What To Do About the Debt Ceiling

Here we are again.  Right back at the edge of the fiscal cliff.  I wonder what happened to those colorful words this time around?  The term "fiscal cliff" became all the rage just a few  months ago.

Government borrowing is not the problem.  Incidentally, Congress will raise the debt ceiling, but probably not for a few more days.  We haven't had enough political theater just yet.

Just like you and me, governments should borrow sometimes, but only for the right reasons.  Borrowing to finance productive activities (like successful businesses do) and borrowing to finance long-lived capital goods (like businesses and consumers do) is just fine --- provided businesses and consumers have reasonable expectations of being able to repay their borrowing.   Borrowing to finance continued transfer payments that cannot be sustained is not a right reason for governments to borrow.  What is hard to understand about that proposition?

More than two years ago, EconoBlast featured an article that seems completely timely today.  So, at the risk of boring regular readers, I point today to the EconoBlast archives.  You will find the article here.

Lot's of digital ink will flow over the next several weeks as Congress continues NOT to do its job.  Until Congress gets to the business of why we have Congress at all, the United States and the rest of the world will face the plunge.  It's a long way down, Mr. Speaker and Mr. President.  You both should be saying "not on my watch."

Saving, Not Borrowing, Will Heal America and the World

Here, Gregory Bresiger explains why saving is so vitally important to our nation's economic health.  Modern political thought, and sadly enough, what passes for main-stream economic thinking, even from Nobel Prize winners like Paul Krugman, tells us that borrowing to spend on consumption goods is the path to prosperity.

Borrowing has its place.  Most of us borrow at sometime in our lives.  But prudent people borrow for one of just a few good reasons.  People who borrow to finance a productive activity that will earn enough to repay the loan plus interest on the loan plus income to sustain themselves borrow prudently.  Business owners who produce and sell a product lots of people want to buy do this kind of borrowing all the time.   

People who borrow to purchase big-ticket capital goods (such as a house) that will generate a continuing future stream of value for them may be borrowing prudently, if they have a reasonable expectation of being able to make regular monthly payments over the life of the capital good.  Obviously, people who borrow without a reasonable expectation of being able to make those monthly payments do so imprudently and to their impending peril.  We have lots of experience in the recent past with that sort of imprudent borrowing.

What about borrowing by governments?  The guidelines for prudent and imprudent borrowing don't change just because its a government doing the borrowing.  Borrowing to finance productive activity --- activity that generate sufficient returns to repay the loan plus interest --- can be very prudent government borrowing.  Any number of people believe that a good example of this sort of borrowing is the American space program and its forays to the moon.

Government borrowing to finance spending on capital goods such as roads to somewhere lots of people want to go, bridges to somewhere lots of people want to go, and technology to defend ourselves from bad guys can certainly be prudent.  But only if the value streaming from those capital goods is sufficiently high, and only if government can reasonably expect to be able to repay the loans plus interest.

Government borrowing to finance current consumption with no reasonable expectation of repaying the loan plus interest is imprudent, just as it is if you or I borrow to finance current consumption with no reasonable expectation of repaying the loan plus interest.

I have written in EconoBlast more than once that you can't borrow what hasn't already been produced and saved.   Today's politicians don't seem to get that message.  Until they do, America's economic future is in jeopardy.  Europe's perilous economic future has already arrived in the body of the PIIGS.  Despite the lack of continuing mainstream media coverage, the PIIGS are not anywhere near out of the woods.  Some people think that the next stock market meltdown will be precipitated directly by the ongoing European debt problem, even though we haven't heard much about it in recent months.

Imprudent borrowing, like the borrowing the PIIGS have done and like the United States Congress continues to do, will be our undoing.  Saving like our grandparents and parents did could heal America and the rest of the world.  Regular readers of EconoBlast may be growing weary of it, but it's still true.  You can't borrow what hasn't already been produced and saved. 

Keynesian Policy Comes Up Short Again; My What A Surprise

Anyone remember all the dire, dour pronouncements of BHO and his Keynesian economists just a few months ago about how the across-the-board reductions (the sequester; remember?) in growth of the federal budget were surely going to cause incredible job loss and economic downturn?  I remember.

