The whole political scene is abuzz with the “fiscal cliff” that the US government is facing and must resolve before falling off of. But my question is, why does it even matter anymore?
Neither of the parties are actually proposing to do anything that will actually bring about fiscal responsibility back to the US government, nor are they proposing to do anything worthwhile about entitlement spending, which is only going to increase year after year. All this political bantering and speculating going on is similar to construction managers arguing about which hole of a collapsing dam the worker should put his finger into.
Regardless of which end of the political spectrum you are on, everyone agrees that the spending can’t continue the way it currently is. Something has to give. This year’s deficit is already being projected to be over $1 trillion, and is the fifth in a row that high. Even if we were to cut all spending not associated with Medicaid, Medicare, and Social Security by 50%, we would still be in the red by about $200 billion. And the above entitlements are only going to continue to get worse.
The only solution given by the government right now is to continue to monetize the debt. Hoping that stimulus will still turn things around is continuing to follow a siren song to our destruction. Even if it did work, which I do not believe it ever could, the results would not be apparent for some time, and several years before it could be expected to contribute to the solution. In the meantime, our liabilities will continue to grow, and will drag on the system like an anchor.
But monetizing the debt only puts us on a path between a Scylla and a Charybdis. Which is to say that we will have to face either the rising monster of hyperinflation or the gaping whirlpool of a debt-collapse.
What is at stake is the ability of the US government to continue to keep a checkrein on its interest payments related to *previous* debt monetizations. Monetary stimulus used by the Federal Reserve ends up not only reducing interest rates for the private sector, ostensibly to bolster borrowing and growth, but also keeps interest rates down on government bonds and borrowing. Keeping the rates down helps to keep the interest payments down that the government has to pay, which helps to reduce the overall deficit that the US government has to face. In 2009, this amount was approximately $383 billion, and accounted for approximately 27% of the deficit. Allowing interest rates to rise even a point or two from their current low rates (US Bond Rates) of 1% – 2%, would dramatically alter the financial situation. And letting them rise to the 8% they were in 1990 would be catastrophic.
So, as long as the US government has no intention of balancing the budget anytime soon, it has no choice, if it wants to survive, but to continue to borrow. And if it continues to borrow, it has no choice but to keep the interest rates low. And if it continues to keep interest rates low, it has to continue to monetize the debt through the Federal Reserve.
Instead of monetizing the debt, why not just borrow, you might ask? Well, when the Federal Reserve monetizes the debt, it prints new money and injects it into the economy by buying bonds. But this input of money into the system pushes down interest rates by artificially creating more supply of money which is looking to be borrowed. If the government were to openly approach the public and ask for money, then the situation would be reversed and there would be more competition for the amount of money in the market. Prices (interest) would increase, and the situation would be aggravated further.
So here’s the rub: If the government chooses to continue to inject money into the system, it can only result in a devaluation of the dollar and any assets denominated in dollars. Setting other consequences aside (like devaluing retiree savings, making fixed income groups more vulnerable, and causing conflicts about currency manipulation), prices economy-wide will increase. Eventually, lenders, foreign and domestic, will abstain from lending the government any money, especially long term, when they know that the return they get will be less than what they originally loaned. Inflation protected securities (TIPS) aren’t much of a solution, because while they mitigate the unfortunate aspects of inflation, they take on the effect of making the “interest” owed by the government much larger than the rate on the note, and simply mask the need to borrow at higher interest rates in order to keep moving forward.
The system then begins to feed on itself. With ever-inceasing injections of money, ever more money is needed to be borrowed to overcome the price inflation created by the injections and the withdrawal of lenders because of the devaluation of the principal of the loans. Eventually even the public begins to reject the currency and begins, as quickly as they can, to convert it into some sort of hard asset, such as precious metals, stocks, or real estate. Saving is discouraged, as money in a bank loses its purchasing value. With interest rates kept low, banks won’t borrow any higher than they can loan it out, and price inflation begins to outstrip returns from financial institutions. Eventually money loses all of its value and crashes in a hyperinflation. The government, being tied to its currency for purchases, will find that it cannot buy anything from anyone and becomes insolvent.
Without a comprehensive visiting of the financial mess that is the US government is in, it won’t matter whether or not the US falls off its cliff. Current “solutions” aim only to delay the inevitable crash long enough to put the failure onto another’s shoulders. Falling off the cliff would be a “disaster,” but delaying would create an even greater disaster. Republicans and Democrats are like lions and hyenas fighting each other over a rotting carcass. They could care less who gets hurt in the aftermath as long as they get what they want.
And since those are the only two options being given to us, what does it really matter?
Shade Tree Economist 