The Obama Watch

America’s Accelerating Downward Spiral

The stagflation of the 1970s was chicken feed compared to what Obama has concocted.

By 3.23.11

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For two years now, I have been arguing in this column and elsewhere that President Obama's economic policies were a throwback to the 1970s, and so were going to produce the same result as the 1970s -- the worsening cycles of inflation and recession known as stagflation. With last week's reports regarding the Producer Price Index and the Consumer Price Index, those results are now here.

But these developments are just several further spins in an accelerating downward spiral for America that leaves our traditional prosperity, high standard of living, and national security extremely vulnerable to three looming disasters, at least two of which are likely to happen within the reasonably near future.

The Inflation Trap

The Producer Price Index rose 1.6% in February, an annual pace of nearly 20%. Over the last 5 months, the index has increased by nearly 5%, an annual pace of over 10%. The index for food increased by nearly 4% in February alone, the largest one month rise since November, 1974. As of February, the Producer Price Index for intermediate goods had increased by 7.8% over the prior 12 months.

This trend is now beginning to show up in the Consumer Price Index as well. The CPI increased by 0.5% in February, an annual pace of over 6% compounded. Over the last 3 months, the CPI has increased by 1.3%, an annual pace of 5.3%. The energy price index rose 3.4% in February alone, and nearly 10% over the last 3 months. The CPI is arguably understating inflation today because 40% of it is now represented by housing, which is still in a recession.

This follows a long-term trend that has been flashing red for inflation for quite some time now. First gold started to rise, eventually to record highs. Then the dollar started to fall, now near record lows. Then commodity prices started to soar, with oil now zooming over $100 a barrel.

Under supply-side economics, the Fed is supposed to tighten monetary policy when these inflation sensitive market prices first start to accelerate. Once the CPI starts spiking at 5-7%, the necessary tightening to stop it will cause sharply rising interest rates, and recession a year or so later. But if the Fed doesn't reverse course, and continues printing money excessively, inflation will just continue to accelerate. To stop the 1970s double-digit inflation, the Fed finally had to impose double-digit interest rates for over a year, which caused the sharp 1982 recession.

In the past four decades in the U.S., every substantial increase in the real price of oil (meaning in excess of general inflation) has been followed within a couple of years by a sharp rise in unemployment. So with oil now surging past $100 a barrel, what does that suggest about unemployment over the next two years? And what does it say about President Obama's economic IQ that the goal of his energy policy has been precisely to raise the price of oil, through cap and trade and restrictions on supply? The man can be well-spoken, as President Obama undoubtedly is, and still not have the slightest idea what he is talking about.

America's accelerating downward spiral advanced on Friday when CBO released a report on President Obama's exploding deficits and debt. Last month, President Obama's own budget admitted that he will more than double the national debt in just one term of office, with an admitted budget deficit this year of $1.645 trillion, the highest anywhere in world history by several times over. Friday's CBO report concluded that federal deficits over the next 10 years under President Obama's budget would soar by nearly a third more than he estimated, totaling nearly $10 trillion over those 10 years, which would nearly double the national debt again to $21 trillion by 2021.

The Fed's policy today is known as QE2, meaning the second round of "quantitative easing" (printing money) under the Obama Administration. That basically involves using the printed money to buy 70% of the Federal bonds issued to finance the deficit, a classic prescription for inflation. This Fed policy, continued from QE1, is the only reason that interest rates have remained so low in the face of the unprecedented trillions in federal deficits.

QE2 is scheduled to continue through June, at which time most commentators expect the Fed to end this reckless policy. But if the Fed suddenly stops this "quantitative easing," who is going to step in to buy the bonds to finance the 70% of the remaining federal deficit of $1.645 trillion for this fiscal year, and the $1.4 trillion deficit the CBO projects for the next fiscal year? Finding real buyers for those bonds is going to require paying soaring interest rates on them, which will only further increase the deficit. And that will cause soaring interest rates across the credit markets as well.

And that will mean another recession about a year later. Which would be in the middle of 2012. Which is why that is not going to happen. Which is why QE2 will be followed by QE3, QE4, and quite possibly QE5, just to make sure no recession or ominous economic clouds darken President Obama's door during his glorious 2012 re-coronation tour, however much this continuing QE parade may rightfully horrify Larry Kudlow.

But this scenario does not involve President Obama dancing on sunbeams through 2012. For with that extended QE overdosing, how high will inflation be by the summer of 2012? But what is the alternative? Mr. Obama, meet Scylla and Charybdis.

Maybe this is why surveys are indicating collapsing consumer confidence over the past 2 ½ months. Whatever the reason, those surveys don't portend a rosy scenario for unemployment in the coming months.

