If We Don’t Cut Debt and Spending, the U.S. Is Poised for Another Financial Crisis

. . .Here’s the thing about inflation and fighting it: In the short term, raising interest rates actually accelerates inflation. From April 1977 through April 1980, the Fed very cautiously raised interest rates, just a little at a time, hoping to gently rein in inflation. Instead, inflation took off like a bull out of a rodeo chute.

The Fed responded by accelerating interest rates with panicked leaps, adding as much as a percentage point a month for several months between 1980 and the peak in 1981. Interest rates on three-month Treasuries jumped from 7.07 percent in June 1980 to 16.30 percent in May 1981. . .

Picture this: There’s a stack of privately held money that’s almost as much as all the things that can be made and sold within a given year. The people who hold onto that money are content with keeping it in low-interest bank accounts, their mattress, or a safe. Sure, they might lose 2 percent of the value to inflation every year, but that’s more than worth it because the cash acts as a hedge against uncertainty.

The higher inflation gets, the more expensive it is to hold cash. High inflation makes it more likely that these stocks of money will be spent or converted to assets, pushing prices up even higher. It’s like a fire and it feeds on itself accelerating with panic buying. Only by paying recession-inducing higher interest rates on bonds and bank accounts can saving cash become economical.

Here’s where we are today: If everything goes according to plan, the Congressional Budget Office (CBO) calculates that, by 2020, more than half of all personal income taxes will be required to just service the national debt, and those interest payments will exceed our military budget. However, if inflation kicks off, we have much more privately held money sitting on the sidelines now than we did back in 1981. If people become afraid to hold cash because inflation is eating it up too quickly, the tsunami will be unstoppable. (Read more from “If We Don’t Cut Debt and Spending, the U.S. Is Poised for Another Financial Crisis” HERE)

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