Guest Post: Fuck The Deficit (Or Will The Deficit End Up Fucking Us?)

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Fuck The Deficit (Or Will The Deficit End Up Fucking Us?)

Submitted by Gonzalo Lira

Currently, the United States is conducting one of the most remarkable experiments in fiscal finances in world history.

The
American economy is in a severe recession. Coupled with that—as both
partial cause and partial effect of the recession—the United States'
banking system crashed in the Fall of '08, a crash which in many ways is
still ongoing as I write this, nearly two years later.
What
the recession and the concomitant banking crisis have caused are,
essentially, a fall in aggregate demand levels, as well as a fall in
aggregate asset value. In other words, the population is spending less,
and asset values have deteriorated, both nominally and as compared to
any basket of hard commodities.
These are the
two metrics which the two principal camps of current American
macroeconomic thought consider vital. “Saltwater” economists look to
aggregate demand levels, while “freshwater” economists look to aggregate
asset value—each of these camps view their fetish-object as the
cornerstone for economic growth, development and prosperity. Naturally,
when either of these camps see their juju slide, they freak out. They
declare the economy to be “in crisis”—and further declare that
“something must be done”.
Something has been done: It's called The Deficit.
To
combat the fall in aggregate demand levels, the Federal Government has
embarked on a massive spending program. This spending program has been
financed by debt issued by the Treasury. The way things are looking,
another big spending package is in the offing some time soon—that should
keep the “saltwaters” happy.
On the other
hand, to combat the fall in aggregate asset value—and keep the
“freshwaters” happy—the Federal Reserve Board has embarked on an asset
purchase program that is also massive and unprecedented.
Through a
fairly complex scheme that seems to be deliberately opaque, the Fed has
relieved the Too Big To Fail banks of their deteriorated assets, and
given them cash, in an ongoing process. The Too Big To Fail banks have
turned around and used that cash to purchase Treasury bonds—which are
being used to finance this massive Federal Government spending. Whether
there has been collusion between the Treasury, the Fed and the TBTF
banks is for the courts and the historians to decide—but prima facie, it would certainly look so.
This
two-sided scheme—more Federal Government spending on the one hand, and
more propping up of asset values on the other—adds up to The Deficit.
When
I refer to it as The Deficit (it is too majestic for the lowercase), I
am not referring to a mere fiscal shortfall—I am referring to a policy
mentality. This policy mentality—shared by both “saltwater” and
“freshwater” economists—effectively amounts to a suspension of the
notion of opportunity cost. In the realm of The Deficit, the
macroeconomic policy questions cease to be “either/or”—they become
“both/and”. All policy options can be achieved because—according to the
macroeconomic policy known as The Deficit—the American fiscal shortfall
can never bring the United States to bankruptcy. As Dick Cheney so
memorably phrased it, deficits don’t matter—so The Deficit as a
macroeconomic policy can continue indefinitely.
In
a historical sense, The Deficit is unprecedented: Never before in world
history has a reserve currency provider gone into this much debt, with a
currency that floats on nothing but air. This is the key issue: The
dollar is a fiat currency. The Roman, French, British, Austro-Hungarian
empires, all of them world-historical empires in their times, all might
have gone way into the red on more than one occasion—but none has ever
done it on a purely fiat currency before.
America is the first to do so (“U!! S!! A!! WE’RE!! NUMBER!! ONE!!”). Hooray.
The Deficit is the policy that the United States is implementing, and it has had several effects:
1.
The most obvious, it has allowed the Federal Government to finance
every last one of its spending programs, in an effort to boost aggregate
demand levels. No need for Obama’s vaunted talk of “tough choices”—the
Federal Government has officially been renamed the Great American Teet.
2.
It has prevented the TBTF banks from acknowledging the plain fact that
they are broke. Indeed, the Fed asset buy-back has effectively kept the
banks solvent in a practical sense—they have money to pay off any of
their liabilities. But more importantly from the Fed's point of view, it
has sustained deteriorated aggregate asset values in the overall
economy, at least on a nominal basis.