The Three Horsemen of the Apocalypse

But the problem is much bigger than the 1970s style inflation trap that President Obama and his supporting cast of left-wing flower children have worked us into. For America is financially much weaker today, with government spending, deficits and debt dwarfing anything America suffered in the 1970s. And the world is far less stable than then, financially, economically and politically. Moreover, America suffers far more virulent enemies today, at home and abroad, far more focused and determined to bring America down. As a result, America is extremely vulnerable today to three looming disaster scenarios.

First, our soaring national debt is not free. We have to pay interest on all those trillions in debt, every year. The Fed's extremely loose, bordello-style monetary policy has kept interest rates at record low levels throughout the Obama Administration, with short-term rates near zero.

But that can't and won't continue. Accelerating inflation will itself push up interest rates, as investors demand a market real return in excess of inflation. When the Fed finally moves to counter inflation with a tight monetary policy, that will further sharply increase interest rates. The pressure of trillions in federal borrowing further contributes to rising rates, as does continuing economic recovery at home and abroad, though that may be less of a factor in America going forward.

With America's national debt already over $10 trillion this year, and projected by CBO to grow to over $20 trillion by 2021, America is extremely vulnerable to soaring interest rates on that debt, which will produce soaring federal spending for debt interest, resulting in further soaring deficits and debt. Already, assuming only a modest rise in rates over the next 10 years, CBO projects that annual net federal interest spending on the national debt will soar from $214 billion this year to nearly a trillion by 2021. More rapidly rising rates could quite possibly result in federal spending, deficits and debt exploding out of control, beyond our capability to finance. The resulting financial chaos would further cripple our economy, making all the numbers much worse, indeed, completely intractable.

Secondly, with our deficit already at an all time world record by far of $1.645 trillion, what happens if we fall into another recession? How high will the deficit go then? Well over $2 trillion for sure. Will America even be able to borrow that much to keep the federal government functioning? That will be all the more dubious if the Fed has to stop printing money to buy so much of that debt. But if the Fed does not stop, how high will inflation go?

With soaring oil prices, regenerating inflation threatening to force the Fed into tight monetary policies, and all the Obama tax rate increases now scheduled for 2013, due to the expiration of the Bush tax cuts and Obamacare, another recession is frankly already on the horizon. That would likely leave America bankrupt just like Greece. The EU provided a trillion dollar bailout to back up Greece. But who would bailout America? Who even could?

Finally, these financial vulnerabilities leave America militarily vulnerable as well. America defeated Nazi Germany and Imperial Japan in World War II by running up the national debt to 109% of GDP. But CBO projects that on our current course the national debt will already be soaring close to 90% of GDP by 2021, exceeding the World War II historical record soon thereafter. With America already so deeply in debt, if we have to fight an extended, serious military conflict in the near future, beyond the limited actions we are already fighting, who will lend us the money to do it? China? Japan? The extra financial burden of military spending will cause federal deficits to soar further. If we have to borrow that much domestically, what will happen to our economy? Does this obvious financial weakness effectively invite war, if not directly against America, against our allies, from Israel to South Korea to Taiwan, even Japan?

Yet, at this moment, serious war drums are beating, even while our media and political establishments so thoroughly ignore them. President Obama got elected in part laughing over how he would solve the Iranian nuclear problem with his brilliant insight of just talking to Iran. Now in the third year of his Administration, none of that has amounted to anything. Obama said himself during the 2008 campaign that nuclear arms in the hands of such madmen would be "unacceptable," but that just turned out to be more boob bait for bubbas, as so much else of Obama's 2008 rhetoric.

Indeed, Mideast developments only further encourage the Iranian march to war. Regime change in Egypt has already allowed Iranian warships through the Suez Canal for the first time. Iranian infiltrators foment revolution among the Shiite majority in Bahrain, where the U.S. Navy maintains its top regional base. With the world distracted by Libya, Iran accelerates arming Hamas in Gaza and Hezbollah in Lebanon, both committed to mass murder of our Jewish allies in Israel.

What this all adds up to is that America faces an existential crisis today as grave as World War II, the Civil War, and, indeed, the original American Revolution itself. The year 2012 may well be the last chance to save our nation from ruin.

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About the Author
Peter Ferrara is Director of Entitlement and Budget Policy at the Heartland Institute, General Counsel of the American Civil Rights Union, Senior Fellow at the National Center for Policy Analysis, and Senior Policy Advisor on Entitlements and Budget Policy at the National Tax Limitation Foundation. He served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under President George H.W. Bush.