“It was the best of times; it was the worst of times”

“It was the age of wisdom; it was the age of foolishness”—thus started Charles Dickens classic 1859 novel A Tale of Two Cities. There could not be a better description of where we find ourselves today. It is the best of times for the economy, with the stock market hitting recent all-time highs; the worst of times for government economic leadership. Our economy is full of innovative and creative ideas displaying more commercial wisdom than ever before; our growth hampered only by the foolishness of our government’s policies.

One must ask themselves how the economy is helped, the future is advanced, and public welfare is promoted by shutting down a significant percent of domestic oil and gas production, allowing 18,000 undocumented migrants to cross our boarders illegally every night, and creating trillions of unnecessary dollars out of nowhere that will do nothing but produce a high rate of inflation for years. The incompetence of our central government’s policies may both crush the economy and destroy existing constitutional government which has sustained this country for almost 250 years. This current mess started with forcing interest rates to unrealistically low levels. This has created two 2 problems: one in the public sector, and one in the private sector that’s a result of the mess in the public sector. Example:

1. Low interest rates for the government are self-serving, and they encourage the government to borrow more. The cost of interest on our $30 trillion of public debt already exceeds $400 billion annually. Each 1% increase in the cost of interest adds $300 billion to the cost of servicing the debt annually. The government has suppressed interest rates to make it easier for them to make payments on government debt, not because they love the people in the country they serve.
2. These uneconomically low interest rates created malinvestment in the private sector, a result of companies borrowing money at abnormally low interest rates who otherwise would have been denied loans. Abnormally low interest rates also drove investors out of bonds, which paid almost no yield, and into stocks. Retirees, who represent the largest block of wealth in this country, receive almost no yield on bonds, so they have been buying high dividend yielding stocks, driving up stock market values. With interest rates going up, there will now be selling pressure as investors switch out of the stock market to purchase higher yielding bonds.

Question: Isn’t that switch a good thing for everybody who likes income?
Answer: It’s a double-edged sword. Bonds holders will now receive more income; however, it is done at the expense of the taxpayer. With government debt exceeding $30 trillion, each 1% increase in the cost of interest costs the public $300 billion in interest payments. In 1980 the Fed increased their key rate to 20%. Inflation peaked at 14.8%. Should we reach that percentage of inflation, and the Fed funds rate was 20%, that would add a staggering additional $5.6 trillion to our annual budget, almost doubling the entire current budget now estimated to total $6.0 trillion. Interest payments alone will dominate the federal budget. That is beyond Third-World budgetary problems.

Question: Can inflation be solved under current government policy?
Answer: Inflation is only solved when interest rates exceed the rate of inflation. With inflation stated by the government at 8.6%, interest rates would need to be in the 9-10% rate range.

Question: Could this lead to conflict with the economy?
Answer: There are three things going on simultaneously; inflation at a rate of around 10%; rapidly increasing energy costs; and rapidly increasing interest rates. Two of the most important costs in business are energy and the cost of money, interest rates. Rising energy costs make everything that is produced more expensive—ditto increasing interest rates.

Question: What can the government do about this?
Answer: The government is responsible for every bit of it. It started with the government flooding the market with cash. Inflation is caused by too much cash in the market. Adding trillions to the spending stream created huge demand, and left producers unable to meet that demand, causing prices to increase for the products that were produced. That is an example of the inflationary cycle in which we are currently mired. Before the administration cut off delivery of oil by the pipeline and closed productive oil fields, the U.S. was an exporter of petroleum products. We are now an importer, and we are at the mercy of world demand, which is being disrupted by war in Ukraine.

Right now, there are record amounts of cash in the economy and consumers are continuing to spend, but not with abandon as they have the past year. The slowdown in spending is problematic, but the tremendous amount of cash in the economy is the one thing that might sustain the stock market at these levels as investors look for buying opportunities. That is happening right now: the market drops a few thousand points and bargain hunters jump in.

GDP Statistics
Fiscal Year	US GDP	Deficit	Total Debt	Deficit-to-DP Ratio
2021	$23.20 T	$3,000 B	$28.4 T	13.0%
2020	21.48	3.100	26.9	14.4
2019	21.69	984	22.7	4.6
2018	20.81	779	21.5	3.8
2017	19.88	665	20.2	3.4
2012	16.42	1,087	16.1	6.7
2007	14.72	161	9.0	1.1
2002	11.06	158	6.2	1.4
2022 BANKING FINANCIAL/22 GDP Statistics Jan19C

Because of the government’s monetary policies, there has been a tremendous increase in asset values. The lower 50% of taxpayers can’t enjoy those increases. Their purchasing power has decreased to the point where it’s difficult to buy food and pay rent. Nobody is talking about this, but it will inevitably lead to more government borrowing to aid in the support of people who can’t meet living expenses.

A look at the GDP statistics chart is telling. Notice on the right-hand side that in 2002 the deficit to the GDP ratio was 1.4%. On the other hand, when you look at 2021, debt represented 13% of our GDP, all a result of the FED making money out of thin air which has come back to haunt us with inflation.

Question: How do we get out of this situation?
Answer: The resolutions are bankruptcy, or inflation. The government talks about keeping inflation low, but that’s misleading us, again, as they would love to have 6-8% inflation sustained over several years. It would eat away at the real “principal amount” of the debt. Five years of 8% inflation would reduce debt by 1/3, making the “principal amount” of debt less than $20 trillion.

Question: It’s mentioned above that the market is overpriced. If the market was selling at an average price, what would that be?
Answer: To determine the historical average price of the Dow, one needs to determine the average dividend yield on the Dow. The average long-term dividend yield is 4.1%. If the market were selling at the 4.1% yield, the Dow would be 15,400 points instead of $32,500. The current market is yielding 1.9%.

Question: How would one assess the current position of the U.S. in economic, and world, affairs, and how might that affect the stock market?
Answer: One has to take into account that this country is in trouble: politically, economically, and militarily. While our mortal enemies, Russia and China, build and train their militaries, we are holding classes on how to treat each other “civilly” and we are taking our eye off the ball on China’s military innovations. That ignorance is likely to lead to catastrophic consequences. Politically, we’re spending billions of dollars pushing agendas helping children decide if they are really males or females, and other confusing, and distracting, subjects. These interferences create a disorderly society, and they are dominating the national agenda. Rising interest rates, escalating oil prices, years of inflation, and investors switching into the bond market for higher yields represents a huge set of obstacles to overcome if the market is going to move forward.

It is hard to fathom any set of circumstances in the next 12-24 months that mitigate other than a continuously depressed market pushing stocks well below present values.

Caveat Emptor!

George Rauch
June 1, 2022

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