3. It has created a fiscal shortfall of staggering proportions—currently about 100% of GDP, and growing without end.
4.
Finally—and most importantly—it has created the generalized impression
among policy makers that fiscal shortfalls indeed do not matter, and
that liquidity and stimulus simply mustbe provided whenever there is a crisis, the rationale being that the economy is too “fragile” to withstand the “shock”.
This
is a key effect of this policy, I would argue the most important of all
of the effects: The fact that the fiscal shortfall has crossed the 100%
of GDP mark, and nothing bad has happened has given everyone a false
sense of security—the sky has not fallen, the world has not ended.
Therefore,
as a practical political matter, the people with decision-making
authority in American public policy have effectively said, “Fuck The
Deficit, let’s keep on truckin’.”
But what if
the sky does fall? What if we are simply living in the lull before the
fall? I mean, it can't be that this enormous fiscal shortfall can
continue growing indefinitely, can it? It has to lead to some kind of
ruinous effect, right? Like drinking a bottle of scotch in a single
sitting—you feel good while you're doing it, sure, but you know you’ll
feel like death warmed over soon enough, right?
I mean, The Deficit will eventually come back and bite us on the ass—right?
Lately, there have been an awful lot of clever people explaining how, in fact, The Deficit will not harm us in the long term.
Very sensible-sounding words, and seemingly-sophisticated arguments, are deployed to make precisely this point. Others further argue
that The Deficit, because of its sheer size, will become its own growth
engine, and hence will grow the economy to such a point that The
Deficit will essentially pay for itself—a bit of financial magic that
almost seems believable.
And to any talk that
The Deficit and the stealth-monetization going on might lead to
hyperinflation, these clever people are scoffing and saying, in effect,
“Haven’t you heard the news? We got deflation, pal—forget about
inflation, let alone hyperinflation: We gotta spend-spend-spend, in
order to whip that deflationary monkey. After that’s taken care of, and
the economy’s growing again, that’s when we’ll be able to bring down The
Deficit.”
Recently, I had a private
exchange with a financial blogger, about precisely this point. This
blogger—who should have known better—argued that since we were in a
deflationary environment, there were currently no inflationary
pressures, and none in the forseeable future. Therefore, she argued,
since the economy was experiencing a deflationary trough and inflation
highly unlikely, then hyperinflation was an impossibility. Nay, an
absurdity, or so she claimed.
She's clever, but she made a common mistake—she confused inflation with hyperinflation.
Granted,
they do seem to look alike—both of them are essentially money losing
value against wages, commodities and goods-and-services over time.
Commonly—and mistakenly—hyperinflation is viewed as simply
inflation-plus, inflation-XL. After all, the name seems to imply it: Hyper-inflation. Inflation’s big brother. Inflation with an extra bit of kick.
This is a dangerous fallacy.
Inflation
is indeed the economy “over-heating”, in Neo-Keynesian parlance—wage
pressures, say, dragging prices up across the economy, or perhaps raw
commodity prices doing the same. Inflation can gallop up to 25% a year,
but still remain a distinct animal from hyperinflation. Ordinarily,
inflation is simply the economy eating up commodities—be it raw
materials or labor—so as to meet demand.
Hyperinflation,
however, is the loss of faith in money. It is not that prices are
rising because the economy is moving forward—it’s that prices are rising
because nobody believes that money is worth a damn anymore.
Hyperinflation
is not simply money-printing: Rather, it is when no amount of money
will get you what you want. Zimbabwe-style hyperinflation is an example
of government money-printing run amok. The Zimbabwe example gives us the
mistaken sense that hyperinflation only happens in “disorderly
printing” regimes. But that’s not the case.
Chilean
hyperinflation in 1973 (which led to the September 11 coup), or Weimar
style hyperinflation (which led to you-know-who), are more indicative of
what I’d call “scarcity” hyperinflation: Both are examples of when the
scarcity of basic commodities suddenly and abruptly leads to a complete
loss of faith in money—the belief that no amount of money will get you
what you want or need.
That’s hyperinflation.