Remember how BHO and his administration instructed federal agencies to make cuts in the growth of federal spending (not real cuts, mind you) that would be most noticeable and irritating to folks --- such as furloughing  the air traffic controllers and closing federal parks.  I remember.

Did it come out that way?  No?  Hmmmm.  Live and learn.  Or more likely, live and fail to learn.

The federal government can't spend a dime without first keeping the dime's rightful owner from spending it.  People easily see the federal spending.  They don't see the foregone spending that's not done by the person the feds stole the dime from.  What about borrowing you say?  Well, we've been all through that on this blog.  You can't borrow what hasn't already been produced and saved.  Just in case you don't get that, read about it here.

Vote for the New Blood Party.   Let's get rid of the same-old, same-old hoots that have given us what we've got (that would be the 545).  Yes, yes, I know.  People who vote for the same-old, same-old don't read this blog.  That's why I don't write in it much anymore.  Nothing new to say.

Pumping, Pumping, Pumping --- Kablooey!

Here, Joseph T. Salerno of the Ludwig von Mises Institute provides spot-on analysis of the Fed's pumping, pumping, pumping tactics in its continuing backstop of the U.S. Treasury's machinations to continue expanding federal spending.

President Obama tells us the federal government simply must keep spending money, else we will surely suffer a dismal fate.  Never mind that the money the U.S. Treasury is spending is simply new money created by the Fed.

Somehow, I think that even people who have never studied economics or finance really do understand the vacuousness of the President's argument.  I think that most people really do understand my well-rehearsed pronouncement in EconoBlast, "you can't borrow what hasn't already been produced and saved."    

Check out the nearby chart, which is one of the most interesting in Salerno's analysis.

The chart "Total Household Net Worth as a Percent of GDP" reveals fascinating evidence for a dark hypothesis that I can't seem to shake, despite its tin-foil-underwear implications.  Allow me to explain.

GDP is the total dollar value of final goods and services produced within our geographical borders in a year.  Total Household Net Worth (let us call it THNW) is the dollar value of assets minus liabilities owned by American households.  Up until 2008, a whole bunch of that net worth resided in the form of residential housing.  A whole bunch still resides there, but not as much as in 2008.

Net worth is accumulated savings of households from income earned over time --- in a word, "capital."  Saving is that part of household income that is not consumed each year to sustain life and finance household consumption spending.  With those basic financial definitions in place, let's  explore the information revealed by the chart of THNW as a percent of GDP over time.

Just as Salerno says, THNW as a percent of GDP fluctuated in the band of 300% to 350% from 1952 through just about the end of the 1980s.  Notice, though, the downward trend in the ratio from the early 1960s through the decade of the 1970s.

Remember the decades of the 1960s and 1970s?  I do.  America was fighting the Vietnam war in the 1960s (I was in that war; draft, you know).  With that war dispatched, America began waging President Lyndon Johnson's "War on Poverty" near the end of the decade.  Throughout the decade of the 1970s, price inflation in the United States grew to reach 10% per year by mid-decade and approached 14% by the end of the decade.

Those of us who lived through the decades of the 1960s and 1970s pretty much understood that we were not really becoming wealthier as the prices of oil and gasoline continued their upward march with the Fed pumping furiously on the money supply.  America had to finance its misbegotten war in Southeast Asia and its War on Poverty somehow.  It did so through the graces of the Fed creating ever more money for the U.S. Treasury to spend.

Paul Volcker, Chairman of the Federal Reserve, appointed by Jimmy Carter in 1979 and reinstated by Ronald Regan four years later,  righted the ship at the opening of the decade of the 1980s.  Price inflation had to be stopped, and Volcker did just that.  He did it by bursting the bubble in U.S. Treasurys that his predecessor Chairs of the Fed, Arthur Burns and G. William Miller, had pumped up to finance the Vietnam War and the War on Poverty.

Following Volcker's bursting of what I will call the "Wars Bubble," the ratio of THNW to GDP stayed above 300% but below 350% until the mid-1980s.  The ratio began to grow in the mid-1980s as the economy enjoyed real growth, not inflation growth, reaching a new plateau just above 350% throughout the decade of the 1990s.

