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July 11, 2010
Ratcheting to Ruin
The U.S. government moves closer to a debt death spiral. Arguably, we are already in the beginning phase of this spiral as this rather scary observation points out:
With no spending restraints, the economy moves inexorably toward its date of collapse.
The excesses and imbalances created by the explosion of debt over the last thirty years virtually ensure a depression, regardless of what policy actions the government chooses. That was determined before Obama took office. His spending only accelerated the debt spiral, never had any chance of success and sped up our date with economic destiny.
The tipping point of debt that Ludwig von Mises warned against was passed long ago:
Our political leaders do not have the fortitude to abandon spending. So-called austerity measures represent little more than lip service for markets. Government economists and the political class have never implemented such measures on anywhere the scale now required. They will not willingly do so now.
What Mises termed a "catastrophe" will eventually result. The chaos that creates will eventually force action. We know the ending is not good. We don't know its timing or its form.
It is likely the government will continue on its spending path until market forces terminate this behavior. The first sign of market pushback will come in the form of a failed Treasury auction. Perhaps such an event has already occurred, albeit covered up by primary dealers buying the shortfall amounts or other slight of hand practiced by the Fed. Regardless, the deficits are so large that at some point, a shortfall will be too large for chicanery to cover. Once this happens, the government will have two choices.
One choice is to allow interest rates to rise so that markets will buy the additional government debt. The interest rate rise will further choke off what little economic activity exists. Without dramatic reductions in spending and deficits, the rise in interest rates would likely be substantial.
The other choice is to employ overt Quantitative Easing (printing money). The Treasury would order the Fed to use QE to cover the deficits. It is unlikely the Fed would or could resist. This choice might hold interest rates down, at least temporarily. Once the policy became known, fear of inflation would eventually affect currency exchange rates, interest rates and prices.
Based on the last fifty years of government fiscal and monetary policy it is not difficult to forecast what the government will do. The second alternative is likely. It defers somewhat the timing of the economic Armageddon, but not for long. It also makes the final pain that much worse. The last fact will not influence the political decision. They will try to escape the reckoning day for as long as possible. Deferring pain today is always their preferred choice, no matter the pain tomorrow. Let someone else worry about tomorrow.
Regardless of what the Fed does or does not do, our future was determined by past policies. A depression is now unavoidable. The first choice is less harmful than the second but will produce the depression sooner. The latter choice will result in massive inflation, if not hyperinflation, before the depression. It will wipe out the purchasing power of most savings and fixed income.
Which flavor poison do you prefer? After all, "in the long run we are all dead."
Monty Pelerin blogs at www.economicnoise.com