It’s a sad irony that the Federal Reserve’s decision on September 18 to continue stimulus—due to weaker economic data—may in fact cut future US gross domestic product (GDP) growth by as much as 50 percent, by adding to America’s national debt, according to a report on historical country debt trends.

The Fed’s continued dovish stance on inflation is showing the markets a lack of backbone at the central bank, a perception exacerbated by the withdrawal earlier this week of the more hawkish Lawrence Summers as a candidate to be the next Fed chief. The upshot is that the markets expect the Fed to be less aggressive in slowing monetary stimulus.

The top candidate for the post of Fed chief, Janet Yellen, is considered to be an inflation dove and she’s expected to hold short-term rates lower for longer if she succeeds Ben S. Bernanke in January.

These developments bode ill for those concerned about a future spike in inflation. Historically, central banks have acted too slowly to tame inflation—and one would expect the same from a central bank that has explicitly made inflation a lower priority.

Of course, the Fed in its decision to continue stimulus does also forecast lower future growth. However, that forecast isn’t predicated on high debt levels, but rather on weak employment figures and higher rates that are impeding a full recovery.

In a new set of quarterly forecasts, the Fed now sees growth in a 2 percent to 2.3 percent range this year, down from 2.3 percent to 2.6 percent in its June estimates. The downgrade for next year was even sharper: 2.9 percent to 3.1 percent from 3 percent to 3.5 percent.

Moreover, the Fed reiterated that it will not start to raise rates at least until unemployment falls to 6.5 percent, so long as inflation does not threaten to go above 2.5 percent. The US jobless rate in August was 7.3 percent.

However, among the 20 advanced nations, those with high debt-to-GDP levels have seen median growth fall by half as debt levels moved from less than 30 percent of GDP to 90 percent or more, according to a 2010 report, “Growth in a Time of Debt,” by economists Carmen Reinhart and Kenneth Rogoff. The US national debt is now about 73 percent of GDP, according to a Congressional Budget Office (CBO) report released September 17.

The CBO reported, “The percentage of debt is higher than any point since around World War II, and twice the percentage it was at the end of 2007.”  If current laws stay in place, debt will decline “slightly” relative to GDP over the next few years, the non-partisan agency said. But it warned that growing future deficits will push the debt to 100 percent of GDP 25 years from now (see Chart A).

The manner in which continued Fed stimulus could add to the national debt obligation is through the process of monetization. In 2010, Richard W. Fisher, president of the Federal Reserve Bank of Dallas, warned that a potential risk of quantitative easing (QE) is “the risk of being perceived as embarking on the slippery slope of debt monetization.”

Chart A: Increased US Debt Levels = Lower Growth in the Future


Source: Congressional Budget Office

“We know that once a central bank is perceived as targeting government debt yields at a time of persistent budget deficits, concern about debt monetization quickly arises,” Fisher asserted. Later in the same speech, he stated that the Fed is monetizing the government’s debt.

“The math of this new exercise is readily transparent: The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation’s central bank will be monetizing the federal debt,” Fisher surmised at the time.

Naturally, the only effective way to determine whether a central bank has monetized debt is to compare its performance relative to its stated objectives. Many central banks have adopted an inflation target. It is likely that a central bank is monetizing the debt if it continues to buy government debt when inflation is above target, and the government has problems with debt financing.

When asked about this issue, Ben Bernanke said the Fed is not monetizing the debt, since the Fed plans to sell the debt on the open market at a later date. But critics have openly challenged whether that would be truly possible (sell the debt) given the unprecedented increases in the Fed’s balance sheet.

But if one only considers the CBO’s report projecting the US will surpass the 90 percent debt-to-GDP threshold from its current 73 percent level, this raises disastrous implications. It could mean that future growth forecasts would need to be cut by up to half in the next 10-20 years, representing an extraordinary decline in value in the US economy and a cut in wealth for those invested in US companies for the purposes of retirement planning.

According to the aforementioned Reinhart, Rogoff economics paper, the US is already within the band of a marked slowdown given its debt levels and historical trends. “The drop in average growth between countries with debt ratios of 60 percent to 90 percent of GDP, and those above 90 percent of GDP, was even greater: 3.4 percent to 1.7 percent,” according to the report.

“The sharp run-up in public sector debt will likely prove one of the most enduring legacies of the 2007-2009 financial crises in the United States and elsewhere,” the authors conclude. “[A]cross both advanced countries and emerging markets, high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes…Seldom do countries simply ‘grow’ their way out of deep debt burdens,” the economists stated.

Given all the evidence of potential future wealth destruction, investors are well advised to move into various asset classes recommended in the Inflation Survival Letter.

Gold Begins to Shine Again

The gold market rallied sharply in the immediate aftermath of the surprising “no-tapering” announcement this week by the Fed. Thrive Portfolio holding Goldcorp (NYSE: GG) increased almost 8 percent after the central bank’s announcement.

Chart B: Goldcorp (NYSE: GG) Spikes on Fed’s 2:00 p.m. Stimulus Announcement



Created by Y Charts

In the last edition of Survival of the Fittest, we lamented gold’s sharp decline that over the last year had affected Goldcorp, but viewed the firm as one of the best ways to hedge against inflation and a way to buy high-quality businesses when they are cheap, which occurs when they are out of favor. But Goldcorp and gold in general may be back, though this is still an early trend. Goldcorp is a buy up to 39.

Another way to play commodities to preserve wealth during inflationary periods is through Survive Portfolio holding GreenHaven Continuous Commodity Index (NYSE: GCC), which also has some exposure to gold and has been up 1 percent this week off of expectations of the Fed announcement.

Chart C: Investors Have Retreated to the Safety of GreenHaven (NYSE: GCC)



Created with Y Charts

GreenHaven is exposed to 17 commodities, including corn, wheat, soybeans, soy oil, live cattle, lean hogs, coffee, cocoa, sugar, cotton, platinum, gold, silver, copper, natural gas, crude oil and heating oil. Due to its equal weightings, the exchange-traded fund (ETF) offers significant exposure to grains, livestock, and soft commodities and a lower energy weighting than many of its peers.

Currently, the ETF has 24 percent of its allocation in soft commodities, 24 percent in metals, 34 percent in agriculture and 18 percent is in energy. GreenHaven Continuous Commodity Index is a buy up to 32