The decade of the 1990s, the most economically prosperous time ever on planet earth, saw the ratio of THNW to GDP rise to just above 350%, until mid-decade.  Beginning in 1996, the ratio began to rise on trend, topping 450% in the year 2000.  Of course the ratio began to rise.  The Fed, under guidance from Chairman Alan Greenspan, was pumping away, fueling what is now called the "Dot-Com" bubble in the stock market.

Like all financial bubbles pumped up by money creation --- a phenomenon that Salerno points out is a repeating event --- the Dot-Com bubble had to explode, and it did.  I remember the Dot-Com bubble well.  Everyone was getting rich quick in the stock market.  American households were elated with their new-found wealth.  But of course, the new-found wealth wasn't real; it was just a financial asset bubble.

The ratio of THNW to GDP plummeted, as it must, when the Dot-Com bubble burst.  But this time the Fed was determined to fight.  Greenspan continued to pump.  And a new bubble was born.  We know it today as the "Housing Bubble."  Pump, pump, pump went the Fed, and up, up, up blew the housing bubble.  Americans were once again riding high and getting wealthy.  Anyone could do it.  Even people who had insufficient income to borrow money to buy a car could borrow money to buy a house.

With the help of the Fed, the Housing Bubble raised the ratio of THNW to GDP to new, dizzying heights, pushing above 450% with a steely eye on 500%.  But, as always, like all other financial bubbles pumped up by the banking system, the Housing Bubble literally exploded in 2008.

But the new Fed Chair, Helicopter Ben Bernanke, would not take this bubble bursting sitting down.  Chairman Bernanke has led the Fed's pumping, pumping, pumping with previously unseen zeal since the bottom of the Great Recession, continuing to this day.  Guess what.  A new bubble has formed.  Asset prices in particular sectors of the economy are rising, rising, rising.  I wrote about this new bubble a few days ago here.

Do you think this new bubble will burst?  Of course you do.  It has to.  Now here comes the dark part that I can't seem to shake.  All that fake net worth above the 350% of GDP mark has to get wiped out somehow.  Real wealth is about real stuff.  Real wealth is not about money.  We all know that real GDP around the world is languishing, even as the ratio of THNW to GDP in  America is back on the rise, thanks to the pumping, pumping, pumping of the Fed.

So what's dark about that observation?  I don't think bubbles just burst naturally, anymore than I think that bubbles get pumped up naturally.  What's usually called "the business cycle" isn't a naturally occurring phenomenon like hurricanes are.  It takes a flawed banking system led by a central bank (or banks too big to fail acting in concert) to pump up an asset bubble.  Always has, always will.

World history, not just American history, is full of asset bubbles created by pumping, pumping, pumping fiat money.  The pumping requires the confluence of strong central governments and highly concentrated banking.  The banking can be highly concentrated under the leadership of a central bank (as it is now), or it can be highly concentrated under the collusion of a few big banks (as it was in the run up to creation of the Fed in America in 1913).

Everyone can't be wealthy at the same time in a world of scarcity.  But central banks can pump, pump, pump up asset bubbles for a time, creating the illusion of wealth.  But because it is illusory wealth, not real wealth, the fake wealth must be extinguished somehow.  Why?  Because paper wealth cannot long buy real goods and services in a world of scarcity.  As Robert Heinlein put it in The Moon Is A Harsh Mistress, "there ain't no such thing as a free lunch."  I call that line the "economic maxim."

Did you know back in 2008 when the bubble would burst?  Neither did I.  I knew it would burst, but I didn't know when.  But some people knew when.  That's the dark part.  Financial bubbles don't just burst.  After all, the pumping, pumping, pumping by the Fed could be continued to stave off the explosion.  Of course, continued pumping would eventually lead to a rising and high rate of general price inflation across all goods and services, instead of just rising asset prices.  The Fed cannot allow that; way too obvious what's going on if price inflation gets out of hand.  That's what happened in the decade of the 1970s, until Volcker burst the bubble on purpose in full view of one and all.

We humans learn.  The Fed has learned.  The Fed still pumps up asset bubbles, but it doesn't keep pumping so long that general price inflation gets way out of hand.  The new bubble in town will be burst.  I don't know when.  Wish I did; I could become very wealthy if did know.

