I would ask for $10,000 to be on the safe side), so that they could convert the US debt into debt that can be repaid in gold, index the US money supply against the US gold stock, shut down the Fed and all the other central banks as well, and thereby go back to the gold standard. That would keep inflation very low for a sustained period, or even lead to deflation, and make it easier for the past debt to be serviced, because the short-term rates would be close to zero.
It is likely that this is what the USA will end up doing, because, as Churchill put it, “You can always count on Americans to do the right thing — after they've tried everything else”. We are rapidly heading for the end of the fiduciary currencies, and it’s not that they are a bad idea in theory, it’s quite simply because our political regimes have shown themselves to be incapable of managing them. At any rate, that is what China has been preparing for since at least 2007.