The dual perils of current fiscal and monetary policy
Art Laffer has a piece in the WSJ about the economic double whammy just over the horizon. It happens when the terrible fiscal policies of the Obama administration (and the debt needed to fund them) collide with the need for the Fed itself to issue bonds to contract the monetary base back to normalcy. The result will likely be the depressing picture we painted the other day:
Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That’s more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers’ expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.
With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs — such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid — are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises…as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences…
starting in early September 2008, the Bernanke Fed…radically increased the monetary base — which is comprised of currency in circulation, member bank reserves held at the Fed, and vault cash — by a little less than $1 trillion. The Fed controls the monetary base 100% and does so by purchasing and selling assets in the open market. By such a radical move, the Fed signaled a 180-degree shift in its focus from an anti-inflation position to an anti-deflation position. The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10…
It’s difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed’s actions because, frankly, we haven’t ever seen anything like this in the U.S. To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits. Gold prices went from $35 per ounce to $850 per ounce, and the dollar collapsed on the foreign exchanges…
the Fed…should contract the monetary base back to where it otherwise would have been, plus a slight increase geared toward economic expansion…I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury’s planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds.
When we asked the other day who was going to buy the net new $10 trillion in Treasury securities to fund the Obama deficits, we didn’t realize that the matter was even more serious than we suggested, given the Fed’s need to issue $1 trillion in new debt itself. The strangest aspect of this situation is that our out-of-control Congress and President may ultimately be reined in by, of all things, the refusal of communist China to buy US debt.
Humorous footnotes on the Obama economic policies: (a) Guess how the NYT apportions blame for the future deficits — you got it, blame George Bush: “Mr. Obama’s main contribution to the deficit is his extension of several Bush policies”; and (b) the NYT’s claim in the same piece that cap and trade “doesn’t cost the government any money” is a howler — the English press seem to understand these things better than their American counterparts: “a vast and unfathomably complex new system, which fosters corruption, raises little revenue and tries to suppress the incentives that are its entire purpose.”
It is a very sad day in America when the Europeans and the Chinese can see clearly what is going on in this nation, but the American press is blinkered because of its increasingly strange worship of a President seemingly untethered from the realities of everyday life.