Debt and the Fed (Michael Pento)

Wednesday, January 26, 2011
By: Michael Pento

The salient news of today is undoubtedly the new estimate for the 2011 deficit. The Dow Jones Industrial average has crossed above the 12k mark once again and the MSM is busy clamoring over that. However, the real news of the day is that the Congressional Budget Office (CBO) raised its deficit projection for this year’s shortfall to $1.48 trillion from $1.07 trillion. That’s an increase of over $400 billion!

Maybe not so coincidentally, President Obama vowed to cut spending by $400 billion over 10 years during last night’s State of the Union Speech. I say big deal! Even if he was successful in cutting red ink by that entire amount immediately, the deficit would still be over $1 trillion. It is only a matter of time before the bond vigilantes turn their eyes away from Europe and over to America.

The CBO’s update also indicated that the U.S. economy will expand 3.1 percent this year and 2.8 percent in 2012, with real gross domestic product growing an average of 3.4 percent in 2013-2016. CBO Director Douglas Elmendorf also indicated that "…debt held by the public will probably jump from 40 percent of GDP at the end of fiscal year 2008 to nearly 70 percent at the end of fiscal year 2011."

But the really bad news here is that their estimate for growth is most likely way too high. The Fed has now kept interest rates at near 0% for 25 months. And government debt is growing at well over a trillion dollars per year. The process of returning to a market based economy instead of one based on inflation and debt is very painful in the beginning. The end of debt monetization—if such a strategy is ever implemented—will bring asset prices much lower. And balancing the budget will temporarily bring down GDP growth and government revenue in a significant manner. Therefore, the CBO has most likely overestimated GDP or grossly underestimated inflation and deficits.

The Fed’s decision to keep interest rates unchanged didn’t surprise anyone. However, what was a surprise is that Messrs Plosser and Fischer didn’t dissent from the Fed’s zero interest rate policy. In addition, the Fed continues to concentrate on the core rate of inflation and ignore rising commodity prices and a falling dollar. Their statement indicated that they will complete the $600 billion in bond purchases even though it is causing long term yields to rise. And that the central bank will keep rates “exceptionally low for an extended period of time.”

It’s should now be clear to everyone by now that their intention is to facilitate government deficit spending by monetizing the debt.

Michael Pento, Senior Economist at Euro Pacific Capital is a well-established specialist in the “Austrian School” of economics. He is a regular guest on CNBC, Bloomberg, Fox Business, and other national media outlets and his market analysis can be read in most major financial publications, including the Wall Street Journal. Prior to joining Euro Pacific, Michael worked for a boutique investment advisory firm to create ETFs and UITs that were sold throughout Wall Street. Earlier in his career, he worked on the floor of the NYSE.