A Debt Beyond Redemption

The word “redeem” means “buy back.” It is used in Christian theology to describe what Jesus did for mankind in general (common grace) and individuals (special grace). It was used during the era of the gold standard to describe the right of a holder of paper money to redeem this money for gold coins at a fixed price.

The debt of the United States government is now beyond redemption.

The only way for this debt to be redeemed officially is through mass inflation. If this is the way of redemption, then the economy is beyond redemption.

There will be a great default. The question is when, not if.


Arthur Laffer is famous for his famous curve, which shows that tax revenues rise when tax rates are cut . . . if the tax rates are too high.

He and I disagree on tax policy. He prefers taxes to be cut until government revenues are maximized. I advocate even further reductions until taxes are barely a factor in the economy — “not worth talking about,” as they say. He made his reputation with the top half of the Laffer curve. Nobody ever talks about the bottom half, where tax revenues fall. That would be politically incorrect. As for me, I like sliding down the bottom half. When it comes to tax cuts, I am a “slippery slope” guy. I just can’t get enough of them.

He and I first met at a conference sponsored by Pepperdine University in 1975. It was on taxes and economic growth. It was in the middle of the terrible ‘seventies. Inflation was rising, people were being pushed into higher income tax brackets, there were large Federal deficits, and there was a major recession in progress.

Here we go again!

He is an effective communicator. I know this because of a shared experience we each had (and probably no one else) over two decades ago. As far as I know, we are the only two economists ever invited to speak to the assembled junior and senior classes at Redondo Union High School in Redondo Beach, California. We did this separately. Keeping 1,000 highschoolers awake for 45 minutes is no easy task. Neither is avoiding the low rumble of bored teenagers. It was the toughest speech I ever had to deliver.

Recently, Dr. Laffer published an article in the Wall Street Journal. It had a shocking title: “The Age of Prosperity Is Over.” It is a summary of his latest book, The End of Prosperity.

Dr. Laffer is a good marketer. He knows that to put “The End of” in a book title will sell more copies than “The Slowdown of” or “Really Bad News for.”

We both appreciate the power of an attention-grabbing headline. But it’s not good to be grabbed by it two or three years later, when conditions have changed and the headline looks silly.

Is his headline an exaggeration? Yes. This is not the end of prosperity. It is surely the beginning of the end of many of the false dreams associated with Greenspan’s era of continual monetary expansion. It is also Keynesianism’s last stand.


He begins with a premise — one that is not shared by Wall Street, Congress, or Presidents.

Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production. Asset values fall sharply and wipe out those who borrowed and lent too much, thereby redistributing wealth from the foolish to the prudent.

Every system of economics has a system of wealth redistribution. The questions are: “Who wins? Who loses? Why?”

We now know who wins. Most obviously, financial industry CEO’s who milked the system during the boom. They had their firms borrow short, lend long, and make a fortune in commissions. Then they took their bonuses for five years and then were fired with multi-million-dollar severance packages.

Others who are winning big are bankers whose banks got loans and capital injections from the government and the Federal Reserve System. They are buying up smaller, underfunded banks that have gone bust. The FDIC absorbs the losses, and the large banks gobble up the assets at pennies on the dollar. Think “J. P. Morgan/Washington Mutual.” Think “Wells Fargo/Wachovia.”

Who loses? Officially, taxpayers. But for how long? Not indefinitely. Not alone.

In the textbook world, where governments are restrained, the following is true.

Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses.

It is not true for the biggest of the New York City banks. It has not been ever since 1914, when the Federal Reserve started operations. Since that time, the dollar has depreciated by 95%. There is a pattern here.

In today’s bailout economy, the textbook account of profit and loss do not apply, he says.

Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and injects capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn’t create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved.

He is sensitive to high marginal tax rates and regulation. He is also sensitive to deficits as sources of future tax increases. He is much less sensitive to Federal Reserve monetary inflation. But that is a different issue, for a different article.

He sees what is coming: a Federal government power-grab on an unprecedented scale in the post—World War II era. Its visible symbol is the increase in the Federal deficit. Just 14 months ago, the official projection for 2008 was 0.6% of GDP. (Anyone who believed that forecast was dangerously naïve.) It has turned out to be 3.2%. It is headed in fiscal 2009 toward 3.8%

The net national debt in 2001 was at a 20-year low of about 35% of GDP, and today it stands at 50% of GDP. But this 50% number makes no allowance for anything resulting from the over $5.2 trillion guarantee of Fannie Mae and Freddie Mac assets, or the $700 billion Troubled Assets Relief Program (TARP). Nor does the 50% number include any of the asset swaps done by the Federal Reserve when they bailed out Bear Stearns, AIG and others.

Now there is talk of another $300 billion stimulus package early next year. There is no more restraint on spending.


He sees the stock market as a forecasting tool. The increase in government spending will have negative effects in the real economy, contrary to Keynesians. It will retard economic growth.

He recounts the experience of the 1970’s. First Nixon, then Ford, then Carter ran large deficits. It was a bad era for stocks.

The consequences of these actions were disastrous. Just look at the stock market from the post-Kennedy high in early 1966 to the pre-Reagan low in August of 1982. The average annual real return for U.S. assets compounded annually was —6% per year for 16 years. That, ladies and gentlemen, is a bear market. And it is something that you may well experience again. Yikes!

He adds that this Bush Administration was bad — a true disaster.

Twenty-five years down the line, what this administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity.

Laffer reminds us that “bad economics will sink any economy no matter how much they believe this time things are different. They aren’t.”

Bad economics have escalated since September 7, when Secretary of the Treasury Paulson nationalized Fannie Mae and Freddie Mac on a Sunday. The precedent has been set. It will escalate for the next four years.


The game of politics has always been two-fold: (1) to redirect tax revenues and power to your group; (2) to pass costs to other groups. This will never change.

We have seen how losses have been passed on to taxpayers. Anyway that is where politicians assume. But I am not so sure.

Losses will also be passed along to holders of U.S. government debt. How? Through rising interest rates, which push down the market price of government bonds. Through increasing prices, which are the result of monetary expansion. Through cutting off Medicare and Social Security benefits by raising the retirement age and cutting payouts.

Once the on-budget, official debt increases, the pool of IOUs does not distinguish one debt from another. Supposedly, the Treasury could make a profit on the bailout. Taxpayers will not see a dime in refunds. The Treasury will spend every dime of profit, and then borrow a dime more against future earnings.

The grand game of politics in the next Administration will be to redirect the flow of funds to new constituencies. But there are limited funds at stake. Most of the money is already spoken for. Existing programs will absorb all of the revenue and then some. New programs will have to be funded by increased debt. The grand game of the Administration elected in 2012 will be to avoid the bills that will be coming due. That will be the grand game of every Administration thereafter.


I do not think we are facing the end of prosperity. We are facing a recession. The dreams of millions of Americans will be smashed in this recession. A big smashed dream is retirement in comfort. That one is statistically doomed. But it always has been. It was a fantasy dream. It has been exposed as a dream for those few Americans who have vested pensions. The majority have always relied on the promise of Social Security, which was a statistical fraud from day one.

Over the past 200 years, the American economy has grown at 2% per year on average, despite wars, recessions, boondoggles, and politicians. I think this will not change. But there will be a hiatus for a few years. Millions of people whose dreams rested on faith in 7% economic growth per annum will come to naught. Reality will intrude.

Be ready for this intrusion.

November 5, 2008

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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