There’s a lot that doesn’t make sense about the economy these days. The situation is so mind-numbing that an increasing number of Americans seem to be opting to simply ignore it all in the hopes that it just goes away. Most people I know have stopped looking at their account statements, and “bailout fatigue” is nearly universal.
Part of the reason for our collective denial is that we don’t want to come to terms with our diminished circumstances. When the average American’s life-savings has been cut in half, its understandable that people would be reluctant to face the new realities. However, I would argue that there’s something deeper going on. Not only does a clear-eyed appraisal of the situation require people to come to terms with painful facts, but it is also threatening to their basic sanity. How are we to make sense of the idea that the way to solve a crisis caused by excessive debt is by taking on even more debt? Faced with such counterintuitive notions, the rational mind simply turns away.
The latest insanity announced by the government is a plan whereby the Fed will buy over $1 trillion of government bonds and mortgage backed securities. In other words, the government is going to print money and then loan it to itself.
Likewise, on the same day that the Congressional Budget Office released staggering projections of the largest deficits in history, President Obama repeated his claim that he will halve the deficit by the end of his first term. This is double-speak that even George W. Bush would be proud of. Its no wonder that people choose to tune out rather than try to make sense of such absurdity.
There is, however, an explanation for the government’s actions which is logical and straightforward but will never, ever be officially acknowledged.
It is increasingly clear that we have dug ourselves into a hole that we can never hope to dig ourselves out of. Individuals, corporations, and government have borrowed more money than they can ever hope to repay. In such a situation, there is really only one option left open to policy-makers – i.e. devalue the currency.
Currency devaluation (i.e. inflation) is a way of transferring wealth from creditors to debtors. When a nation finds itself so in debt that it can never realistically hope to repay, there is a strong temptation to simply crank up the printing presses and inflate the debt away. An extreme case of this was Germany after World War I. The Treaty of Versailles imposed financial obligations on Germany that it could never possibly meet, so they did the only thing they could do – they printed enormous amounts of money. By the end of 1923, one pre-war Mark was worth one trillion post-inflation Marks. If we did likewise, we could eliminate our entire national debt for about ten dollars.
The actions of the Treasury and Fed make it clear that the government is willing to print any amount of money it deems necessary. A year ago a trillion dollars was an unheard of amount. Today it seems that every week the government pledges another trillion to the latest bailout/stimulus plan. It is the most basic common sense that you can’t print money indiscriminately without destroying its value.
My guess is that all of this is crystal clear to the President and his economic advisers. The destruction of the dollar is already a fait accompli. Its just a question of when. We have poured so much gasoline into the flooded engine of our economy that when it finally does fire, the whole thing will go up in a massive inflationary conflagration. Viewed from this perspective, it is completely understandable why the government would continue to print trillions upon trillions of dollars. If the destruction of the currency is already a certainty, why not print as much of it as you can as long as there are people dumb enough to take it? As long as the Chinese are willing to take our worthless paper, why not let them have as much as they want? As John Maynard Keynes observed, “The creation of legal tender has been and is a Government’s ultimate reserve; and no State or Government is likely to decree its own bankruptcy or its own downfall so long as this instrument lies at hand unused.”
Those who hold US debt are in a catch-22. If they don’t continue to lend us even more money, the value of their holdings will evaporate. So, for the time-being they have kept the money flowing. But even now there are ominous signs relating to the long-term health of the dollar. The Chinese Premier recently cautioned the US government against policies which will further erode the value of the dollar. (The very fact that he’s saying so publicly is highly significant.) Meanwhile, the UN is discussing replacing the dollar as the world reserve currency with a basket of national currencies.
So far, the game of hot-potato continues, but the music will eventually stop, and when it does, anyone holding dollars will have to pay the piper.