America's Crashing Clown Car - Part 3

(A Continuation My 5/27 and 5/10 Postings)

A Storm Of Money

          Many Republicans are, and should be, embarrassed by the fact that for all their posturing about budgetary discipline, it's been under their presidents that much of the fiscal profligacy has occurred in recent decades. They have tended perversely to embrace tax cuts and high defense spending at the same time, without showing much more real interest than their Democratic colleagues in limiting the growth of entitlement programs or the size of the nation's costly administrative bureaucracy. Ronald Reagan's budget director, David Stockman, in 1985 even resigned in protest at this hypocrisy. Stockman's gesture achieved little, however, as Reagan's Vice President George Bush was elected his successor and continued in much the same vein.

          It was only when Democrat Bill Clinton came into office that the long running economic expansion initiated under Reagan began throwing off enough tax revenue that the seemingly permanent deficit began to shrink. In 1998, the deficit actually turned to surplus for the first time in a generation and remained there for the last three years of Clinton's presidency. This embarrassment of riches even got to the point where some economists fretted that a shortage of Treasury securities loomed and potentially threatened the stability of the banking system.

          They needn't have worried. Bush's son George W. was waiting in the wings, and his presidency brought about a return to sharply rising deficits and the consequent renewed supply of Treasuries. Furthermore, his presidency ended with a scary financial crash in 2008 that was followed by a severe and prolonged recession.

          Barak Obama, his successor, entered office in the midst of this mess and ushered in four years of trillion dollar-plus deficits. While his policy was on one level engineered to stimulate the doddering economy, it did so by throwing money around to political constituencies who had been clamoring for it all along anyway. The Democrats, now in control of the Presidency and both houses of Congress, felt finally free of fiscal constraints. They started behaving like happy weight-watchers who had just been told it was healthy to gorge at their favorite smorgasbord.

          Obama was a widely-admired President - even I liked him - but his actual policies were never as popular as Party stalwarts believed. His coattails quickly wore thin and the Democrats lost control of the House in another two years, and then the Senate four years after that. The resulting legislative gridlock meant that trillion-dollar deficits seemed like a thing of the past, although deficits remained high both in absolute terms and as a percentage of GNP.

Trump Arrives 

          Donald Trump always had the instincts of a crony-capitalist and he was never in the least bit serious in his occasional throwaway lines about cutting deficits. During his 2016 campaign he even let slip the notion - surely unvetted by his advisors and probably even by Trump himself prior to the parting of his lips - that he would eliminate the debt aggregate itself during the spectacular eight years of his approaching two-term presidency!

          Orthodox Republicans quickly had cause to join their Democratic friends in bemoaning the President's lies. He never had any problem whatsoever with either big government or its associated debt burden. What actually started happening the day he assumed office was a resumption of the upward sloping deficit trend line. It in fact took only three years for the budgetary shortfall once again to cross Obama's famous trillion-dollar mark, and this while the economy remained strong and before COVID-19 blasted onto the scene!

          When the virus did hit, all stops were kicked loose. No politician of either party seemed ready to express any skepticism regarding the scale of expenditures needed. Even AOC herself in March had warm words of praise for the President's early covonovirus proposal, albeit with the hastily-considered proviso that her Party planned to "bump it up a little". Dem radicals appeared stunned into momentary comity as the enemy President was suddenly suggesting outlays that exceeded what only months earlier had been the stuff of their own fondest dreams.

          The dust is as of yet still far from settling on all this, but current estimates suggest that the 2020 deficit will approach $4 trillion, nearly quadrupling estimates that only earlier in the year had already been sounding over the moon. Furthermore, no one is seeing much light at the end of this tunnel, and fairly optimistic consensus guesswork has those trillion-dollar-plus budgetary holes continuing out about as far as the academic eye can see. Far from being scaled back or even stabilized, the debt aggregate appears to be growing at an accelerating pace.   

The Siren's Song 

          Economists have never agreed about deficits. They have no consensus formulas telling them when a fatal line is being approached. Conservatives have always talked about all deficits as reckless steps down the primrose path to hyperinflation. Liberals on the other hand, citing Keynes, have regarded them as policy devices necessary for heading off downturns, albeit mostly ignoring his caution about their use during expansionary periods. Generations of serious policymakers have indeed treated deficits as tools, while keeping a wary eye on their dangers if pushed too hard.

          Serious policymakers, however, are being crowded aside in the current environment. Desperate times breed desperate ideas.

          There is a relatively new school of economic thinking that styles itself as Modern Monetary Theory (MMT). Its spokespeople include Randal Wray, Bill Mitchell, Warren Mosler, Stephanie Kelton, and others. MMT's central idea - not an idea at all really, but a simple fact - is that all the world's central banks, including America's Federal Reserve, are now free of gold or any other fixed standard. These banks can thus at any time create unlimited quantities of new money, and always stand ready to do so whenever the volume of maturing debt exceeds the roll-over capacity of bond markets. Short of irrational political interventions, default is thus rendered impossible. Debt is nothing to worry about and neither are deficits.

