Are We Poised for Weimar?

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Recently by Michael Pollaro: Money Supply Firing on All Cylinders?

     

It is a long standing proposition of many, supported on both theoretical and historical grounds, that one of the surest roads to hyperinflation is one grounded in a government whose answer to every economic and social problem is to borrow and spend the problem away, supported by central bank able, willing and ready to finance the effort. That support is of course to simply print the money through which to buy the debt so issued by the government – what is euphemistically called monetizing the debt – thereby exploding the supply of money and eventually trashing its value.

We here at THE CONTRARIAN TAKE wholeheartedly agree with this proposition.

So, given the extraordinary borrowing needs of the U.S. government, currently being supported by a Federal Reserve whose QE II asset purchase program is large enough to finance 100% of the government’s funding requirements through at least June, we thought we would take a look at the prospects for a hyperinflationary event in America. And while we think hyperinflation – defined as the total destruction in the value of the U.S. dollar – is a low probability event, a lot, and we do mean a lot more monetary inflation most definitely is not. You see, when you have a government that seems reluctant to change its borrow and spend policies in any meaningful way – a subject we took on here – teamed up with a central bank chaired by a man who thinks that loose fiscal and monetary policies are the springboard for a downtrodden economy, you have a recipe for a whole heap of monetary inflation. Indeed, in the opinion of THE CONTRARIAN TAKE, never has a U.S. central bank been chaired by a man who is more certain that loose fiscal and monetary policies are exactly what an economy mired in excess productive capacity and high unemployment requires to make things right.

Before we discuss the prospects for hyperinflation, some preliminaries…

Preliminaries

First, U.S. government debt is being here defined as the debt of the U.S. Treasury plus the debt of the government-sponsored agencies Fannie Mae and Freddie Mac (popularly called agencies). Inclusion of the latter may appear to be a bit of a stretch, but as we discussed here, to us, its inclusion in the U.S. government’s debt footings is obvious. Creations of the U.S. government, these government-sponsored enterprises and their debt obligations have always been implicitly backed in varying forms by the full faith and credit of the U.S. Treasury, a backing made explicitly clear to any and all doubters when on December 24th 2009, in the depths of the credit crisis, the U.S. government gave the government-sponsored enterprises unlimited access to the Treasury essentially until further notice. We wonder why anyone would have thought anything different, that when push came to shove the U.S. government would protect its own, make this implicit guarantee an explicit one and the debt of Fannie Mae and Freddie Mac the defacto debt of the U.S. government.

Second, it is common practice to measure a government’s burden on the economy by comparing the government’s debt to the nation’s productive output or GDP. And while we agree that over the long haul it is a nation’s productive prowess that provides the means necessary to pay the government’s debt obligations, we think it is more instructive to compare those debt obligations to the nation’s savings. You see, it’s a nation’s savings, its willingness to defer consumption that makes the government’s borrow and spend programs possible. All other things equal, an economy that consumes much and saves little is an economy that cannot long afford a borrow and spend government. The crucial question then in any proper examination of a government’s burden on the economy is this… is the nation’s pool of savings large enough to fund the government’s borrowing requirements, for how long and at what rate of interest?

Third, the Federal Reserve is not the only stateside institution that has the power to monetize the U.S. government’s debt. Because of our government protected, fractional reserve banking system, they have a partner – the private banking system – which can and does buy U.S. treasury and agency securities, paying for those securities simply by crediting the bank accounts of the sellers. That’s right, by printing money just like the Federal Reserve.

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Michael Pollaro [send him mail] is a retired Investment Banking professional, most recently Chief Operating Officer for the Bank’s Cash Equity Trading Division. He is a passionate free market economist in the Austrian School tradition, a great admirer of the US founding fathers Thomas Jefferson and James Madison and a private investor. He is a columnist on the Forbes blog.

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