Provisional
Truth |
Essays | November 6, 2006
Faith-Based Money
Richard
Russell, author and publisher of the
Dow Theory Letter since 1958,
coined the phrase "faith-based money" in an October 7, 2005 newsletter.
I think it an entirely appropriate description of America's current
fiscal and monetary system as we continue to deficit-spend our children
and grandchildren into oblivion or - worse - second-tier global status
as a wholly owned subsidiary of one or more creditor nations, such as
China, to which we quickly are becoming so vastly indebted.
Faith-based money represents our fervent hope our
government, specifically the Federal Reserve, the Treasury
and Congress, will do whatever necessary to keep history's
greatest confidence game - our economic system - alive and
well.
"The US
government is now on a spending binge that boggles the
mind," Russell wrote, "but I'm not going to recite the
statistics on all the debt and deficits and liabilities
again. Let me just put it this way -- the facts are
horrendous. The question is, 'How are we going to pay for
them?' There are only two possibilities -- The government
will default on them or the government will simply inflate
them away. And the winner (but you already knew this) is
- inflation."
Current Fed chairman Dr. Benjamin Bernanke is believed to be
unwilling to burst economic bubbles by tightening the money
supply, having seen the disastrous effects of such policies
most recently in Japan in the 1980s. More likely, his
Fed stands ready to supply massive liquidity - money supply
increases - at such time a bubble, like the residential real
estate bubble - bursts, as predecessor Alan Greenspan did
when the stock market topped and cratered in early 2000.
But even Bernanke warned
Congress in July, “Deficits matter because they
represent additions to debt that our children and
grandchildren will either have to pay through higher taxes
or reduced services.” Bernanke's key word is “pay,” not
borrow more, and the result of higher taxes and reduced
government spending generally would be a shrinking
economy, which, ultimately translates to a lower standard of
living.
Observers such as Richard
Russell, however, believe the U.S. will not default on its
debt, nor tolerate reduced government spending or a
shrinking economy, and therefor stands ready to inflate its
way out of this situation by continuing to increase the
money supply. Inflation results, as we know, from a
greater supply of money chasing a finite supply of goods.
But inflation is a harsh master
and provides only the illusion of economic progress.
The concept is simple: $1 million in 30-year Treasury Bonds
issued in 2006 will have the purchasing power of $412,000
in today's dollars when they mature given a compound inflation rate of
only 3
percent. Alternatively, at 3 percent inflation,
you'll need $2.4 million in 30 years to purchase a home
valued at $1 million today.
Perhaps our national debt will
stand at $20 trillion in 2036. A car, if such a thing
exists then, might cost $75,000 for a basic sedan. But this game only works if
there are players at the table who will be willing to buy
our debt and finance our continued deficits, which are
expected to grow significantly in the next thirty years as
Baby Boomers begin to soak up Social Security and Medicare
benefits.
* * * * *
Much ink and cyberspace has been
devoted to the success of the Bush-Republican Congress tax
cuts of 2001 and 2003 (the "no taxpayer left behind" acts)
in stimulating the U.S. economy the last five years, despite
the initial negative economic consequences of 9/11.
In
reality, it is government deficit spending to finance two
wars and two tax cuts and a liberal (easy) Federal Reserve
monetary policy that has kept our economy afloat.
If
you think back to Macroeconomics 101, you will remember a
tax cut, which reduces government revenues, financed by a
concurrent reduction in government spending, essentially
is a neutral, zero-sum policy. Government revenues
decline, government spending is reduced, personal spending
or saving is increased, roughly balancing.
A
tax cut financed by deficit spending (borrowing), then, is
economically stimulative. Government revenues decline,
but government spending is unchanged and personal spending
or saving is increased, leaving the equation out of balance,
to which increases in government borrowing to fund the
shortfall are required for equilibrium.
The end result is more national debt that our
children and grandchildren must address in the future.