If you have your 401(k) or your 403(b) back in the stock market just now, be forewarned.  If you have your wealth in U.S. Treasurys, thinking those will surely be safe assets, be forewarned.  If you have your wealth in corporate junk bonds just now, because the yield over U.S. Treasurys is the only yield in town, be forewarned.  Even if you have your wealth in Midwestern farmland acreage, just now, be forewarned.

Nearby is one more chart I stole from Salerno's excellent article.

The Wilshire 5000 index can be taken to be a record of what the stock market did over time.  Let's see; pumping, pumping, pumping --- kablooey!   Pumping, pumping, pumping --- kablooey!  The next kablooey may not be far away.  I don't know when, but someone will know before it happens.

This new bubble in town will also be burst.  Those few who somehow learn about the impending kablooey will not lose their wealth.  Only the dumb money will be lost.  The smart money will be out of the bubble assets just in time.  I wonder how the smart money will know when to leave

I hope that Peter Schiff (check it out here) is off the mark this time, but I don't really think he is.
 
  

Perspective on the Federal Debt Ceiling and the Sequestor

If you have any questions or comments after you watch this video, please post them.

There's A New Bubble In Town

Here, Victoria McGrane and Jon Hilsenrath of the WSJ, write about about unintended perils of the Fed's zero-interest-rate regime (ZIRR) for the short end of the yield curve, and historically low interest rates for the long end. They write, 

Federal Reserve Board Governor Jeremy Stein said there isn't an imminent threat to the wider financial system (in an address Stein made in a symposium at the St. Louis Federal Reserve bank recently), but highlighted several markets—including junk bonds, mortgage real-estate investment trusts and commercial banks' securities holdings—as areas where potentially troubling developments are emerging, possibly as a result of the Fed's easy-money policies (a.k.a., quantitative easing).

In 2007 --- just before the credit bubble created by the Fed in the preceding seven years exploded --- Ben Bernanke had expressed his confidence that no imminent threat was at hand to the wider financial system, even though the housing market was CTD (circling the drain).  Right.  So, perhaps readers will forgive me if Fed Governor Stein's assurances now are less than comforting about the new credit bubble in town.

So what's going on?  Let's see if we can understand.

The Fed keeps interest rates historically low (in the basement, actually) by purchasing assets --- typically U.S. Treasuries --- in the open market.  If you understand how that works, great; if you don't, trust me, you can ask around; I'm not lying.  The Fed buys bonds with new money, which the Fed creates with key strokes on a computer.  No printing press needed; it's all done with computers these days.  What happens to the new money?

The new money gets deposited in the banks of whoever sold the U.S. Treasuries to the Fed.  If it was the U.S. Treasury itself (which usually isn't the case; the Fed does not like to be that transparent), the U.S. Treasury's bank account now has new money in it.  Of course, the U.S. Treasury spends the new money rather quickly. Sixty percent of the spending is to pay recipients of entitlement programs and recipients of other transfer payments.

If the seller of the federal debt wasn't the U.S. Treasury (say a bank, a private citizen, an investment company, an insurance company, a sovereign account, a business, or anyone who wanted money instead of the U.S. Treasury they sold to the Fed), the new money typically shows up in a demand deposit account (a.k.a., a checking account) of the seller.

Commercial banks (which is where most people set up a checking account) are in the business of acquiring money at a price lower than the price they can get by lending money or by purchasing a yield-bearing financial asset --- assets such as U.S. Treasuries, bonds, real estate --- you name it; whatever  banking regulations permit.

In fact, operating all together as a system, the banking system can purchase up to about 10 times as much as the new money that was injected by the Fed when the Fed bought U.S. Treasuries, kicking the whole money creation cycle off.

These days, the Fed pays banks about 75 basis points (three quarters of one percent per year) just to keep the new money on deposit with the bank's regional Federal Reserve Bank.  That's not a lot, but the spread between the price the bank pays to use the money, which on ordinary checking accounts is way less than 75 basis points, still provides a little profit for the bank.