          I became aware of these writers a number of years ago and took comfort in the knowledge that hardly anybody seemed to be taking them seriously. However, I remember thinking at the time there would be hell to pay one day should they ever start finding ears within the Democratic Party. Left-fringe ideas for unlimited government could stop sounding so silly if those show-stopping funding constraints could just be made to disappear.  

Have You Heard The Good News? 

          Well, MMT has now proclaimed these constraints to be illusions, and the Party's suddenly-prominent neo-socialists have indeed opened their ears to the good news. Bernie Sanders and AOC have both publicly embraced MMT, seeking to rescue it from the cold waters of crankishness and to reel the what-me-worry theory into the warm political mainstream. Proposals for omnivorous programs like their Green New Deal and Medicare For All are being positioned for the first time as doable schemes. Indeed, they can be paid for without even raising taxes, and hence does MMT shore up this most common angle of attack against the new socialism. It all sounds great.  

          I'm not trying to belittle the MMT theorists. They are in fact sophisticated analysts with a sound grasp of how our monetary system works. Most of them are primarily academics, but some also have pragmatic real-world experience. Warren Mossler, for example, is a hedge fund founder and automotive engineer. He also once operated a broker-dealer, and this experience provided him an insider's perch overlooking Fed operations and the mechanics of the American monetary system. He has a deeper understanding of this stuff than most economists or politicians of any persuasion. Hence, when he talks about the ease of money creation, he knows exactly what he's getting at, as do most of his MMT colleagues.

          The problem with these folks, however, is that having understood the power of unlimited governmental authority, they have allowed themselves to become seduced by it. It's not surprising then that they're now finding common cause with our neo-socialist politicians, who have long been enthralled by the promise of government free of impediments. Perhaps tongue-in-cheek but revealingly, Mosler titles his web homepage "The Center Of The Universe". And in the style of a true self-referencing zealot, he's even proclaimed a doctrine he calls "Mosler's Law", which goes: "There is no financial crisis so deep that a sufficiently large fiscal adjustment cannot deal with it". No wonder Bernie and AOC are coming to love this guy and his colleagues.  It wouldn't surprise me if Trump too, lover of HUGE things that he is, might himself be secretly falling under MMT's spell. With the power of unlimited money, his great accomplishments could be written in the stars for all eternity.  

The Deadly Cost Of Free Money 

          Economic life, however, is not so simple. All developed economies are sprawling systems functioning via a virtual infinity of moving parts. No person, party, philosophical faction or government can see any more than a small fraction of the whole picture. However, no entity at any level is forced to operate completely in the dark either, because they have small points of light to guide them in their decision-making. These lodestars are prices, which in theory allow all players in the system to acquire goods and services they need in a manner that optimizes supply and demand. Stuff in relatively short supply is expensive, while anything flowing freely out of mass factories or God's green earth is cheap. Furthermore, for many goods and services, high prices stimulate production which then lowers prices again and contributes to general abundance.

          This is bedrock free market dogma, and the problem with it is that, while prices generally do perform their allotted function, the job they do is imperfect due to the many distorting factors that are at work. As our liberals would correctly point out, extreme disparities of wealth pervert pricing because uber-rich consumers buy more stuff than they need and thus make it more expensive and less available for everybody else. Liberals, like many conservatives, would also make the case that big, inefficient corporations add to the problem, since they often undertake wasteful mass projects that exceed their managerial capacity. They consume resources and drive up prices often without adding enough value to compensate.

          What liberals generally fail to acknowledge, however, is that seen in this light, governments behave like the biggest corporations of all. Often with good intentions, they undertake the kind of mass projects to which only governments can aspire, but that even the best of managers would be unable to control effectively. The purpose that budget constraints serve is to limit the ambition of government program managers and their allied politicians to initiatives they have at least some hope of being able to administer.

Our Achilles Heel 

          Hence, when the Socialist-MMT alliance proclaims budget constraints to be illusionary, they draw attention to the Achilles Heel long hidden in plain sight at the heart of our economic system. This is that the Fed's capacity for unlimited money creation has deadly potential if ever coupled with our government's unlimited capacity for high-cost experimental problem-solving.  

          Dollars dumped lavishly and carelessly into medical care, direct transfers, environmental and energy projects, infrastructure and just about any other imaginable program or subsidy would destroy the vital pricing signals that allow our system to function. These points of light, these lodestars, would grow progressively dimmer until decision-makers at all levels would find themselves reduced to operating blindly. This is what happens when central banking excess undermines an economy's mechanism for rational pricing.

