Ben Bernanke gave a grim speech on October 4. It did not get media attention. That was because it was so grim.
It was on the looming fiscal crisis of the Federal government. There will be no easy way to avoid it, he said. Congress has to decide what spending to cut. This means that Congress must decide which special-interest groups to alienate. Then it must decide which taxes to raise. Whose ox will get gored?
Congress has been deferring this two-part decision since the Nixon Administration.
The essence of politics is buying votes with the taxpayers' money, but without losing more votes than you buy. That is to say, there must be deception. Each beneficiary must conclude: "I am going to get more out of this than I am likely to pay into the system." They all cannot be correct about this. So, the tax burden is concealed.
There are two other factors of concealment: increasing deficits and increasing monetary expansion.
Here is where Bernanke is firing a warning shot across Congress's bow. His speech is a warning to Congress that the Federal Reserve will not take the hit. It will not destroy the dollar in order for Congress to play its game of deception.
This was Bernanke's Declaration of independence. The media did not pick up on this. I don't think Congress did, either.
CLOSING ONE EXIT
I am going to take you through the speech. As you read what he said, keep asking yourself this question: "What is he trying to tell Congress?"
He made it clear that Congress cannot maintain its present course. The markets will not allow this. He said that there will be a day of reckoning: rising interest rates. At some point, lenders will decide that the United States government is no longer a reliable borrower.
This warning goes to the heart of Congress's deception procedure. He said that interest rates will rise. But everyone can see that rates will rise on a vastly expanded level of debt. The deficits keep pushing up the total national debt. The interest rate burden is minimized today because interest rates are at lows not seen since the Great Depression. It does not cost much to roll over the debt.
This is true in the private capital markets, too. Borrowers can expand their level of personal debt because their monthly debt repayment schedule is reduced by lower rates. This lures the public into more debt. Bernanke mentioned this briefly. He can see what is coming. When rates rise, they will cut back on new debt and more purchases.
He told his audience that the escape hatch of ready lenders is going to be shut. The lenders will reduce their purchases of debt at low rates.
This is another way of saying that the AAA rating of the U.S. government will fall. The idea that you cannot lose by buying Treasury debt will go the way of the dodo bird. This was a major statement by the FED Chairman. It went right to the heart of Congress's deferral of the day of reckoning.
His point was that one of the two exits will be closed by the free market. The lenders will close it. They will do so out of self-interest.
This will leave only one other exit: the willingness of the Federal Reserve System to buy Treasury debt. He never directly refers to this.
As I take you through the speech, keep this in the back of your mind: "Why is he telling this to Congress?" I can think of a surface reason: he is telling Congress not to count on the FED to bail out Congress when the lenders start saying "no." He is saying that Congress must begin to impose the cuts in the future, because the FED is going to let interest rates rise. The deception will have to end at that point.
He was telling Congress to begin to decide whose oxen must be gored.
NO WAY OUT
He was trying to get Congress's attention. Yet this was indirect. He was not giving the speech at a Congressional hearing. He was giving it to a group in Rhode Island — off the beaten path.
There is no way around it — meeting these challenges will require policymakers and the public to make some very difficult decisions and to accept some sacrifices.Difficult decisions? Sacrifices? Congress? The name of the game in Congress is to avoid difficult decisions and sacrifices. Congress assumes that the FED will be there as the lender of last resort.
I sense that this speech was his attempt to send a signal: "Don't plan on the FED to bail you out."
Then he offered hope. But it was purely hypothetical hope.
But history makes clear that countries that continually spend beyond their means suffer slower growth in incomes and living standards and are prone to greater economic and financial instability. Conversely, good fiscal management is a cornerstone of sustainable growth and prosperity.I ask: Why should we expect good fiscal management from Congress? When? Congress has played "kick the can" for as long as I have monitored Congress: half a century. Bernanke knows this.
What nation in the West has adopted "good fiscal management"? They are all running deficits. They all rely on their central banks to bail them out from time to time.
He was telling Congress that the game of kick the can must end. But not yet! It is not mandatory that anything be done now. It can all be deferred. Indeed, it must be deferred.
For now, the budget deficit has stabilized and, so long as the economy and financial markets continue to recover, it should narrow relative to national income over the next few years. Economic conditions provide little scope for reducing deficits significantly further over the next year or two; indeed, premature fiscal tightening could put the recovery at risk.This authorizes Congress to kick the can until 2012. That is what Congress wants to hear. But he put a poison pill in the party cake.
Over the medium- and long-term, however, the story is quite different.Nobody in Congress ever pays any attention to anything further out than two years. He knows that. So, he concentrated his speech on 2012 and beyond. This means that Congress will not ask him to elaborate.
BUREAUCRATIC BUZZ WORDS
Bernanke used the standard bureaucratic buzz words. "Challenge." This means "politically unsolvable." "Sacrifice." This means "what Americans did during World War II." "Difficult." This means "deferrable."
He then listed the "challenges." They are challenges indeed.
If current policy settings are maintained, and under reasonable assumptions about economic growth, the federal budget will be on an unsustainable path in coming years, with the ratio of federal debt held by the public to national income rising at an increasing pace.Got that? Unsustainable. This means "cannot be sustained." It means "no exit." It means "dead end."
Moreover, as the national debt grows, so will the associated interest payments, which in turn will lead to further increases in projected deficits.It's a vortex. The deficits will become self-reinforcing. It will get more difficult to control them. Today, with very low rates, deficits are growing relentlessly. What happens when rates rise?
