by Gary North
by Gary North
Recently by Gary North: 'No Right to Know': A Wall Street Financial Site's Attack on Congress and Ron Paul
"Everybody wants to go to heaven, but nobody wants to die."
~ Loretta Lynn
Loretta was singing about kicking the bucket. Kicking the can is what people do before they kick the bucket. It is also what Congress does before Treasury bills kick the bucket.
It has become clear to millions of voters around the world that their national governments have not offered statistically viable solutions to the looming budget deficits. These deficits threaten to consume more than the future revenues available to the various national governments to fulfill their long-term promises and welfare programs for oldsters.
Central bankers can call this to a halt at any time by ceasing to purchase assets. This would stabilize the monetary base, at least until banks started failing, thereby contracting M1. This would produce a depression. Politicians say they want solutions to the budget deficit problem, but the political price is the replacement of incumbents by newly elected politicians who campaigned on a call for an end to the depression.
Everybody wants to go to heaven: stable money, rising employment, and economic growth. But nobody wants to walk through the valley of the shadow of death: Great Depression 2.
So, Congress refuses to face squarely the projected costs of these promises. Economists tell us that there is still time to fund these programs, if we begin now. They have told us this every year since the early 1970s. All that needs to be done is for Congress to fund these future expenditures. But Congress does nothing. On the contrary, it increases the amount of unfunded liabilities. These are now in the range of $80 trillion.
Rather than dealing with what are statistically inescapable deficits in an already massive Federal budget, politicians are seeking ways to increase the rate of government spending.
What of the funding of on-budget debt? This is now in the range of $12 trillion. Congress does not examine the sources of the funding. Members assume that the Treasury will be able to find buyers at 0% interest. Who, exactly? Asian central banks. Oil-exporting nations, which are all running massive government deficits. Foreign private investors. The Federal Reserve System.
This thought is not publicly tolerated: the bankruptcy of the U.S. government. This could be through hyperinflation above 50% per annum: a collapse of the dollar. It could also be done by selective defaults. But it will be done.
The Treasury will either renege on its debt or else the government will pass laws cutting expected benefits. Perhaps a combination of these will be the most politically acceptable approach.
There is no way that the Treasury's debt will be repaid. Everyone knows this, including Chinese central bankers and politicians. When Saturday Night Live opens with a skit on Obama's visit to China, where Obama keeps telling President Jintao that China will get its money back, and President Jintao asks him how, exactly, and Obama cannot say, we know that the world knows that America's debt is not going to be repaid. The live SNL audience gets it. The audience at home gets it. Everyone gets it. China is not going to get its money back. While the skit utilizes some crude humor, the message is clear. The economic data in the skit are factually accurate. When the details of America's foreign trade disaster can be turned into an SNL skit, the word is out.
Nothing changes. Nothing will change until China and other Asian nations cease playing kick the can.
MERCANTILISM FOR DUMMIES
Asian politicians have been committed ever since 1945 to a form of mercantilism. They have exported goods to the West, especially the United States. They have built up foreign currency reserves: debts issued by the national governments of the importing nations.
China holds over $2 trillion in total reserves — not all dollars. India holds almost $300 billion. These two nations were third-world basket cases as recently as 1990.
Instead of building up gold reserves, as mercantilist nations sought to do in Adam Smith's day, they have accumulated IOUs issued mainly by Western national governments. Asian central banks have inflated their domestic monetary bases in order to purchase foreign currency-denominated debt.
On the day that they cease buying American debt, other buyers must be found — buyers who think that 0% per annum is a good rate of return for an asset — the dollar — that is declining in purchasing power.
Asian nations continue to give away their nation's goods in exchange for promises of repayment in foreign currencies that will decline in value. Are they really this stupid? No. They are merely ill-informed economically. They do not believe Smith's Wealth of Nations. They remain mercantilistic in their thinking. They think that promises to pay no interest, long-term, is worth buying.
Why? Because they began subsidizing their export sectors as the pathway to wealth. They began inflating in order to keep down the price of their currencies in international markets. This made it cheaper for Western importers to buy their currencies, and in turn buy exported goods.
Once their domestic investors had invested capital in factories to produce goods for Western consumers, any reduction of the subsidies would threaten unemployment. They have been riding the digital tiger.
This domestic monetary inflation has created capital market bubbles in their nations. The governments fear a collapse of their stock markets and real estate markets. They fear widespread unemployment even more. So, they have instructed their central banks to inflate. China has increased M2 by 30% a year over the last year. Before, the central bank had inflated at 16% or so.
China is no longer buying Treasury debt. It ceased in May 2009, when holdings peaked at $801.5 billion. This is now down to $799 billion.
Then who is buying this debt? The Federal Reserve. It reversed course in June. Since then, it has accelerated the rate of expansion. Since August, the adjusted monetary base has risen at about 100% per annum.
The U.S. Treasury has to roll over its debt every 50 months. This is down from 70 months in 2000. At $12 trillion, this is $3 trillion a year.
To this must be added an additional $1 trillion a year. This will repeat every fiscal year.
There should be no confusion about where this is heading. The government's share of the economy will increase if the commercial banks refuse to lend, based on the increase in the monetary base. When they do lend, this will be translated into an increase in M1. The money supply will rise unless the FED increases banks' legal reserve requirements.
