Notes from the McCombs Alumni Network’s 8th Annual Alumni Business Conference on February 8, 2012.
Lewis Spellman, Professor, Finance Department, McCombs School of Business and author of The Spellman Report
“What Lew is talking about may not be pleasant, but we need to take it seriously.”
Lewis Spellman has been jokingly called Dr. Doom by his teaching colleagues, but they acknowledge that his voice of warning on topics such as the national deficit and the rate of inflation is vital to the future of the U.S. and global economic survival. Colleague John Doggett told attendees of the McCombs Alumni Business Conference that “What Lewis is talking about may not be pleasant, but we need to take it seriously.”
Spellman warns that the U.S. has seen a 35x increase in money supply in recent years, which he predicts will lead to currency wars as the U.S. forces an increase in money supply in countries around the world.
“The numbers are staggering,” he says. “The current deficit plus already accumulated debt is a very small proportion of what is coming down the pike. The fiscal gap of the present value of 75 future years of accumulating deficits amounts to $225 trillion on an income base of $15 trillion.”
He warns this deficit cannot be funded and he expresses frustration that there is no headway in confronting the problem, while conditions worsen.
“The country’s high levels of debt slow income, and so the deficit gap becomes even larger,” he says. “Even if we would sell the debt we couldn’t afford the interest payments.” In this environment Spellman sees only “monetary trickery” in the nation’s capital, as leaders search for costless financing options. He specifically addresses four such options:
1. Federal Reserve monitization of Treasury debt. The Fed purchases Treasury debt through increased printing of currency. “The central bank should operate independently,” says Spellman, “but we saw what recently happened in Japan when the central bank chairman resigned because be couldn’t operate independently. This is what happens in this situation, you either go along or you resign.”
2. The Trillion dollar coin. “This is also trickery in a sense,” Spellman says. “They are always looking for legal ways to handle the debt without addressing the underlying problems. There is a ceiling on printing currency, but no ceiling on issuing coins, so its just a legal move to accomplish the same thing. At the end of the day the result is the same as selling the debt to the Fed. It could be an ounce of dirt, it just happens to be a coin because they are authorized to issue coins with no limit mentioned.”
3. Treasury Currency: The United States Note. “During the Civil War the Treasury printed money in order to pay the soldiers, and these where United States Notes, not from the Federal Reserve,” explains Spellman. “This is really just about whatever option goes smoother and raises the least flap with the press.”
4. Silver Certificates. “The Treasury issues the debt and the Federal Reserve two blocks away buys it, and it is all electronic, just claims on dollars,” says Spellman. “The debt disappears, and it is held by some government agency, but the only fixed asset is the extent to which the government is buying some physical assets and equipment.”
Spellman just shakes his head at such options. “I wish I had a printing press to cover my debt, we all wish we had one. So basically, the interest and debt mystically goes away if you live in the White House, and on the face of it things appear to be fine.”
This does not mean the kind of financial woes that brought down the Greek economy. “The exploding interest expense of the Greeks will not happen as long as the debt is held by the U.S. central bank and interest is rebated. The problem the Greeks had is that they don’t control the Euro printing press, and the U.S. government does.”
Even so, Spellman foresees significant financial problems ahead for the U.S. and the rest of the world, focused in large part on investors’ search for stable investments in the future.
“On the face of it, the U.S. takes care of its problem by printing money,” he asserts, “but the long term issues don’t go away. Currently the Fed leverage ratio is 50:1. If any commercial bank was at that level they would be out of business. You don’t think investors around the world don’t know that?”
As a result he sees investors looking at foreign markets if they can’t find what they need in the U.S. market. “The financial market liquidity will look for a new home,” he says, “but there are limits to how much foreign capital any market can absorb without a boom-bust cycle.”
Foreign central banks sell their currency to keep their currency competitive (cheap) in order to export, which leads to a currency war; a fight for the cheapest currency. “Now Japan has entered the currency wars just this past month,” says Spellman. “The energy producers are also intervening, Israel and lots of developed countries. So our money mushroom spreads elsewhere, the trade deficit slows our economy down, and it is hard to argue this is good for us.”
Spellman believes the short-term benefit of financing government spending without more taxes is like a sugar high. “There is a global money supply multiplier that is very large as a result of the ramped up response to U.S. monetary expansion,” he says, “and the long-term impact is astronomical.”
Why Is The Rate of Inflation Not Yet Soaring in the U.S.?
“We have such a depressed economy that the inflation hasn’t hit us yet,” he explains. “It will hit other countries first, and then we will import their inflation through higher prices. With this level of money supply globally it will catch up with us, I estimate 2 to 4 years from now.”
“But politicians see this as a victory, because the social security checks keep coming. On the surface it seems all fine and dandy, but the currency intervention will have investment effects. Where does capital investment go? If you have mutual inflation everywhere we have an incredible wildcard situation or opportunity. Investors will look for a currency that is not inflating, and I think it could be the U.K., Canada, China or Texas [he says with a smile] if it were to secede.”
U.S. Needs to Spur Entrepreneurship and Production
“Sustaining growth and fiscal commitments is better served by doing everything possible to incentivize entrepreneurship, winning the global production war with efficiency,” he asserts. But he has a warning to those who think they will be able to take their investments beyond the shores of the U.S.
“Ultimately U.S. citizens will flee paper currency in general and gravitate to another non-inflating country and commodity money. Washington understands this and they are already putting constraints on capital outflow from the country,” he says.
Spellman points to increasing restrictions and taxes being placed on citizens who seek to escape a potentially explosive rate of inflation and other economic woes in the U.S. “Your avenues for managing your own risk are becoming limited,” he warns.