Updated: May 3, 2013 12:14PM
Originally published: September 19, 2005
For years, even through the terrorist attacks in September 2001, consumer spending has continued to rise. Interest rates remained low, and credit has been easily available. Home prices soared. Debt -- and leverage through debt -- became an accepted way of life. Savings disappeared. Soon, very soon, we’re going to have to pay for our folly.
You don’t need government statistics to tell you that prices are rising. In fact, for some items, prices are rising at an even faster rate than the 0.5 percent increase in the Consumer Price Index in August. Without food and energy increases, the CPI rose only 0.1 percent, but I don’t know anyone who exists without food and energy for a month!
There are other components of the CPI that tend to minimize the impact of higher costs. The CPI’s housing component is figured at the rental-equivalent cost. But with so many people buying homes, rental demand has eased, so rents have been held down. That puts downward pressure on a big component of the CPI, even as monthly mortgage payments get larger as home prices soar.
If you’re a senior consuming health services, your cost of living is certainly rising at a more rapid rate than the index. Ditto if you’re the parent of a college student. And ditto in spades if you’re a first-time home buyer. If you’re a cab driver or have a long commute to work, your budget is certainly strained by the rising cost of energy.
Is inflation the issue?
Rising prices are a symptom of inflation. But the real definition of inflation is the excess creation of money, which destroys the value of the money we hold. And that process of inflation is directly related to the actions of the Federal Reserve Bank.
The Fed has been fighting the possibility of inflation for well over a year, raising interest rates and tightening up on the money supply in a less-noticed attempt to wring the inflationary potential out of the economy.
The banking system had been awash in low-interest, easy money following the Fed’s easing going into the year 2000 transition, and in its efforts to stem the potential impact on the economy after Sept. 11, 2001.
The Fed is almost certain to raise interest rates this week in its battle against inflation.
If the Fed keeps tightening up on the price and availability of credit, consumers will have to start making choices. Rising energy costs, not only for gasoline but home heating oil and natural gas, will take a toll on other consumer spending.
In the 1970s, the Fed tried to accommodate both higher energy costs and war by creating more, not less, availability of credit. The result was inflation. Even with Alan Greenspan gone, they’re not likely to make that mistake again.
Consumers have been attempting to maintain their lifestyles in spite of rising energy prices, but they do it at a huge hidden cost. Our savings rate as a nation has fallen into negative territory. That means that in an attempt to keep up with rising prices, we’ve been paying for our lifestyles with mortgage loans and credit cards.
Even worse, we’ve been spending money abroad in record amounts to buy foreign goods to the tune of $770 billion a year. Stuck with the dollars we’ve sent overseas, foreigners have been reinvesting them in Treasury securities at a rate of around $65-$70 billion a month. In other words, foreigners will be subsidizing the federal Katrina rebuilding deficit by buying our Treasury IOUs.
Let’s hope the foreign appetite for dollars doesn’t dry up. If foreign central banks stop finding those Treasury bills attractive, interest rates would have to go much higher to attract lenders to finance our debt. Global oil producers would demand more of those less-valuable dollars to pay for the oil they ship. And then the house of cards that we call consumer debt would fall faster than any hurricane winds.
Gold bugs rejoice
The gold market recognizes the danger, with gold prices rising to $459 an ounce on Friday. That potential loss of confidence in the dollar is why the Fed must raise rates in spite of the government’s need to borrow money to help the rebuilding effort.
The Fed recognizes reality -- and so should you. If you’re living on the edge with credit-card debt or an adjustable-rate mortgage, wake up to the new reality. Debt has suddenly become much more dangerous. And that’s The Savage Truth.
Terry Savage is a registered investment adviser and the author of the newly published The Savage Number: How Much Money Do You Need to Retire? (256 pages, Wiley, $24.95).