          This already dangerous problem then becomes explosive when we consider that America's Fed is not just any central bank, but is the source of the mighty U.S. dollar. As the world's primary reserve currency, the dollar is the modern monetary equivalent of gold, and the bank wielding the power to spin it out of thin air is able to operate like a cabal of alchemists. Former French President Valéry Giscard d'Estaing, paraphrasing his predecessor Charles de Gaulle, characterized the dollar's power as America's "Exorbitant Privilege". 

          Looked at in this light, it is not all that hard to understand why chronic deficit spending has not yet led to ruinous inflation. America's bonds are forward contracts on its currency, and the world has for generations accepted this currency as though it were equivalent to gold.  By thus absorbing  our excess dollars, the global economy protects us from what would otherwise be the inflationary consequences  of  our monetary policy.

          The problem is that the rest of the world is not as gullible as we have apparently come to believe. Our fellow nations will not go on receiving dollars into their own monetary reserves if it becomes apparent to them that we are blowing our precious currency out the door like confetti.

          What our neo-socialist politicians, now encouraged by their MMT brain trust, are advocating is nothing less than the selfish and reckless abuse of America's Exorbitant Privilege.

Are We At The Tipping Point? 

          Even though economists have no formulas warning them when the monetary tipping point is approaching, the framework for considering the question is actually pretty simple. For nations, as for corporations, almost any debt burden is manageable so long as the debtor's resources are expanding. This is why, in the corporate world, leveraged buyouts (LBOs) can succeed for cases in which the target company is growing steadily. A seemingly insurmountable debt burden becomes progressively smaller in relative terms over time, until eventually the healthy firm easily absorbs its servicing cost.

          The situation is not so sanguine, however, when the firm encounters business adversity and begins to shrink. Under these circumstances, the arithmetic reverses itself and debt looms ever larger relative to the declining cash flow available to service it. If the pattern persists, bankruptcy is the only possible end game.

          Now, as the MMT folks love to point out in their lectures, nations aren't corporations and do not file for bankruptcy. Assuming debt that is denominated in their own currency, nations can and will always create new money to service it and hence technically can never default. The problem for nations occurs when the volume of new money necessary for this purpose begins to undermine the currency's value and the debt gets repaid in money that has lost its purchasing power. This point becomes the functional equivalent of bankruptcy.

          Now let's get back to the current COVID-19 crisis. Everyone seems aware of the fact that our economy is in some trouble, but I have to wonder if people are really coming to grips with how truly cavernous the hole is that has just belched open in front of us. The recent trillion dollar-plus deficit projections still assume a fairly robust economy. Yet what we are now experiencing is not only not a robust economy, nor even a normal recession, but the first stage of a deep and probably sustained depression. No one knows yet what the numbers are going to look like, but some estimates suggest that GDP could drop as much as 9% in the current year - exceeding the worst of the much ballyhooed "Great Recession".  And it will keep dropping if the economy is unable to re-open out of fear for the virus.

          The current U.S. federal debt aggregate is around $25 trillion and is now more than 100% of GDP. This ratio does not in itself have to represent an impossible burden, but quickly does so if the depression we're in sustains itself and our tax base continues to shrink.

          It's not completely far-fetched at this point to think of the U.S. economy as the sovereign equivalent of a corporate LBO. And like a leveraged company encountering a slump, the U.S. entering a depression will find that even its existing debt burden will grow relatively bigger and bigger with time.   

          And the existing debt burden is unfortunately only the starting point. In addition to the routine deficits now accumulating at a trillion-plus each year, a host of other potential claims beckon: 

• State and local governments are grappling with their own budgetary holes, some of them quite severe.
• State unemployment funds are already failing, and more are threatened if jobs don't come back and temporary furloughs become permanent.
• Public and private pension funds, which became a scary focal issue during the last recession, will again face shortfalls should stock market lose its currently inexplicable buoyancy.
• Our banks, while better capitalized than in 2008, may start to totter again.  

       

           All of these entities will appeal for federal subsidies as needed to ensure their survival. And it's not in Trump's nature, nor that of Congress, to resist such pleas. 

          Oh, and one more thing, interest on the federal debt - already a material budget item - threatens to explode when the bond and money markets awaken to the fact that inflation risk is not so non-existent as everyone seems to assume nowadays. And when inflation does return, it is likely to accelerate quickly, even in the midst of the economic downturn.

          The debt resulting from all these factors will be monetized because there is no practical alternative. Higher taxes cannot pay for it even if there was political will to attempt this option.

          The Fed is universally recognized as the backstop now for everything, and it will not hesitate to do whatever is needed to avoid systemic collapse. And why not, when the necessary money can be created in seconds by a few keystrokes entered into the the Fed's omnipotent computer system?

          I lack both the expertise and the stomach to add all this stuff up, but as Bob Dylan explained to us half a century ago, you don't need a weatherman to know which way the wind blows. 

 This certainly sounds like a tipping point to me. 

  And we intend to hold a Presidential election in the middle of it all?