Expectations of large and increasing deficits in the future could inhibit current household and business spending — for example, by reducing confidence in the longer-term prospects for the economy or by increasing uncertainty about future tax burdens and government spending — and thus restrain the recovery.He was warning Congress that the effects of deferral will be to raise rates. If rates rise, the consumer will cut back on spending. This will produce a recession, or at least a slowdown. That will cut tax revenues. So, as rates rise, it will get harder to collect taxes. Again, this is a vortex. By deferring the spending cuts, Congress will make the disaster worse when rates rise. As he said, this will reduce Congress's ability to escape.
Concerns about the government's long-run fiscal position may also constrain the flexibility of fiscal policy to respond to current economic conditions.Translation: "Congress will have little wiggle room when the lenders say no."
Accordingly, steps taken today to improve the country's longer-term fiscal position would not only help secure longer-term economic and financial stability, they could also improve the near-term economic outlook.Notice the passive voice: steps taken. Question: "Exactly who must take exactly what steps?" Answer: silence. He was not going to identify the oxen that will have to be gored. That's Congress's problem, not his.
Our fiscal challenges are especially daunting because they are mostly the product of powerful underlying trends, not short-term or temporary factors.Translation: this is not going away. Why not? Because it's demographic. It's already in the pipeline.
Two of the most important driving forces are the aging of the U.S. population, the pace of which will intensify over the next couple of decades as the baby-boom generation retires, and rapidly rising health-care costs. As the health-care needs of the aging population increase, federal health-care programs are on track to be by far the biggest single source of fiscal imbalances over the longer term.Which Congressman will stand up and say, "We're going to cut off Granny's life-support"? None? Well, then, we have "daunting challenges." "Daunting challenges means "after I retire."
In Rhode Island, as in other states, the retirement of state employees, together with continuing increases in health-care costs, will cause public pension and retiree health-care obligations to become increasingly difficult to meet. Estimates of unfunded pension liabilities for the states as whole span a wide range, but some researchers put the figure as high as $2 trillion at the end of 2009.What are states doing to deal with this? Exactly what Congress is doing to deal with Medicare's deficits: not a thing.
As I have discussed, projections by the CBO and others show future budget deficits and debts rising indefinitely, and at increasing rates. To be sure, projections are to some degree only hypothetical exercises. Almost by definition, unsustainable trajectories of deficits and debts will never actually transpire, because creditors would never be willing to lend to a country in which the fiscal debt relative to the national income is rising without limit. Herbert Stein, a wise economist, once said, "If something cannot go on forever, it will stop." One way or the other, fiscal adjustments sufficient to stabilize the federal budget will certainly occur at some point.At what point? When the FED stops buying Treasury debt. Then there will be a default. Of course, he never used this politically incorrect word. But it is clear that he expects Congress to intuit this.
Will Congress intuit this? Of course not. It will kick the can.
He droned on and on, as he always does. He listed what everyone knows and always ignores. But he did his duty. He warned them. He gave no specifics. Specifics are what he never gives. But he ended on this.
Today I have highlighted our nation's fiscal challenges. In the past few years, the recession and the financial crisis, along with the policy actions taken to buffer their effects, have eroded our fiscal situation. An improving economy should reduce near-term deficits, but our public finances are nevertheless on an unsustainable path in the longer term, reflecting in large part our aging population and the continual rise in health-care costs. We should not underestimate these fiscal challenges; failing to respond to them would endanger our economic future.Will Congress fail to respond? Of course. Is our economic future endangered? Of course.
Well-designed fiscal rules cannot substitute for the political will to take difficult decisions, but U.S. and international experience suggests that they can be helpful to legislators in certain circumstances.In other words, they won't work if there is no political will to impose sacrifice on voters. Is there such will? Of course not. So, now that we know fiscal rules will not work, let us end with cheerleading for fiscal rules.
Indeed, installing a fiscal rule could provide an important signal to the public that the Congress is serious about achieving long-term fiscal sustainability, which itself would be good for confidence. A fiscal rule could also focus and institutionalize political support for fiscal responsibility. Given the importance of achieving long-term fiscal stability, further discussion of fiscal rules and frameworks seems well warranted.
End of speech. Applause. Lunch.
Am I saying that the speech was an exercise in futility? Of course. Does Bernanke know this? Of course. Will anything change until the day that Congress hits the brick wall of the refusal of lenders to lend? No.
Click through and read his speech. Did he offer a sliver of hope that Congress will bite the bullet?
There is going to be a great default. I think he knows it. His speech laid the groundwork for "Don't say I didn't warn you."
What was he really saying? This: "The Federal Reserve will not take the fall in order to bail out Congress." He was saying that both of the escape hatches will close: private lending and Federal Reserve lending.
This was why he spent so much time on the threat of rising interest rates. If the FED is there to bail out Congress, holding down rates through hyperinflation, then Congress will not have to get its fiscal house in order. But he was telling Congress that it must get its house in order. Conclusion: the FED will not hyperinflate.
I don't know if Congress will get the message. The rest of us had better get it.
Congress will kick the can. But the day will come when the FED will not help Congress kick it any longer. That will be the day of reckoning.
Bernanke was saying that Congress will have to nationalize the FED in order to gets its deception game rolling along. The FED will not destroy the big banks by destroying the dollar.
He was speaking for the biggest banks. They have just sent Congress a memo. Congress had better read the memo.
October 9, 2010
Copyright © 2010 Gary North