By STANLEY ESCUDERODAYTONA BEACH SHORES, Fla. -- In my last Guidepost, I very strongly urged the GOP to demand draconian spending cuts as the best means of saving our nation from bankruptcy and the world from a financial crash which could dwarf that of 2008, or even 1929.
For any who think this overdrawn, let me outline why I am so concerned. Ever since 1944, when the dollar became the global reserve currency, successive congresses and administrations of both parties have spent more, sometimes much more, than they took in taxes.
Since 1971, when Nixon de-linked the dollar from gold, the dollar has been backed only by “the full faith and credit of the United States”, whatever that may mean in fiscal terms.
Even so, nations have been consistently willing to lend us money by purchasing our Treasury bills (T-bills) at a much lower rate of interest than for any other country’s debt instruments because the fact that the dollar is the reserve currency keeps the demand for dollars, both to bolster the reserves of nations and to facilitate international transactions, very high.
But in recent decades both our annual deficit and our overall national debt have skyrocketed. The crash of 2008 focused us on the scale of the problem.
Obama blamed the crash on the GOP and was elected in large part to fix that problem but he has made it many times worse. Our national debt is now in the neighborhood of fourteen trillion dollars ($14,000,000,000,000.00) and under Obama’s policies our annual deficit will exceed a trillion dollars as far as the eye can see, meaning that our national debt will continue to grow exponentially.
Our creditors have concluded that we can never repay that enormous debt except through cheaper, inflated dollars. And they’re right.
The Federal Reserve, which contributed to our current mess by maintaining unrealistically low interest rates to protect various administrations from the impact of recessions which followed the collapse of several bubbles, is still holding down rates. Ostensibly this is to encourage economic recovery but in fact it is to cover the gap between what the government raises through taxes and what it has to borrow to spend at its current bankrupting level.
Other countries see the risk to their own economies of buying our Treasury bills at the Fed’s artificially low rates but the Fed does not dare permit rates to increase to market levels lest it promote immediate domestic inflation.
To keep rates artificially low, the Fed monetizes our debt by buying our own Treasury bills at the current low rate and, since the Fed has no money of its own, it creates the money for the T-bills via computer.
The Fed also creates money from thin air to lend at virtually no interest to big banks, much of which the banks use to buy T-bills – giving the banks a guaranteed return while laundering this additional debt monetization.
Monetization is massively inflationary but its effects can be delayed for a time. Obama’s 800 billion pork stimulus was also hugely inflationary. Some 42% of the cost of our current national budget, the one they’re still fighting over in Washington, is borrowed and that too is inflationary.
Of course, the Fed knows this and claims that it will cease monetization on June 30, 2011. But we must sell T-bills to get the money to fund the 42% (about $1.3 trillion this year) of our budget that is borrowed, including the interest on the national debt. And very few T-bills will be sold to anyone except the Fed at the low rates the Fed is offering.
After June 30, the Fed may well sell some bonds at higher interest rates in order to blame foreign countries for the resulting higher interest rates in the US. But once the dam breaks foreign T-bill buyers will demand ever higher rates until a new higher ceiling is established. Domestic US interest rates will rise right along with that of the T-bills because our intra-bank rate is tied to that of the ten-year bond.
Higher interest rates will force up US prices but at the same time the higher rates will increase the cost and diminish the availability of credit at a time when credit is already very hard to come by. Ultimately prices will go up but economic activity will go down. The result will be a return to the stagflation of the Carter years but possibly on a larger scale.
Higher interest rates will force up US prices but at the same time the higher rates will increase the cost and diminish the availability of credit at a time when credit is already very hard to come by. Ultimately prices will go up but economic activity will go down. The result will be a return to the stagflation of the Carter years but possibly on a larger scale.
So before long, I believe that the Fed will again buy our T-bills even though this just kicks the inflationary can down the road because the Fed cannot assure our buyers that the government will not simply continue to print and spend money.
In fact, continued monetization will make the eventual problem, and the effect it will have on our economy, that much more devastating. Massive inflation could eventually crush our dollar and our economy, impoverishing those on fixed incomes and driving prices out of sight.
The process is already underway in rising prices of energy and food, indeed of pretty much everything except existing housing. Other nations see this happening. They realize that our total national debt is today almost 400% of gross domestic product and they know that this cannot be sustained.
They fear that the dollar will collapse and that their economies will be pulled down by the collapse of the value of the dollar. They pray we will find a way out of our dilemma – because the global economy needs a reserve currency to function - but at the same time they have begun measures to reduce the impact on themselves by dropping the dollar as the global reserve currency if absurd US government spending policies make it necessary.
Among them:
* Last year China, India and Bangladesh, amongst other nations, bought gold instead of dollars to increase their monetary reserves. This reduces demand for dollars and indicates growing international expectation that the dollar will cease to be the reserve currency.
* The Chairman of the International Monetary Fund has called openly for dropping the dollar as the global reserve currency and for substituting a basket of currencies and commodities as a basis for special drawing rights to be issued by the Fund. (In my view there is a multitude of reasons why having an outfit like the IMF rule the world’s economy via control of all currency is a horrible idea but that is a subject for a future Guidepost.)
* China has begun to permit export and import trade in Chinese Yuan, without the need for an intermediate dollar exchange. This reduces demand for the dollar, strikes a blow at its international status and begins to establish a basis for the yuan as an alternate reserve currency.
A significant aspect of having an inflated reserve currency is that foreigners who buy our currency to sustain their own reserve or to facilitate international economic activity have bought so much of it that it is really they, if they act together, who control our currency market.
Today the world’s global foreign exchange volume is something in excess of $5 trillion.
There is no way that the Fed can hope to control the price of our currency in so large a market. An overnight shift away from the dollar is unlikely because an abrupt huge drop in the value of the dollar could wreck the global economy as well as our own.
But even a smoother managed change would deprive America of many of the financial and political advantages we have enjoyed for 66 years and make it much harder for our economy ever to recover from its current trough.
An America in which the dollar is no longer the reserve currency would be much smaller, weaker, less influential, less feared and respected than the great power we have all grown up with. Worse, it would be poorer, much poorer and it would stay that way for generations.
If the United States is to remain the “Shining City on a Hill” it must get its fiscal act together and reject the ruinous policies of this administration before present infaust trends become irreversible. Whichever way it goes, the Fed’s decision on June 30 could be a tipping point. Our best hope is for the Congress to demonstrate an uncharacteristic degree of fiscal responsibility.
If the United States is to remain the “Shining City on a Hill” it must get its fiscal act together and reject the ruinous policies of this administration before present infaust trends become irreversible. Whichever way it goes, the Fed’s decision on June 30 could be a tipping point. Our best hope is for the Congress to demonstrate an uncharacteristic degree of fiscal responsibility.
Not only must further spending be reined in but our tax structure must be changed to encourage the private sector and, most importantly, enormous painful cuts in spending must be implemented and endured if we are to survive as the nation we have been.
Only the Republicans will do this and then only if we continue to hold their feet to the fire.