American Missive

ATLANTA— The spread between interest rates on 2-year Treasury notes and 10-year Treasury notes spiked to the highest on record in daily trading yesterday, driven by fears the burgeoning U.S. federal deficits and quantitative easing at the Fed might exacerbate inflation in the upcoming years.  A spike of this variety suggests investors are increasingly demanding higher interest rates to offset the risk of future inflation before they invest their money long-term.

The problem is that under Barack Obama’s proposed budget and related projections, the government is going to have to continue borrowing at record rates over the upcoming several years.  If the markets are behaving this way now- imagine where they will be in a year or two from now?

Now granted, Treasury yields on long-term notes are still at historically low levels for the time being.  In addition to that, Dallas Federal Reserve Bank president Richard Fisher, confirmed in an interview several days ago that price deflation is still the immediate concern over and against price inflation.

Nonetheless, talk of inflation is hitting the mainstream, and is becoming a regular part of the public debate over where our economy is headed.  Warren Buffet is predicting an onslaught of inflation in the upcoming years.  The retreat of the Dow Jones yesterday by close to 200 points was widely attributed to a new inflationary concern.  Gold prices have been rocketing off, since talk of economic recovery became part of the mainstream in early April.  Oil prices are also surprisingly high, given the persistence of the international recession, and they have been moving up.  Commodities such as gold and oil are typically used as hedges against inflation.

What is driving all of this activity?  Two primary things, in my view.  One is the Federal Reserve’s activities in response to this recession.  They have bloated their balance sheet by buying substantial amounts of assets in response to the crisis.  They have also begun quantitative easing, which means they are purchasing long-term treasuries and mortgage products.  Put simply, when the Federal Reserve buys an asset, they are effectively printing money and putting that money into circulation. As a result, the U.S. monetary base is an all-time high, and is going higher.

The other is Barack Obama’s fiscal policies.  Congressional Budget Office projections show Barack Obama’s domestic spending priorities will double (and could triple) our national debt in the upcoming 10 years.  Rather than put on a federal spending freeze, like John McCain suggested during the presidential debates last fall, Barack Obama instead has put on a federal spending surge, committing hundreds of billions of U.S. dollars to various programs in order to “stem the tide” of the recession. 

Barack Obama may be bragging about the results of these programs now, but give him about a year or so, once inflation and high interest rates set in.  My guess is this will sink his popularity and could limit his presidency to one term.

I hope I am wrong— but I do not expect to be.