Saturday, March 1, 2008

Why the Fed has no other Alternative but to print Money

So why is the US Fed so concerned about deflation that Mr.Bernanke even suggested dropping US dollar bills from a helicopter in order to combat it? There is one condition under which deflation is a disaster and this is when total U.S. credit market debt is high as a percentage of the economy.

At the end of 2006, it stood at 336.4%.
Prepare to be shocked.
The US is insolvent. There is simply no way for our national bills to be paid under current levels of taxation and promised benefits. Our federal [debts] alone now total more than 400% of GDP. [W]e find that the official debt stands at $8.507 trillion or 65% of (nominal) GDP but when we add in our “off balance sheet” items [for social insurance] the national debt stands at $53 trillion or 403% of GDP. See table 4, page 10, of the 2006 annual report.

That is the conclusion of a recent Treasury/OMB report entitled Financial Report of the United States Government that was quietly slipped out on a Friday (12/15/06), deep in the holiday season, with little fanfare. Source 2007 Report
1. There is no way to ‘grow out of this problem. What really jumps out is that the US financial position has deteriorated by over $22 trillion in only 4 years and $4.5 trillion in the last 12 months (see table above, from page 10 of the report). The problem did not ‘get better’ as a result of the excellent economic growth over the past 3 years but rather got worse and is apparently accelerating to the downside.

2. The future will be defined by lowered standards of living. As Lawrence Kotlikoff pointed out in his paper titled “Is the US Bankrupt?” posted to the St. Louis Federal Reserve website, the insolvency of the US will minimally require some combination of lowered entitlement payouts and higher taxes. Both of those represent less money in the taxpayer’s pockets and, last time I checked, less money meant a lower standard of living.

The Gokhale and Smetters measure of the fiscal gap is a stunning $65.9 trillion! This figure is more than five times U.S. GDP and almost twice the size of national wealth. One way to wrap one’s head around $65.9 trillion is to ask what fiscal adjustments are needed to eliminate this red hole. The answers are terrifying. One solution is an immediate and permanent doubling of personal and corporate income taxes. Another is an immediate and permanent two-thirds cut in Social Security and Medicare benefits. A third alternative, were it feasible, would be to immediately and permanently cut all federal discretionary spending by 143 percent.

3. Every government facing this position has opted to “print its way out of trouble”. Of course, it is impossible to print our way out of this particular pickle because printing money is inflationary and therefore a ‘hidden tax’ on everyone. Consider, what’s the difference between having half of your money directly taken (taxed) by the government and having half of its value disappear due to inflation? Nothing. Except that the former is political suicide while the second is conveniently never discussed by the US financial mainstream press (for some reason) and therefore goes undetected by a majority of people as the thoroughly predictable outcome of deficit spending. All printing can realistically accomplish is the preservation of some DC jobs and the decimation of the middle and lower classes.

There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.
~ Ludwig Von Mises (1881-1973)