2008
Deflationists (of which I am a member) argued that after the credit
crisis, there would be a deflationary trough. The reasoning of the 2008
Deflationists was, credit should be considered as part of the money
supply—so when credit contracts sharply, as happened following the
banking crisis in ’08, then that’s the same as if total money supply had
contracted. A constriction in the money supply obviously leads to
deflationary pressures: Less money is available for the same or more
goods. Hence prices fall to meet lowered demand. Hence wages fall as
business incomes fall. Hence less money. Hence downward spiral.
As
the 2008 Deflationists predicted, today the U.S. economy is in a
deflationary trough—I am certainly not arguing otherwise: The evidence
is all around, and too obvious.
But what I am
saying is, our current deflation can trip over into hyperinflation at a
moment’s notice. The stumbling block—the thing that could trip us over
from deflation to hyperinflation literally overnight—is The Deficit.
Not just the Federal shortfall itself, but the policy
implicitly embodied by The Deficit: The belief that all you need to do
is throw money at the problem—open up as many liquidity windows as
needed, or expand Federal spending as much as necessary, to prop up
those twin aggregates I mentioned before, aggregate demand and aggregate
asset value.
The pernicious sense among
American macroeconomic policy makers that fiscal shortfalls don’t
matter—and don’t matter especially in a financial or economic crisis—is
what I believe will lead to hyperinflation. Policy makers—who have lost
any fear of providing as much liquidity and stimulus as necessary to
steamroller any problem—will have no compunction about adding to The
Deficit at the next crisis.
That’s when hyperinflation will kick us in the teeth.
If
I had to make a prediction, I’d say that the immediate trigger for a
hyperinflationary catastrophe will be a sudden and unexpected commodity
spike. It won’t necessarily be big, but it’ll be flashy—enough to cause a
panic.
This will be the opening stages of hyperinflation: It will be a market panic, and it’ll be fast.
At
the next panic-inducing crisis, American public-policy makers will once
again turn to The Deficit, providing more liquidity and more
stimulus—and this will make the financial markets realize that the
fiscal shortfall is unsustainable: It will be obvious that all those
Treasuries cannot be repaid—or if they are ever to be repaid, it will be
done by the Fed via surreptitious monetization. In other words, a
dollar with lesser value.
Thus, everyone will
want to be the first to get out of the dollar—and everyone will want to
be the first out the door all at once.
Markets
turn on a dime, and they are not rational in the short term—they’re
rational like a herd of thundering buffaloes hopped up on crystal meth.
As
everyone gets out of the dollar in the financial markets, there’ll be a
cascading effect, as everyone—both Wall Street sophisticates and Main
Street naifs—try getting out of their dollars, and into hard assets:
Gold, land, food, whatever.
In other
words, hyperinflation as I have described it above: A loss of faith in
money. The belief that no amount of money will buy you what you want.
The
Deficit—that’s the demon’s name. The Deficit. Not, as I have argued,
the fiscal shortfall, but the macroeconomic mentality that fiscal
shortfalls in a reserve fiat currency do not matter. The sense that as
much liquidity and stimulas must be and can be provided to maintain
aggregate demand levels and aggregate asset value.
Policy
makers are not exactly known for being prescient timers of the
markets—at the next market crisis/panic, they will without hesitation
provide stimulus and liquidity, adding even more to the fiscal
shortfall. But it will be the market’s and the public’s loss of faith
that that fiscal shortfall will ever be repaid that will lead them to
abandon the dollar.
Once they lose faith in
the dollar, hyperinflation will ensue, as public policy officials
continue providing “stimulus” and “liquidity” which the market will
interpret as nothing but worthless paper.
Actions
have effects—it is stupid to think that massive deficit spending of a
fiat currency won’t have consequences. The policy embodied by The
Deficit has brought the U.S. economy to the brink of oblivion—with no
way to pull back from that brink. So at this point, the only question
is, what will finally tip it over, and when will that tip-over happen,
and what will the . So at this point, there are only two questions that
need to be answered: One, when will the economy finally tip over the
brink, and two, what will give us that final push.