Of course, banks would like a bigger spread to increase bank earnings, which is why banks will likely use the new money to make new loans or to purchase some other financial asset (like longer-term bonds, housing mortgages, and other securities allowed by banking regulations).

Any new money created by the Fed typically gets spent somehow, sooner or later.  In fact, the new money gets spent multiple times, not just once.  In fact, spending of the new money multiple times as it circulates through financial markets and real-goods markets is what creates credit bubbles,  asset-price-inflation, and ultimately, a continuously rising consumer price index.   

Banks are not usually content to keep the new money in a deposit account with the Fed that pays only 75 basis points.  Banks have lots of ways to spend (what banks call "investing") the new money, but all of those ways ultimately bid up the price of something.  During the seven-year run up to the Great Recession of 2008, that something was prices of residential housing, prices of commercial property, and prices of one or another financial instrument, such as mortgage backed securities, credit default swaps,  and other credit instruments created by the financial engineers of Wall Street.

Bottom line, the Fed created a credit bubble, which created an asset-price bubble, as only the Fed can.  Borrowers spent the new money the Fed created to purchase other kinds of assets, real and financial, which bid up their prices.  A bubble is nothing more than prices of particular assets getting bid higher and higher in a tail-chasing exuberance of people who want to hit it big.  That can't and doesn't happen without a central bank (or a collection of colluding banks acting like a central bank).

People who pay attention to financial news understand that the Fed has pumped a bit north of $1 trillion dollars of new money into financial markets since 2008, with tens of billions more coming with each passing month at present (QE3).  What Fed Governor Stein is at least a tad bit worried about is that all that new money may be pumping a new bubble.  Do you think?  So where is the bubble this time?

A big part of the bubble is in the prices of U.S. Treasuries themselves.  The U.S. Treasury just keeps on-a-borrowing.  So far, Congress has raised the debt ceiling as needed every few months to keep that borrowing possible.  All the pumping by the Fed is the only thing keeping prices of U.S. Treasuries high enough to keep government borrowing costs historically low.  In effect, the Fed has purchased about 25% of the Treasury's new debt since 2008. 

Another part of the bubble is evidently showing up in junk bonds, real estate investment trusts, and bank security portfolios, according to Mr. Stein.  By the way, what do you suppose is fueling the rising prices of farm land in the Midwest?  Why do you think the price of gold rose from about $800 per ounce in 2008 to more than $1,600 today?

The new bubble in town isn't quite as concentrated as the housing bubble was from 2000 to 2007.  But that's the thing about bubbles.  They sneak up on us.  Lots of folks, including the Fed, never really see them as bubbles --- until they explode.

Can the Fed let the air out of the new bubble in town just in time to avert an explosion?  Ben Bernanke evidently thinks so.  The Fed's track record for stabilizing financial markets certainly isn't promising.  Why will the new bubble in town be any less destructive of all that fake wealth than the housing bubble was?  After all, the bubble has to explode, if for no other reason than to wipe out all those pretenders to wealth, people who have produced no real goods or valuable services to earn their paper wealth.

I like to sum it all up this way.  You can't really borrow what hasn't already been produced and saved, even if the Fed says you can.  But there I go again, repeating my old refrain. 

We The People

President Obama said in his second inaugural address on January 21, 2013,

“For the American people can no more meet the demands of today’s world by acting alone than American soldiers could have met the forces of fascism or communism with muskets and militias. No single person can train all the math and science teachers we’ll need to equip our children for the future. Or build the roads and networks and research labs that will bring new jobs and businesses to our shores.”

In other words, words which the President also spoke on another occasion, "you didn't build that."  The rhetoric is stirring for many who heard his words, to be sure. What's more, Mr. Obama is entirely correct.  But he is also entirely mistaken.

The President is correct to note that individuals acting alone are virtually impotent.  At least since Adam Smith's Wealth of Nations published in 1776, thoughtful people have understood the power, productivity, and efficiency of specialization and cooperation.  College freshmen routinely learn about Smith's example of the pin factory.  Yes, insomuch as Mr. Obama understands Adam Smith's lesson about specialization and cooperation, he is entirely correct.

