STIMULUS SPENDING: RACING TOWARD INFLATION

May 29, 2009.

Two days ago, a panel of top US economists forecast that the recession, which had begun in 2007, is showing signs of ending this year. At the same time, the economists cautioned that the recovery would be slow. Nevertheless, this recession has shown the same patterns of prior recessions and, while bad, is still not as bad as others the US has weathered.

What's especially interesting about the predictions of recovery is that only a fraction of the trillions of dollars promised to "stimulate" the economy has been spent. The economy is recovering on its own, as economic downturns almost always do.

This begs the question as to why our government should continue to spend as much as $13 trillion to artificially affect the US economy. Yes, there will be people who will still be hurting, but we can help them without spending amounts of money that are absolutely staggering by any historical standard.

Just how much is a trillion dollars? If you had to spend a trillion dollars by spending one million dollars every single day, day in and day out without a break, it would take you over 2,700 years to spend a trillion dollars. To spend $13 trillion, you would need to spend a million dollars a day for 35,616 years.

This isn't pocket change we're talking about. It wasn't too many years ago that numbers such as billions or trillions were used in discussions about light years or the size of the universe, not government spending.

You may ask, "what does this have to do with me or with buying a home?" The answer is plenty.

The US government doesn't have trillions of dollars just lying around. $13 trillion is nearly the total Gross Domestic Product (the value of all goods and services produced and sold) of the United States for an entire year. To raise that kind of money, the government has to either print money that isn't backed by anything, or sell more treasury bonds to countries such as China, Saudi Arabia, Japan and others who have been willing to invest in the US.

At some point, though, the money must be repaid. It's only a question of when.

When you increase the supply of something, you decrease its value. Thus, when you dramatically increase the supply of US dollars, the value of the dollar goes down. When the value of the dollar falls in relation to goods or services, this is called inflation. A dollar during a period of inflation doesn't buy as many loaves of bread as it did before the inflation set in.

With inflation, interest rates increase, because lenders have to charge more interest to buy the same number of loaves of bread that they could before inflation set in. During inflationary periods, interest rates on mortgages, credit cards, consumer loans, business loans, and any other credit transactions increase. Those who lived through the 1970's and early 1980's will recall double-digit inflation rates, and interest rates that ranged from 17% to as much as 24%.

For home buyers, it was a nightmare. A thirty-year $200,000 mortgage at 17% meant a monthly payment of $2850. The total interest paid over the course of 30 years on such a loan was $826,486. Compare that with a $200,000 30 year fixed mortgage at 6%, which would have monthly payments of $1199 and total interest over 30 years at $231,676.

If the federal government continues down the path of spending astronomical sums on stimulating an economy that doesn't need stimulating, you can be certain that high inflation rates are just around the corner.

But it gets worse. The treasury bills that are now being sold will come to maturity in 30 years, and the bond holders will need to be paid. Imagine how much the US government will have to pay out for thirty years of principal and interest on trillions of dollars of treasury bills. The amount will be higher than anything ever seen in the history of mankind.

It will also fall on the shoulders of the children of today who, in thirty years, will have settled into their jobs and begun buying homes and cars. By that time the US government will need to raise taxes to such a prohibitive level that the children of today won't be able to afford homes or cars.

Clearly, it is not in the interest of the public to have the government spending on such a massive scale. Whether or not the government does spend $13 trillion, though, you can partially protect yourself against inflation by buying or refinancing a home now, before interest rates climb to obscene levels.

With home prices at bargain levels, and interest rates at historic lows, there has never been a better time to buy. When interest rates and the inflation rate begin to climb, you'll be locked in at affordable rates, and with a home price that will seem like an absolute steal compared to where prices will head under an inflationary environment.

Hopefully, cooler heads will prevail in Washington, and our government will not spend this country into oblivion. The practice of selling bonds to foreign countries to finance our deficit spending isn't just reckless, it's also dangerous to our national security. With a country like China holding so many of our bonds, a war with the US would not be necessary. All China would need to do to bring the US to its knees would be to sell of its holdings of US bonds, and the US economy would collapse overnight.

If that were to happen, having an affordable mortgage would be the least of your worries.