One concern for which little debate now occurs is the
ownership of our increased national debt. More and
more, foreign governments are buying our treasury paper in
increasing volumes, some of which are not entirely friendly
to the United States.
Thus our growing international creditors, such as China,
from which we buy all manner of inexpensive consumer goods
like salad shooters and video cameras and, soon,
automobiles, host our national spending spree and high-times
lifestyle.
At
some point the proverbial punch bowl may become empty and
our new creditor-masters may refuse to fill it again.
But we party on, knowing such a day will come eventually,
but, why worry,? our descendants will have to pay the tab
and our collective morning-after hangover will emerge in the
form of a protracted economic depression as our fiscal house
of cards collapses around us.
Economically there is no difference between a tax cut and
increased government spending when both are financed by
increasing national debt. It becomes merely a question
of who or what is doing the spending: consumers or
government.
Our Great Depression (1930-1941) was addressed in similar
fashion. In the 1930s, however, tax cuts were less
effective because of mass unemployment (nearly 30 percent),
and, as such, increased government spending was the only
tool available to stimulate the economy. And it wasn't
until rearmament and our entry into World War II, for which
government (deficit) spending soared to 120 percent of GDP,
that the U.S. economy finally recovered from the Great
Unwinding of Inflated Asset Values known as the Depression.
Now, as then in WWII, war has been good for the economy.
Those billions spent in Afghanistan and Iraq (nearly $400
billion to date) significantly
have helped our wartime economy grow at a significant pace.
Inflated residential real estate values, at least until
recently, also have allowed us to leverage those values with
home equity lines of credit, further fueling our insatiable
personal spending habits as we escalate our indebtedness to
the maximum amount afforded by the most recent appraisal of
our homes.
Which brings us to the really scary part in this new
millennium. If the various economic bubbles forming in
paper assets, real estate, credit and commodities around the
world merge and burst, we will experience another Great Unwinding
of Inflated Asset Values. (See Doug Noland's
Credit Bubble Bulletin at
prudentbear.com for further insight.)
Our government, however, may be unable to provide the
economic stimulus necessary to lift us from this
sinkhole-to-come as, with IOUs outstanding all over the
world and essentially bankrupt, we will be unable to sell
treasury obligations to anyone to finance increased
government spending. And, once again, tax cuts will be
immaterial if unemployment escalates to 1930s levels.
One other disconcerting difference: in the 1920s, few
Americans had any personal debt outstanding other than for a
home and maybe a car. And few people owned investments
or speculated in the stock market and other paper-asset
chases, only bank deposits. The real disastrous impact
of the Depression was from the falling dominos of bank
failures, business failures and resulting unemployment,
which created a vicious circle that spiraled ever downward
to equilibrium (the great unwinding).
In
2006, we are indebted to our eyeballs in unsecured credit
card obligations and maxed out on real estate, vehicle,
boat, airplane and RV indebtedness. What net worth we
can claim is constituted primarily of paper assets such as
stock and bond investments, mutual funds, 401k and IRA
accounts, life insurance cash values, money market funds and
bank deposits.
As
the Depression exemplified, a Great Unwinding of Inflated
Asset Values is non-discriminatory. Prices/Values
always represent the point at which buyers and sellers
agree. When buyers disappear, as in April 2000 through
October 2002, stock market prices/values plunge. When
buyers disappear, as may be occurring selectively in
residential real estate around the country, home values
begin to erode. If it becomes a widespread phenomenon,
prices may collapse across the country, which itself could
trigger that ever-spiraling vicious circle of asset
deflation and falling dominos.
The personal debt remains, unfortunately, as stock-market
margin players discovered in early 2000, and as homeowners
are beginning to find this year. Bankruptcy becomes
the only option to relieve that debt, and, of course, that's
not good for the banking system.
And should faith in our economy, our government, our
Federal Reserve and in the value of a dollar falter, such
will be the end of our faith-based monetary system.
What do I know?
Send me an email.
--Keith Hazelton
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