Beyond the Cusp

October 14, 2012

What Happens when the Party Ends?

The signs are all around that the party is beginning to wind down and the end is near. The music has slowed and the volume has been lowered, the lights are slowly being brought back to full illumination and the satellite bars have closed. Soon everybody will wander out into the parking lot and realize that while they were partying like it was the middle of the summer, outside it is cold and a blizzard has hit town. The party I am talking about is this false realm we are living in where everything is sunshine and we act like there is no storm brewing just outside the door. We have our fancy hats on and celebrate the low inflation and interest rates at such a level that borrowing is virtually free; and borrow we have. We have borrowed in about every manner that is conceivable to record levels. The National Debt in the United States is at levels never even imagined possible a mere decade ago and much of Europe has reached similar levels though they have been building their debt steadily while the United States seems to have caught up and passed them almost overnight. Personal debt in the Western World is at unprecedented levels and student loan debt is being touted as very likely the next overly inflated bubble to burst taking many banks down with it. This is the real reason that the government has taken over the student loan industry, they can force the payment for this unfunded, collateral free indebtedness onto the American taxpayer when the defaults hit the fan. Add to all of this that many cities, counties and states are at debt levels that they are unable to contain and even keep up on paying the interest. All of this debt is being managed solely because the interest rates have been held down by false pretenses mostly because if it were allowed to rise even slightly the entire house of credit cards would come a tumbling down around our ears. The music slows and sounds even more distant and the lights are coming back on.

Currently the interest rate on much of the national debt is below 2%, much is actually at 1%. We can afford our debt at this level, but even at this bargain rate it takes all we can just to keep up with the interest payments. Eventually there is going to be a real economic recovery. A good thing, right? Well, not entirely. When the recovery takes hold in earnest and that causes prices to start to climb, that is when the Federal Reserve, actually a group of unnamed bankers who have little or nothing to do with the government except they can sway elections with their policies, will have to address the inflationary tendencies. The normal way to nip inflation in the bud is to raise interest rates at the first signs which will act to keep the lid on and force a slower rate of increases in prices as credit becomes more expensive. The reason the inflation is guaranteed to come as soon as a real and true recovery starts in earnest is because of the massive increase to the money supply. Right now, much of that cash is simply sitting in banks and other repositories and not being used to finance or buy goods. When the recovery gets into gear it will cause businesses and individuals to begin to invest more in production and other mediums. This will require more active cash flow which will force all of these funds from lying around and not flowing through the economic picture to begin to be moved into the economic picture giving it what is called velocity. This extra influx of capital will cause an excess of money in the system which will necessitate an increase in prices. Hopefully, it will also be reflected in salaries or we will have additional problems. As soon as the velocity hits a certain point it will cause undesirable levels of inflation to set in which will necessitate higher interest rates. This is done as a method of removing some of the now activated excess cash which we had printed in order to pay for some of the government programs which were intended to stimulate the economy but had thus far failed to produce, actually we do not print new money as much as simply invent it electronically which makes it way too easy to do and thus so tempting. There are only three methods of balancing the economic equations once you have infused trillions upon trillions of dollars into the mix, either you increase interest rates, increase taxes, or inflate prices or some combination of these three. Since the Federal Reserve can control the interest rate and they wish to prevent runaway inflation at virtually any cost, they will necessarily raise interest rates. Government, on the other hand, cannot afford to have the interest rates go up too steeply as that would make the interest payments on the debt unmanageable which would cause default, ask Greece how that works. This gives government, especially the Federal Government, a strong shove to increase taxes across the boards so that the Federal Reserve does not have to raise the interest rates as much as the government is also removing excess monies that had been infused to carry through bad times but are now a threat in good times. The one problem is that both increased taxes and higher interest rates take time to pull the excess money out of the system. So, what that means is that initially, until the increased taxes and interest rates balance the economic equations, everything in this world had its own equations, prices will rise as a reaction to the additional cash flowing in the system.

Oddly enough, the inflation will prove to be the least of the problems initially. In the end the inflation will necessarily run rampant as there is one huge elephant in the living-room that everybody is doing their best to ignore. What is going to happen when the interest rates go from ranging between 1% and 2% to the 4% to 7% range? This will cause the interest payments on government debt to necessarily double. And what happens if government faces a shortfall and finds itself unable to pay the interest on the outstanding loans? Well, they will do exactly what they did to “invest” in stimulating the economy which got us all into this mess; they will wind up the old computers and electronically invent the needed monies to pay the increased debt interest payments. Once the government, in this case it would be the Federal Government as the States are forbidden by the constitution from making money out of the thin air, once again resorts to increasing the money supply it will cause the same conditions that forced the interest payments to rise in the first place. Soon we will face interest rates between 9% and 15% which will redouble the interest payments if not triple them. If you want to see where this all ends, simply find a book or research the Weimar Republic of Germany from 1919 to 1923 and then continue your research until you find references to Adolph Hitler and the Nazis and you will be at the end result of the Weimar Republic and its fiscal mismanagement. Pay particular attention to their wonderful cure-all for fiscal insolvency and you might see some similarities to the United States under Presidents George W. Bush and Barack Obama.

If you wish to see an adult approach to facing such a problem, read about the years under President Jimmy Carter to see how we faced a similar predicament in the late 1970s and then read about the first term of President Ronald Reagan. Today everybody tends to remember the last five years under President Reagan, which were particularly nice and comfortable economically. In order to get our economic scales balanced and everything running as it is hoped for by every person in a position responsible for the economic wellbeing of the United States or any other country or entity, President Reagan faced all resistance to taking our lumps as they came in order to allow the situation to work itself through to a balanced and proper end. President Reagan did the most difficult thing any leader can do in a situation of dire fiscal troubles, he set the course that would eventually even everything into balance and then did absolutely nothing and waited for it to reach equilibrium. Sometimes doing nothing is both the correct solution and also likely the most difficult solution. The problem with waiting out the storm is that the public is often not that lenient so as to allow you the moment’s peace to take such an approach. The worst thing that government can do when facing fiscal difficulties is to try something new every few weeks expecting immediate results as this makes for an uncertainty in the rules of the game which forces those who invest or run large or small companies to shore up, store whatever cash they can, and wait until the madness ends and somebody sets the rules and promises not to further adjust them. Those constant and repeated changes in policy as a reaction to the public’s demands to do something, anything, are what I call Panic Policies.

Well, looks like the party is almost at an end and it is almost time to go out into that blizzard. Let us hope that whomever takes control as the next President has enough sense or his advisors have the sense to set a path forward, announce it and promise all will be well if we all have faith and stick to the plan, and really mean that and then just keep reassuring those who may panic and wait for balance to return which is almost always followed by a period of wealth and optimism. In the meantime, button up as it is going to get nasty for quite a while.

Beyond the Cusp

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