USA Interest Rates Foresee No Inflation

A run away inflation train is what many believe we'll see resulting from tons of USA money printing and borrowing.

Many of us recall the rising inflation days of the 70's exploding into ultra high interest rates that peaked around 1981. But if history is to repeat itself then we should be seeing rising interest rates in 2009 not declining (or stable) rates.

Ok, I know conventional conservative wisdom would say, "Massive money printing and jumbo government debt and deficit spending leads to run away inflation". Yes, I'd agree. But if the worlds governments had reduced the money supply and banned government stimulus spending plans last fall (in response to the crisis) where would we be now? Back in the 1930's? John Maynard Keynes said it best when his critics pointed to the long-term negatives of government deficit spending, he said, "...in the long run we're all dead."

Yes, the classic response is, "we're mortgaging our childrens futures". So what if my kids have to pay for this deficit spending to keep the economy working today? It's about time they pay for something! Just joking folks. But if the choice boils down to doing nothing or do something...I choose doing something. Now what we do is certainly up for debate. The Wall Street Journal, citing confidential documents, reported recently that about $50 billion in 2008 bailout money from A.I.G. went to at least two dozen firms, including Goldman Sachs, Merrill Lynch, Bank of America and European banks. If it were up to me I'd say let the rich wall street gamblers lose thier jobs and spend the $50 billion on rebuilding aging American infrastructure to employ large amounts of poorer hardworking main street Americans.

The charts below show no rising interest rates (for now).

The times, as Bob Dylan sang,"..they are a changing" and someday we (USA) may have hyperinflation or stagflation again. But for the next year just expect Japanese style stagenation. After all, if the Japanese can be in a 20 year Stagnation cycle of low inflation with low interest rates why can't the USA have the same? Why must we have Stagflation now simply because we had it in the 70's? But wait, I'm forgetting one gagantic detail. Our excessive national debt. True that will come into play but I'm perdicting later not sooner.

Forget what you want to believe. Just look at the facts in the charts below. Todays, interest rates (in ever area) are about 50% below any area of interest rates we had during the 70's and 80's recessions. And guess what? Our National Debt averaged around $750 Billion in the 70's and today it's averaged over $7.5 Trillion over the last decade. The highest interest rates we've seen this decade were still at least 50% below what we say in the 70's.

So, when are we going to get this runaway inflation and high interest rates that the world's most loved predictors of doom keep talking about?

What causes inflation?

Milton Friedman noted, “Inflation is always and everywhere a monetary phenomenon....It is a situation in which too few goods are being chased by too much money". The monetary policy is as lose as it gets. Economic's teaches us that inflation has two key drivers. #1. Cost-Push Inflation, workers’ ability to negotiate higher wages for themselves and business ability to raise prices. Rising commodities prices and product shortages can also cause this problem. We have neither. #2. Demand-Pull Inflation, resulting from an increase in aggregate demand, caused by an increase in money supply and increases in government and consumer purchases. We have both with one big exception. Consumer spending is only modestly recovering.

True, government gifts for spending like Cash for Clunkers $4,500 and $8,000 for first time home buyers resulted in a spike in spending. But at this point no bear or bull nor economist believes consumer spending is rapidly rising.

Therefore the U.S. monetary policy will (most likely) maintain the Fed-Funds rate under 1% through 2010. You can thank (or curse, if you have large amounts of savings earning near zero rates) our governments for keeping rates low like they did in 2001-2004. But unlike 2001-2004 we have record breaking amounts of unemployed and under employed people. And the (2001-04) housing building and spending boom is now bust. So, I'd bet we'll not see any meaningful inflation spike until late 2010.

What about our gargantuan national debt?

There’s also the inconvenient truth of U.S. debt, running up such gargantuan fiscal liabilities, both privately (consumers) and publicly. And just like the 70's once again we're spending a fortune on the military, war and nation building. This time it's in Iraq and Afhganistan. Combine this with our future social security and medicare liabilities. No question we have long-term issues that could result in rapidly rising future inflation. Yet, the only hint of big inflation now is oil prices. But oil prices are now inversly correlated to the value of the dollar more than world demand and supply factors. Still you recall how the doubling of oil in the 70's caused a major surge in inflation. So, why is inflation not spiking? Well, I'm tolled the impact of oil prices today has less impact on inflation than it did in the 70's. And one big variable has changed from the 70's that is keeping the cost of borrowing money low.

One big change from the 70's. One word. CHINA.

Yes, our enemy for 35 years has evolved into the worlds factory for cheaply built products (thanks to it's inclusion into the World Trade Organization). China has become our banker and product supplier. We have become their most important export market. We are their consumer market.

Why all the worry over China's willingness to lend us money? Why the worry over China dumping dollars? Why the worry over China wanting to cash in their USA treasury bonds? Folks, forgive my bluntness but these are nonsense worries (if only in my mind). It's like saying we need to worry about drug dealers not wanting to sell drugs for profit and employment to drug users.

I hear a few people saying: what is this Madman-Across-The-Water talking about?

Think about this. The USA is China's number one export market. China will gladly work to keep us (and the world) addicted to buying their goods to keep their labor force employed. And do you really believe that China wants to kill the U.S. Goose that lays their golden eggs? No. Just because you're a Communist does not mean you're an Economic Neanderthal Man. In fact, China has hired the finest investment banking minds the west has, to advise them on money matters. There's no better way to beat a Capitalist then at his own game and on his home field!

30-Year Conventional Mortgage Rates, 1971-2009:


30-year Treasury bond yields, 1977-2009:


Baa Corporate 30-year Bond Yields, 1962-2009:


AAA Corporate 30-year Bond Yields, 1962-2009:


Prime rate, 1955-2009:


Dr. Mark J. Perry is a professor of economics and finance in the School of Management at the Flint campus of the University of Michigan. He(and many other economist)has pointed out that historically low 30-year mortgage rates reflected relatively low market expectations of future inflation. Some commenters (and Robert Shiller this afternoon on CNBC) pointed out that the Fed is buying mortgage securities, which is temporarily keeping 30-mortgage rates low, rather than low inflation expectations keeping rates low.

What we believe and what is, are often two sides of a coin.

But the charts above show that other long-term rates (30-year Treasury bond, 30-year AAA corporates and 30-year Baa corporates) are historically low, as well as the prime rate being historically low, and these low rates wouldn't necessarily have anything to do with Fed purchases.

Question: How could all of these long-term rates be so low if there were inflationary pressures building up in the economy, which would lead to higher expected future inflation, and higher nominal long-term interest rates, and not historically low long-term rates?