At that point, the FED must decide which tiger to ride: the inflationary tiger or the depressionary tiger. It can cease buying Treasury debt or keep buying and watch the dollar sink by 20%, 30%, or more per year.
Deflationists predict the former. I predict the latter. In either case, Asia's mercantilism will at long last hit the wall. Their export industries will hit either the wall of a Great Depression 2 — few orders — or else mass inflation: orders in money not worth holding.
Asian mercantilism is going to fail sometime in the next five years. From the looks of China's recent refusal to add to its holdings of dollars, the central bank may have begun this transition. The government's adoption of a massive Keynesian stimulus package indicates that its economists have realized that mercantilism is for dummies.
So is Keynesianism.
China is playing kick the can. It is inflating faster than ever. It is riding the same inflationary tiger that the West is. It cannot get off without moving to the depressionary tiger. It wants to delay the decision until rising prices for commodities choke off the economy.
Long-term thinking is not characteristic of politicians. Their time perspective is limited by the date of the next election.
The owner of a piece of property benefits from any price appreciation of the market value of that asset. In contrast, a politician cannot legally capture the value of the price appreciation of assets owned by the government. He is tempted — sorely tempted — to gain for his personal use the value of government assets. He accomplishes this by performing the equivalent of alchemy: the transmutation of government capital into votes.
When I worked for Congressman Ron Paul in his first term in 1976, I learned of a policy of agencies in the Executive branch of the Federal government. When a Congressman voted in favor of some boondoggle that would spend money in his district, the agency would send a press release to the local newspaper, telling of the money that would be spent. Included in this press release was a reference to the support given to the project by the Congressman.
The message was clear: vote for a boondoggle, and there will be money spent in your district. "Get credit for bringing home the bacon" — in Washington, the most popular form of pork.
There is a popular myth that the government must preserve assets for future generations, because private enterprise wastes resources in the present. This makes no economic sense. Private ownership furthers the conservation of assets that owners believe will appreciate. They want to capture the value of this increase in value. Politicians are more likely to consume government-owned resources in such a way that incumbents are re-elected. Civil Service—protected bureaucrats are anxious to gain more control over assets. The agencies may lease the assets to private industry, thereby capturing the value of the output for the agency or department.
The public is no different. It also wants to defer the day of judgment. It wants stable prices, which it now has. It wants low unemployment. It is getting the opposite. It wants low interest rates, which it now has. It wants economic growth. The government's Bureau of Economic Analysis dutifully now reports this. Meanwhile, tax receipts in the states continue to fall, indicating economic contraction.
Americans refuse to look at their retirement portfolios and ask this question: "Will I be able to live comfortably on this capital?" With interest rates at banks under 1%, the answer is obvious: no. Yet they do not change. They do not triple or quadruple their rate of savings. They do not plan to stay in the work force until 75 or 80. They do not buy foreign currencies or gold. They do not plan to start a business to retire into.
The voters want the government to guarantee them a safe retirement, Medicare benefits, and a stable dollar. But the government is already so far down the road to default that it can only play kick the can.
We are on the back of a tiger. To get off the inflationary tiger, the depressionary tiger will maul us. We want to defer the decision.
PERCEPTION IS NOT ACTION
To perceive what is about to happen is not the same thing as taking evasive action. People want to believe that the numbers will not get worse for them. They may believe that things will get worse for strangers, but they do not believe that this could happen to them.
Most people know nothing of all this. The audience that laughed at the Saturday Night Live skit did not wake up on Sunday morning and say, "What the Treasury is going to do to China is what it is going to do to the rest of us." They assume the following: "The Chinese are fools to let us do this to them, but the government would never do this to us."
The government has implicitly promised not to default on its sovereign debt. The trouble with sovereign debt is that it is issued by sovereign governments. Sovereign governments are sovereign. That is to say, they are above the law. They enforce the laws they choose to enforce. Short of going to war, foreign governments cannot compel compliance.
The voters think they can enforce compliance. But they cannot get blood out of a turnip. They also cannot get money out of a bankrupt government. Some can. Everyone can't.
Everyone thinks, "I am in the group of citizens who will get paid." Everyone cannot be correct about this.
The numbers tell us that there will be a default. But, psychologically, even the tiny handful of people who understand the implications of the numbers do not all take evasive action.
The cost of action is higher in the short run than the cost of inaction. It isn't in the long run, but the long run does not command respect in a present-oriented culture. This is why kick the can is such a popular pastime. People assume that the bad numbers will improve merely from the passage of time.
They believe that sovereign governments are sovereign over economic cause and effect. They don't believe in rigorous cause and effect. They believe in it only insofar as it benefits them personally. They believe in selective causation.
The acceptance of the idea that the objectively bad numbers will not compound over time is an indication of a person's rejection of economic causation. It is an acceptance of the efficacy of perception without action.
Count the personal costs of inaction. If the bad numbers are compounding faster than the good numbers, draw the correct conclusion: inaction will turn out to be very expensive.
Then take appropriate evasive action.
November 25, 2009
Copyright © 2009 Gary North