When I came to Australia in 1980, America and other western countries faced challenging economic times. The inflation rate was 13.5%, though many thought the actual rate was much higher. If you were looking to buy a home and secure a mortgage, you would be paying 18.5%. Today it's hard to believe that we ever lived in such an economic climate.
The high inflation rates were due to numerous reasons: the Arab oil embargo of the '70s, currency speculation, budget deficits, and government overstimulating the economy. These processes started early in the 1970s and peaked in the early 1980s when the U.S. Federal Reserve increased interest rates substantially to dampen demand. Does this sound familiar? Invariably, rampant inflation is damaging to an economy, and it has occurred many times before.
One of the earliest examples of an inflationary bubble was the Tulip craze in Holland during the 1630s. Tulips were a sought-after commodity by the elites of Dutch society, and people traded them on the Dutch stock exchange. Everyone wanted in on the action pretty soon, and the price went up so much that a tulip bulb was worth as much as a mansion. Many bought on credit with derivatives like options. When buyers couldn't honour their contracts, the price started to fall and eventually collapsed.
Today we are not trading in tulip bulbs, but the financial system is on a precarious footing. We are in an economic bubble. The U.S. government has been printing and borrowing money at unprecedented levels since the Covid pandemic. It's unlikely to stop anytime soon. The U.S. debt is at $29 trillion and continues to rise. The Biden administration is planning to borrow another 4 trillion dollars by printing more money. This policy is highly inflationary.
Right now, prices are rapidly increasing for homes, gasoline, commodities and food. The "official" inflation rate is 5%. Still, as Peter Schiff of Euro Capital states, it is in the double digits in reality. Also, Schiff states that inflation is like a tax because you have to spend more to buy the same amount of goods.
So what is it that is causing inflation today? Simply put, it's due to an over-supply of money by the government with historically low-interest rates. As a result, more money in the economy is chasing fewer goods, which drives prices up. Also, gasoline has gone up significantly because the U.S. is in danger of once again having to become an oil importer due to a stifling of domestic exploration. Higher gas prices are exacerbating the inflation spiral. Finally, businesses that sell their goods have had their costs go up and pass those on to the consumer. We may be at an inflexion point.
Everything is relative. If you condition yourself to pay 2.6% interest on a mortgage and rates go to 5%, you pay almost double. No doubt, many would-be panic-stricken if that eventuated. Could you, with a mortgage, sustain that? Historically, mortgage rates have averaged about 5%. Still, if they rose to those levels, you would most likely have a significant recession with job losses and a collapse of property prices and the stock market. We have seen this scenario before.
The Harvard professor and philosopher Santayana stated, "Those who cannot remember the past are condemned to repeat it." Unfortunately, it appears that we are doing just that. The party may be over sooner than we think, and it may not be due to Covid. A big recession is looming if we continue on our current trajectory, and the bubble may indeed burst. High interest rates, job losses and reduction in government spending would be harsh measures. Still, they would be the only way to bring things back to a healthy financial state.
Comments