Wednesday, September 26, 2012

The Fed ventures into dangerous, uncharted waters

Understand what is now happening monthly in fiscal policy and monetary policy in this nation:

1)  The Federal government, engaging in profligate spending for which there is no political courage (Republican or Democrat)  to restrain, is plunging us further and further in to debt.

2)  One of the natural consequences of that debt is rising interest rates on both the debt, thus forcing rising interest rates for market-based debt for home owners, businesses and others.

3)  In what would be a fiscal calamity, that rise in interest rates would cause the debt to rise even more,  as is addressed in this COAST blog entry, as eventually those higher rates would be paid on all U.S. debt.

4)  In order to avoid that rise in interest rates, using the law of supply and demand, The Fed simply "prints" more money each month to buy the debt that the U.S. government is issuing.  But, in reality, they don't actually need to print money, as the transactions are all electronic fund transfers.

5)  Because there is an excess demand for government bonds (beyond what the market would provide), there is a suppression of the interest rate.

6)  But that suppression comes with three critical costs to the nation:

A)  First, by expanding the supply of money, money becomes worth less compared to products.  As money is worth comparatively less, prices invariably rise (i.e., inflation).  That rise in prices eventually spirals out of control, an effect known s hyper-inflation.  As history has shown, hyper-inflation is extraordinarily difficult to control.

B)  In a descent into the unknown, perhaps even worse is that The Fed then loses one of its few tools to deal with crisis.  If the economy takes another dive, there are no remaining rabbits to pull out of the Fed's hat to ameliorate that.

C)  Finally, as with all interference with the marketplace by government manipulation, it temporarily skews the natural market forces, and allows bad behaviors to continue as if they did not matter.  This, in turn, encourages the continuation of the bad behavior.  In application, the temporary shielding of Congress and the President from the consequences of unrestrained deficit spending (i.e., higher interest rates), simply encourages more deficit spending.
Read here about these latter two factors.

What we learned from the multiple fiscal crises arising from and after the summer and fall of 2008 is that policies that don't make sense, don't make sense, and it does not take a Wharton Business School MBA to figure that out.  (Making home loans to people who can't possibly pay them back as a broad national policy is an extraordinarily bad idea.)

Similarly, printing money to pay for our uncontrolled and continued over-spending and borrowing habit solves nothing and contains the seeds of economic destruction of a once proud, powerful and wealthy nation. 

In the end, as with the housing crisis that begat the banking crisis, that begat the sovereign debt crisis that continues to beguile the world, when the avalanche starts it is difficult to stop. 

And we kid ourselves in thinking that next time it might just be merely "difficult" to stop.  It may be impossible, and the plunge into economic oblivion may well be a long, painful and irreversible fall.

The casual way our nation presently is engaging in risky fiscal, monetary and economic policy is stunning, and ignores the lessons of history that unthinkable calamity may well befall us, substantially exacerbated by these reckless policies.

The downside, the real potential downside, of the deleterious and risky behaviors in which our elected and unelected leaders engage are not considered real by policy-makers.  And they should be.   

Party on, U.S.A., after we pass out worshiping the porcelain goddess, the hangover is going to be a long and painful one.

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