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Print version: http://jaygaskill.com/BlackWeekendHeadsUp.htm
Dot 2 Dot
The Black Weekend Edition
SUNDAY, 11/28/2010, Northern CA
When facing avoidable peril, “Those who fail to recover from denial will be consumed by reality.”
HEAD’S UP – WHY THE FISCAL TRAP IS REAL
“But if interest rates remain at current levels, interest payments will still be relatively manageable: $290 billion in 2015 and $355 billion in 2019.
“Now suppose quantitative easing is “successful” in the way the Fed intends, taking inflation close to the average 2.4 percent rate of the last two decades and government borrowing costs back to their two-decade average of 5.7 percent. To get an idea of what happens to the budget, assume this transition happens over three years, so that by 2013 interest rates are back to “normal.” This “return to normal” will mean the government’s interest costs will rise to $847 billion by 2015 and $1.15 trillion by 2019.
“The increase in annual interest costs in 2015 alone—$557 billion—is nearly six times the additional revenue that is supposed to be collected by letting the higher end of the Bush tax cuts expire, the centerpiece of the current fiscal policy debate in Washington. The increase in interest costs in 2019—$795 billion—is two-and-a-half times the value of all the Bush income tax cuts of 2001 and 2003 that are due to expire. On the spending side, just the extra interest cost from a quantitative easing “success” would swamp, say, the entire defense budget for the rest of the decade. No plausible increase in taxes or reduction in spending could fill a gap of that magnitude.”
Lawrence B. Lindsey is president of the Lindsey Group and a former governor of the Federal Reserve
Fed. Chairman Bernanke’s “quantitative easing” plan is like reducing the cost of heroin for a patient dying from the addiction, without seriously attempting to achieve addiction recovery. That the current US fiscal path is unsustainable is no longer seriously disputed. Our leaders-of-the-moment, however, are in deep denial about the severity and immediacy of the problem. We may have the remaining two years of the Obama administration before we reach a tipping point or we may not.
But inaction or inadequate action to preempt a fiscal collapse is a choice. The current dithering is the result of the fear of public wrath, much like the hesitation by the executor of an estate to hide the truth that its value has already been looted by decades of mismanagement. The knowledgeable players are complicit in the delay to address the looming and worsening problem. They have made the cynical calculation that the austerity measures required will be more marketable after a real currency crash.. This is like waiting to sell fire extinguishers until after the fire has consumed most of the city.
What does it mean to say that the current borrowing patterns of the US government “are unsustainable”? It means that an endpoint is reached when the borrowing must stop and the repayments must start. This is moments comes on in the same way that it presents to irresponsible private borrowers. The lending terms get worse, in the form of shorter due dates and higher interest rates, and then the flow of money essentially stops. When that happens, the resulting crash will exceed all the prior ones by several orders of magnitude.
In the meantime, while the dithering continues, the interest rates on borrowed money will continue to increase, as will the difficulty of repaying existing debt (see the full article by former Federal Reserve Governor, Lawrence B. Lindsay, linked above). Moreover, over time, the flood of lending will begin to contract. President Bush has written in his recently released book, “Decision Points” that the debt crisis point was thought to be safely around the corner…. That is no longer the case.
In the near term, there are other consequences. The private money that otherwise would be attracted by higher rated of return from new investments is diverted to the presumed safe haven of profitable government debt instruments. This depresses new business activity. A death spiral can easily be set off in which the debt service costs are being paid by money effectively diverted from new job-creating investments in the private sector, thus holding down the entire economy while the public sector teeters towards collapse. So called “quantitative easing”, really a policy of creating fiat money out of nothing to service existing loans, always works to drive up borrowing costs, feeding the death spiral.
This is the Fiscal Trap. Getting out of it by spending more borrowed or created federal money is much like the struggles of the insect caught in a Venus Fly Trap; it only makes things worse.
FINDING A SAFE EXIT
In a series of articles, Breakout 1.0, 1.2 & following, I am outlining the optimum way out.
Those articles appear regularly on the Renaissance 411 Blog ( www.jaygaskill.com/411 ).
There are several related pieces, the Keynesian Collapse series, and the China Inc. series; all are referenced below.
BREAKOUT 3.0 – pending