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Spiking Gas Prices, Inflation Stoke American Debt Woes

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Americans at the pump are worried. They should be. As civil war looms in Libya, oil prices are up 19% in just three weeks, topping $105 a barrel. And even through there has been some easing today, that spells bad news not only for the American consumer, but also for our fragile economy and for our politicians trying to wrangle with the American Debt crisis.

The worry is that rising oil prices will flame already-heated inflation fears worldwide. As the week opened, treasury traders increased bets on inflation to the most in 32 months. Gold futures reached a record high for the second consecutive session and silver rose to a 30-year peak, as investors looked for safe havens against rising prices.

The same worries rattled world stock markets -- in the U.S. -- and also in China where the government has raised borrowing rates three times in the last four months to battle growing inflation. There's likely another hike coming. The Bank of Korea has also raised its benchmark interest rate three times since July of last year. Brazil, England, Continental Europe, Russia, Argentina, and India are all enacting or considering similar measures in order to deal with rising inflation, ranging from a mere upturn to double-digit increases in countries like Argentina.

In the Unites States, however, Fed Chairman Ben Bernanke maintains that inflation is still not a worry. He reports, the inflation rate ("the personal consumption expenditures index") is a modest 1.2 percent. Further, the economy -- with a jobless rate of 9 percent -- is still not operating on all cylinders.

But Wall Street doesn't seem to agree. No one expects the Fed to raise rates from their current "zero to 0.25 percent" anytime soon. Nevertheless, Bernanke's quantitative easing program coupled with the rise of commodity prices have caused investors to worry about creeping inflation --most recently, those hundred-dollar-a-barrel oil prices. But oil is only part of the problem.

Inflation is partially a self-fulfilling prophesy. When the markets expect inflation, they begin pricing it into the cost of debt, commodities, and everything else -- which causes inflation. One indicator of this expectation is that bond traders investing in short term bonds over long term are getting better yields than their peers who are doing otherwise. Further, U.S. mortgage rates seem to be pricing in inflation, jumping to the highest level since April. The average rate for a 30-year fixed loan is just under 5% percent, which is up from April of last year.

What's most troubling is that there seem to be lots of different kinds of inflation triggers going on at once:

There's demand-push inflation present in rapidly growing economies like China or India where demand outpaces supply.

There's fiscal inflation because world governments have enacted high spending programs to pull us out of a global recession.

There's cost-push inflation where input costs rise and manufacturers hike prices to maintain profit margins. Commodity prices everywhere are up from wheat to oil. That's due to rapidly increasing demand in the BRIC (Brazil, Russia, India, China) countries, as well as environmental issues, like the wheat drought in China and political issues surrounding oil supply.

Finally, there's monetary inflation when governments simply print too much money. Enter Ben Bernanke and quantitative easing. Many analysts are saying that we here in America are the prime cause of the inflationary atmosphere worldwide. By printing too much money, we are sending up commodity prices (largely valued in dollars) and those increased commodity prices are being felt everywhere.

But what's the man to do? If Bernanke lets interest rates rise, the cost to America could be devastating. Not only does he risk slowing down a still-fragile economic recovery, rising interest rates could threaten the financial stability of our federal government.

Just consider: The U.S. government owes over $14 trillion dollars, but we pay very little to finance that debt because interest rates have been historically low. In fact, our net interest costs dropped from $253 billion in 2008 to $197 billion in 2010 -- even though we borrowed a whole lot more money ($3 trillion dollars).

But as soon as interest rates rise, so too will the cost of our debt. The Congressional Budget Office predicts that without significant changes to our spending patterns, debt service could quadruple within the decade. That means, very little money left to pay for Social Security, Medicare, defense - or anything else for that matter.

Bernanke himself warned: "In a vicious circle, high and rising interest rates would cause debt-service payments on the Federal debt to grow even faster, causing further increases in the debt to GDP ratio and making fiscal adjustment all the more difficult."

In some part, Bernanke's job is to forestall that scenario as long as possible. He's buying our politicians time to get it together and fix our decades-long spending binge. Up until recently, most analysts have said that he can perform the balancing act for the rest of 2011. But forces are now working against him. With rumbling in our bond markets, inflation spikes worldwide, and now ongoing turmoil in the Middle East, it's becoming less and less likely that Bernanke can keep up the juggling act.

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