1-2 Punch: Bernanke and the Debt Ceiling

Not long after the State of the Union address, the Congress voted to substantially worsen that state, delivering a one-two punch directly at the value of the U.S. dollar. Not light jabs, but crippling body blows that will leave the prosperity of the American people reeling. The damage this combination of monetary and fiscal hits will do is being telegraphed in advance: first the monetary blow, as the Senate confirmed Federal Reserve Chairman Ben Bernanke for another four-year term; next the fiscal blow, as both the House and Senate approved another increase in the statutory national debt ceiling. The new limit, a debt increase on steroids, adds $1.9 trillion to bring the ceiling to $14.3 trillion, an amount roughly equal to the U.S. gross domestic product.

When freshman Sen. Barack Obama said that a Bush debt-ceiling hike was a sign of "leadership failure," he was right. When Bush came into office the debt ceiling was less than $6 trillion dollars; it was $11.315 trillion when he went out the door. Bush presided over seven increases in eight years. In less than a full year of Obama’s presidency, the debt ceiling was lifted twice. This new increase is his third.

Just the increase in the national debt under the joint leadership of Bush and Obama in the last two years is almost three times the entire federal debt accumulated between the nation’s founding in 1776 and 1980.

Because long-term increases in sensitive barometers like the global price of oil and gold are a reflection of the world’s assessment of the prospects for the dollar, a referendum on the U.S. debt and America’s fiscal irresponsibility, it should come as no surprise that under Bush and Obama, increases in the national debt ceiling have been a harbinger of higher gold and oil prices.

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Gold tells the story in detail. In November 2004, a Republican Congress under a Republican president raised the government’s debt ceiling to $8.18 trillion. Gold was $434 that day. Sixteen months later, March 2006, the Congress voted to raise the debt ceiling again, this time to $9 trillion. Gold had moved up as well, to $556.

After the Republican majority had made a fiscal mess of things for a few years, and sent gold to $625, Americans thought it was time to try the Democrats again and gave them a majority in both houses in the next mid-term elections, November 2006.

But it was business as usual. A year later the Senate voted another $850 billion increase in the U.S. debt ceiling, increasing it to almost $10 trillion. Gold had begun the month at $672; that day it traded at about $740.

It has kept climbing ever since except for a short period during the mortgage meltdown, when hedge funds and other institutions sold everything in sight to raise cash for a flood of redemptions. But even that was a short-lived reversal as gold prices soon resumed their march over $1,000 to the drumming of national debt increases. Meanwhile, oil, about $35 a barrel when Bush was inaugurated, has more than doubled.

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The rest of the world sees America’s exploding debt and wonders why anyone would want to continue trusting the U.S. dollar or continue holding U.S. dollars as reserves. And in fact, they are losing trust in the dollar. As crude oil has flirted with $80 a barrel — even during a period of "weak" global energy demand — it should be noted that the Gulf Co-operation Council monetary union agreement was recently ratified by Saudi Arabia, Kuwait, Bahrain and Qatar. It is a major step toward the establishment of a Gulf central bank and joint currency that could be pegged against something other than the dollar. Similar steps reflecting dollar skepticism are being taken elsewhere around the world. In November the central bank of India chose to substantially dis-hoard its dollar reserves, buying 200 metric tons of gold instead. Russia recently began to reduce its dollar exposure, diversifying its reserves into Canadian currency and securities.

There may be no better gauge of Washington’s fiscal irresponsibility than the statutory national debt ceiling. It is something everybody can understand: Congress passes a bill, which is signed by the president, allowing them to spend even more money and to take the country deeper in debt. It is as though a family could raise its Visa or MasterCard credit limit around the dinner table. Of course, if a family were allowed to simply print money to pay its bills, it probably could raise its own credit-card debt limit!

That’s where the Federal Reserve’s monetary blow to the dollar comes in — with a new four-year term for the enabler-in-chief of Washington’s spendthrifts — because the Fed can and does print money, and it has done so exceedingly aggressively under Bernanke’s direction. It is foolish to think that the explosion of the monetary base, which grew by 150 percent during Bernanke’s first term, can have done so without consequence. The global price of gold is signaling that consequence, having practically doubled during Bernanke’s first term.

As U.S. debt heads toward $14 trillion, the Fed will do its part, buying government bonds increasingly as others back away, with money it creates out of thin air. It amounts to a direct hit on the purchasing power of every dollar you own.

Don’t be surprised when, as gold and oil prices have done, consumer prices begin to take off. When a series of knockout blows are clearly telegraphed, smart people see them coming and do something about it.