In my “Too Big to Fail?” post, I talked a little about the unprecedented monetary expansion we have entered. Perhaps it’s time to expand on this topic. In 2007, the federal deficit was 1.2 percent of G.D.P. Two years later, more than a year into a serious economic crisis it is 13% of GDP -- more than twice the size of the next largest deficit since World War II -– the projected deficit is the result of a year when the federal government, at taxpayers' expense, has acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries. The average historical deficit is about 2.5% of GDP.
With the ill-conceived government reactions to the financial crises, and the economic downturn that has followed, the unfunded liabilities of various federal programs -- such as Social Security, pensions, Medicare and Medicaid -- are over the $100 trillion mark. With U.S. federal tax receipts at about $2.4 trillion, this level of debt virtually guarantees higher interest rates, huge tax increases, and -- partial default on some government promises.
Beginning in early September 2008, the Bernanke Fed made an abrupt turnaround and radically increased the U.S. monetary base -- currency in circulation, member bank reserves held at the Fed, and vault cash -- by a little less than $1 trillion. The Fed totally controls the monetary base by purchasing and selling assets in the open market. By making such a radical move, the Fed signaled a 180-degree turnaround in its focus from an anti-inflation position to an anti-deflation position. The stimulus bill passed by Congress early in the Obama Administration added almost another $1 trillion.
This percentage increase in the monetary base is the largest increase in the past 50 years -- by a factor of 10! (See chart, courtesy of Laffer Associates) This is so far outside the realm of our experiences that historical comparisons become meaningless.
It's difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed's actions because we simply haven't ever seen anything like this, ever. To date what's happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime rate peaked at 21.5% and inflation hit the low double digits. Gold prices went from $35 per ounce to $850 per ounce, and the dollar collapsed on the foreign exchanges.
When the Fed is no longer able to monetize this kind of expansionary monetary policy by selling Treasury securities, we face a brand new kind of financial collapse. Once again, I say “Let them fail”. The markets are much better and more efficient at sorting out these kinds of excesses than any kind of government intervention, no matter how well-intentioned. You are going to have job losses in either case – as we are seeing right now. Even with all the so-called “stimulus”, the unemployment rate has continued to rise throughout the first half of 2009. All that has resulted is you and I are a lot poorer, because somebody is going to have to pay the Piper!
Andrew Klavan has one of his “culture” videos about “Why are Conservatives so Mean” that really brings this concept home:
My regret is that fiscal conservatives waited until after Mr. Obama got elected to rediscover their “small government” principles. This is INEXCUSABLE.
What we’re being left with is a huge bill that our generation cannot possibly pay, and a Socialist –style economy that would make our forefathers turn over in their graves. Let Them Fail! What am I talking, Greek?