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Too deep a hole to climb out!

The debt trap

Stimulus and bailouts cost money. Not that you will get an invoice, mind you. Although that argument has been put forth. Issue an invoice for government spending on an itemized bill to every working American and it is argued we would see fewer military excursions, fewer social programs and fewer bailouts.

The reasoning for government spending is either for defense, improving the greater good by whatever method, or addressing an economically stressing event like COVID-19. The term often used is the government borrows in order to spend so we “grow our way out” of an economic problem.

When the government spends money, it either borrows it, taxes it or creates it.

The Federal Reserve creates money, and then loans it to the Treasury in exchange for IOU’s.

Since the Federal Reserve is a quasi-government agency, the borrowing is more like a bookkeeping entry than an actual lender and borrower. The Treasury is supposed to pay it back to the Federal Reserve, but in actuality has been running up the tab for decades. That “tab” is called the U.S. debt, and it stands at about 23.3 trillion (look up the U.S. debt clock webpage for a sobering moment).

The debt doesn’t include what is called unfunded liabilities. Unfunded liabilities is not what we owe right now, but what we promise to pay sometime in the future. Examples of these might be pensions or bills that come due in the future but are not due yet.

The United State’s unfunded liabilities are so large a number, the estimates vary depending on whom you ask. Wikipedia pegs the official figure at 43 trillion while Forbes clocks the figure at 210 trillion.

The argument for government spending revolves around the concept of return on investment. Borrow a buck and plow it into the economy and it will generate more than a buck in return. The return might come from a factory that is built or some kind of other investment that returns more money to the economy than the original dollar borrowed, as measured by U.S. Gross Domestic Product (GDP).

Continue to borrow, however, and the risk of a debt trap materializes. The term “debt trap” was originated by the Bank for International Settlements.

As long as the return is positive, a government can continue to borrow. Simply put, if every borrowed dollar yields more than a dollar, any new borrowing will grow an economy by more than a dollar, enabling the dollar to be paid back while the residual stays in the economy. The more money borrowed, the more the economy grows. Continue to borrow and the interest to service the debt continues to grow. Much like someone endlessly running up credit cards, eventually the principal cannot be paid as the interest continues to grow as more money is borrowed.

The debt trap occurs when each dollar borrowed by a government yields less than a dollar in benefit. Instead of getting more back than what is borrowed, the return is less than what is borrowed. This is the exact opposite of what occurs when the return is positive and the economy benefits. Instead, the debt trap is when the yield goes negative and for every dollar borrowed, less than a dollar is produced in the economy and for every dollar borrowed, the economy now shrinks.

Think of it like transferring water using a bucket with a hole in it. The more you use it, the more water you lose. The same goes with a debt trap. For every dollar borrowed, the economy gets worse. While that occurs, however, the debt and its interest continues to increase. To stay afloat, the need to borrow more accelerates. As more is borrowed, more is lost.

Hence the trap. You cannot go forward and borrow more without making the situation worse, yet the debt cannot be serviced without additional borrowing.

Opinions vary as to where U.S. debt is in regard to “trap” conditions, but many argue we’re close to it now, while others claim we are well past the point of negative returns and already in the trap.

In summation, the answer from many in government about how to fix the debt problem is to “grow our way out of it.” The problem is we may have already passed the point of no return and be caught in the trap making the situation worse with each passing day.

Opinions expressed here are those of Mr. Cuniberti and may not reflect those of any media outlet. For a list of the services offered by Mr. Cuniberti, call 530-559-1214. California Insurance License #0L34249 and Medicare Agent approved. Email: news@moneymanagementradio.com.

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Is there inflation in our future?

Depending on what kind of inflation and to what degree makes answering this question a bit more involved than just a yes or no response.

Inflation to most people means the increase in the prices of the things we buy. Why it happens and to what degree it occurs requires we take a little trip through our economic schoolbook.

One might describe inflation as either the fear your dollar will lose value (think Mexican Peso) or something will soon rise in price making it more expensive (think home prices in the mid-2000’s).

We could add a third definition by saying that in lieu of thinking something could cost more later, as in the above home prices example, one could also describe it as the hope something will be worth more later (think Bitcoin) hence turn the owner a profit. A rising bitcoin price is just another form of inflation in the truest sense of the word.

No matter what view applies to your perception of inflation, the concept centers around the same event: a change in price.

Inflation can have many causes, and without getting to deep into the weeds, just know the most common type of inflation is monetary (think money) inflation. This type of inflation can be the most insidious and dangerous type, but it is also a type of inflation that can usually be prevented if there is a will to do so.

Simply put, print a lot of paper dollars in a relatively fast amount of time and put those dollars into circulation and you will likely get monetary inflation.  All three conditions must be present to see monetary inflation.

Printing a lot of dollars means just that: creating dollars without regard to restraint.

The timeframe that this printing is accomplished is also a contributing factor. Print copious amounts of currency over centuries and inflation won’t  likely be an issue. However print a lot of dollars quickly and the second part of monetary inflation equation is complete. The third part of the equation is the circulation of the newly created dollars. Burying newly created currency in the ground so no one can use it will cause no inflation. The money has to circulate and be used by people in the economy to cause inflation.

Eliminate or avoid any of the three conditions (quantity, timeframe or circulation) and monetary inflation will not occur. Do all three and monetary inflation will eventually occur.

Most people can conceptualize monetary inflation when the Mexican Peso is mentioned, and rightly so. Although many will not be able to put their finger on the exact mechanism of the Peso event, most will grasp the general economic principle at work. The Mexican government printed too many Pesos. They did it over a relatively short amount of time, and the Pesos were distributed and used in the economy by the Mexican people.

Fast forward to the U.S. 2008/9 bailout period. Most analysts expected inflation due to the trillions of dollars created that were used in the bailouts.

We did see some inflation in certain asset areas but for the most part, prices remained stable and actually fell in other areas. What was missing in the three part monetary equation was the circulation variable.

In 2008/9, most of the trillions went into the banking `system` and not to the average everyday consumer. The banking sector dumped questionable loans (think mortgages) onto the backs of the U.S. Federal Reserve Bank (FED) in exchange for cash. The cash then paid off some of the banks’ bad debt and enabled them to continue to function. What is not widely known however is that a good portion of the money was given right back to the FED in exchange for interest payments in a program called Excessive Reserves.

So to be clear, the Fed gave money to the banks, then the banks gave much of that money right back to the Fed and got paid to do so.

Hence, much of the newly created FED money never made it into the hands of the consumer and subsequently into circulation.  It came right back to the coffers of the FED. Since this money did not circulate, there was little to no monetary inflation.

This time around, the CoVid-19 bailouts have about half of the money going to consumers and businesses. Although trillions will continue to flow to the financial sectors (causing inflation in stock prices), much of this new money will go into public circulation.

That said, it is in this analysts opinion, inflation is on its way.

Opinions expressed here are those of Mr. Cuniberti and not those of any bank or investment advisory firm. Nothing stated is meant to insure a guarantee, or to be construed as investment advice. Neither Money Management Radio (“Money Matters”) receive, control, access or monitor client funds, accounts, or portfolios. For a list of the services offered by Mr. Cuniberti, call (530)559-1214. California Insurance License #0L34249 and Medicare Agent approved.  Insurance services offered independently through Marc Cuniberti. Email: news@moneymanagementradio.com.

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