Where the Big Lessons will be Learned

Reading the headlines of this week’s data reports tells the story of a strong, robust economy.  According to the Commerce Department announcement on Tuesday, single-family home “sales increased 2.1 percent to a seasonally adjusted annual rate of 476,000 units – the highest level since July 2008.”

But that’s not all.  We also got word on Tuesday that U.S. consumer confidence is also at a five year high.  AP reports

“The Conference Board, a New York-based private research group, said Tuesday that its consumer confidence index jumped to 81.4 in June.  That’s the best reading since January 2008.  And it is up from May’s reading of 74.3, which was revised slightly downward from 76.2.”

Yesterday the Commerce Department confirmed that people are earning more money.  On top of that, they’re using their increased proceeds to buy more stuff…

“Personal income increased $69.4 billion, or 0.5 percent, and disposable personal income (DPI) increased $57.0 billion, or 0.5 percent, in May,” according to the Bureau of Economic Analysis.  “Personal consumption expenditures (PCE) increased $29.0 billion, or 0.3 percent.”

No doubt, these data reports are marvelous and wonderful.  Prosperity and affluence are returning to the economy.  If this keeps up, we’ll all soon be rich.

The Best Scenario for the U.S. Economy

But, alas, it ain’t so.  For as we noted earlier this year, The United States Can’t Afford Prosperity.

The premise at the time was that heavy handed fiscal and monetary intervention into the Treasury market had gotten the whole U.S. economy into a giant pickle.  Here’s how we described it at the time…

Perhaps they [the Federal Reserve] can keep yields on the 10-Year note around 2 percent as long as the economy slumps.  But eventually, and in spite of the actions of government policy makers, economic growth will return.  What’s more, when that happens inflation will return along with it.

Right now, the Federal Reserve’s promised to inflate its balance sheet by over $1 trillion per year until more people have jobs.  Considering the money multiplier effect and the “magic” of fractional reserve banking, at some point, each $1 trillion added to the Fed’s balance sheet could translate into $5 trillion – or more – of money flowing into the economy.

All this new money flowing into the economy will drive up prices.  Conversely, it’ll drive down the value of the dollar.  Foreign lenders, like China and Japan, with massive holdings of Treasuries will demand higher compensation for holding a dwindling asset.  In other words, interest rates will rise and payments on government debt will become completely unserviceable.

Any boost to GDP and increase in tax revenues will quickly be overwhelmed by the rising price of interest on government debt.  So, in a most unfortunate way, the best scenario for the U.S. economy is slow, sluggish, lackluster growth.  Anything more than that is simply unaffordable.

Where the Big Lessons will be Learned

The great thing about living within the madness of a magnanimous fiscal and monetary policy experiment is getting to observe, real time, the dramatic mood swings of market participants on an almost minute by minute basis.  From geed to fear to mania to panic – and all over again – all in a single trading day.

Last week, for instance, while we were contemplating life outside the U.S., investors lost their minds over the mere suggestion that one day, perhaps later this year, the Fed may print money at a rate slower than what it’s currently printing.  Yields on the 10-Year Treasury note jumped to 2.55 percent…up from 1.65 percent in May.  Stocks took a nose dive too.

This week, while yields are generally holding for now, stocks have run back up.  The DOW’s back above 15,000.  But why?  Is it because consumers are more confident…and that housing prices are on the upswing?

Quite frankly, we don’t know.  The fact is financial markets have been so distorted through extreme government intervention that no one really knows what is going on.  Mark Hulbert says that for stocks, The Worst is Yet to Come.

He’s probably right.  But regardless of if stocks boom or bust our attention is on Treasuries.  That’s where the big lessons will be learned.

We believe interest rates have hit a new inflection point.  In other words, rates will rise over the next 30 years…you can count on it.

Plus, in addition to the U.S. government, the whole economic shebang, which has been handicapped by artificially suppressed rates, won’t be able to afford higher rates until the last of the rot has been purged from the system.  By then, debt will be ridiculed like the President’s mom jeans.


MN Gordon
for Economic Prism

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