Federal Reserve debt 4.5 trillion, national debt 21 trillion. 2.7 trillion in government bonds to Social Security. Figure about 30 trillion the government has borrowed and issued paper for. Then spent it.
Imagine that you have 10 billion in the bank. What you need to realize is that you have no way of realistically spending it. So, in this case, we have a person well off, that doesn’t need the extra dollars in his account. From an economic perspective, the money does not exist, because there is no opportunity for the owner to spend it, the sum is so large.
This 10 billion cash savings from one person represents a small portion the future buying power of deferred consumption. Count the total amount of funds involved for all the rich, the amount could be quite substantial. Since the inclination to spend it is absent, inflation remains low and plenty of product remains on the market. The extremely rich are holding on to dead money that will never enter the financial system to generate inflation. So, the government is happy with the rich getting richer, no appreciable inflation for just that reason.
Naturally the drive to get richer involves the rich as a group to suck more money into their grasps. The government loves the idea. A real millionaire in 1960 could buy a house and a car every year on the interests of 30,000 generated a year. In today’s market, 10 million dollars in the bank might generate 30,000 a year and might buy half a luxury car. To be wealthy today, you need to be a billionaire. Cigarettes have gone from 22 cents a pack in 1964 to 100 dollars a carton today.
This pretty much explains why schools don’t offer much education that revolves around the concept of inflation. Even if they did, it would do no good. Everything an 18-year-old wants to buy has always been that price. They have no historic memory of price. The funny thing is, for the super-rich, it is the same concept. Even though one zero drops off of their buying power because of inflation, they don’t see it. But in reality, the 10 billion has lost 90 percent of its buying power over the last 20-year period.
The cumulative savings in this country for retirement have increased dramatically over the last 10 years. An awful lot of individuals realize that they didn’t save enough to retire comfortably and are saving a lot more. They are now working longer to make up the difference. This too, decreases consumption and keeps inflation lower that it should be.
Some people argue that this game can go on forever. And I do not think it can. From 1960 to 1990 we lost a zero on buying power vs money in the bank. Then we lost another zero from 1990 to 2010. The thing to notice is that the gaps are getting shorter in time. I think it foolish to say that the next zero drops off in 2020. The progression of 30 years to 20 years to 10 years makes too many assumptions.
Once the rich realize that they are losing a zero (90% of their purchasing power) on their net worth over a 10-year timeline, there will be a very significant switch in asset allocation.
The investment model has to change. Compound interest is no longer the 8th wonder of the world. The rule of 72 where you divide your interest rate at the bank into 72 gives you the time it takes to double your savings. That kind of sucks when one into 72, returns 72 years. Compound interest at that interest rate will not make you rich.
So, with today’s back of the envelope calculation, 100,000 in the bank for 10 years will lose one zero in buying power. 10 years from now, you’ll have the purchasing power of $10,000 to $20,000. You are looking at 9 percent inflation per year. In reality, the bank should be paying the inflation rate plus 2.5 percent on savings.
You might disagree with everything above, but there are two things we can agree on. If there was a shortage of funds to borrow, interest rates would have to rise. And you cannot force people to borrow money. What you can conclude from that is there is a hell of a lot of dollars looking for an investment and surprisingly they are satisfied with the interest rate offered. Economically that puzzles me.
The other factor that bothers me is the spread between junk bonds and Treasury’s. Its 4 percent. It portends that every loan transaction is a viable and fungible event with a very high bond rating. More than likely, an older person is looking for the highest rate of return to keep from exhausting his retirement fund. The poor guy probably thinks triple D is like a bra size, very desirable. The small spread implies that there is very little risk in the market.
We are at a point where we have tremendous wealth and tremendous debt and it is kind of a zero-sum game. People are looking for a stock market crash, but it could be different this time, it could be an electronic credit and debit card crash that the structured internet cannot handle.
This could play out in the coming months. October is the month to watch, that's where the action has been in the past.