I have always considered it an interesting coincidence that in 1776 when Thomas Jefferson and the other Founders wrote about inalienable rights and voluntary cooperation --- political freedom --- Adam Smith was also writing about how voluntary exchange leads individuals to cooperate without compulsion, resulting in splendid and unmatched prosperity for the members of a free society --- economic freedom.

But just as surely as Mr. Obama is entirely correct about the power and productivity of cooperation, he is entirely wrong about how free individuals come to cooperate.  Mr. Obama believes it is the state and its power of taxation under threat of force that is the blessing of individuals living together in a society.  For Mr. Obama conflates government and society.  Obama mistakes government for society, and in that premise he is utterly wrong.

Government is not society.  Individuals in free association, engaging in voluntary exchange free of compulsion, are society.  Government is the antithesis of freedom, the antithesis of voluntary exchange, the antithesis of moral human conduct, for government is the penultimate coercer of humans, and coercion of one by another is immoral.  One person compelling another is immoral, and 545 people compelling millions is also immoral, notwithstanding the imprimatur of majority rule.

It does take a village for humans to prosper.  But a village is not a government.  A village that is moral and prosperous is an association of free individuals who do not compel one another, but instead engage in voluntary exchange --- in a word, in capitalism.

Mr. Obama made his intentions for the next four years about as clear as he could, while still confining his language to the rhetoric of speech writers composing for a politician.  It is unfortunate that the President and his supporters seem to understand only part of what Adam Smith and Thomas Jefferson had to teach us.

Pay Attention to the Bond Market

Here, George Melloan explains in clear terms how economic reality will have its day, notwithstanding the machinations of politicians.  Dare I repeat an old message in this blog?  "You can't borrow what hasn't already been produced and saved."

The Real Problem with Rising Federal Debt

On January 1, 2013, Congress and President Obama approached the fiscal cliff, looked over and backed away.  But as the nearby cartoon depicts, the cliff didn't go away.

Everyone knows that the next few weeks will feature rancorous debate in the halls of Congress and the media, lots of blame-game finger pointing, and an ultimate showdown over raising the federal debt ceiling. Obama's recent declaration that he refuses to negotiate about raising the federal debt ceiling is simply political bluster embedded deeply in political theater.

In the end, Congress will raise the federal debt ceiling, just as it always has.  In a more distant end --- but not an end out of sight --- entitlement programs (Medicare, Medicaid, and Social Security) will be altered as needed to kick the can down the road, as they say.  

And of course, we will all pay higher taxes --- if not higher tax rates.  A very small percentage of folks called "the wealthy" will begin paying higher tax rates almost immediately.  Given a bit of time to adjust their affairs, "the wealthy" will end up paying about the same or even less in actual taxes as they now pay.  The rest of us will pay higher taxes soon enough due to provisions buried in Obamacare, notwithstanding the President's promises that we wouldn't.  But thoughtful people have known that for a long time.  We all know there really is no such thing as a free lunch, right?  

Most everyone I know is worried about our ever-rising federal debt.  Some of them are CPAs.  Some of them have Ph.Ds.  All of them are good, intelligent people.  According to one readily available debt clock, the current deficit tops $1 trillion and the level of our national debt exceeds $16 trillion --- more than our nation's annual GDP.  That would seem a bit worrisome.  The rate of growth of our national debt (the ever-increasing annual gap between federal spending and tax receipts) and the awesome size of the national debt are worrisome, to be sure.  But most people are worried about the debt and rising annual deficits for wrong reasons.

Many folks are worried about the burden that paying back federal borrowing will impose on our children and our children's children.  Still others worry that our current national consumption largess, spurred on and augmented by entitlement spending, necessarily means reduced national consumption in the future.  Some people worry that the Chinese and Japanese --- two of the largest groups of external holders of U.S. Treasuries --- will end up "owning" us.  If true, these outcomes would certainly be worth worrying about.  But they are not true.

Our children and their children will not be burdened by paying back our federal debt.  After all, are we currently burdened by paying back that portion of the federal debt we inherited?  Not a bit of it.  We haven't and we won't pay off the federal debt.  Annual deficits that we are adding to the the debt won't be payed back by our children, any more than we are paying back debt we inherited.  That's just an empirical observation that happens to be the case.  Explaining how this non-payment can continue indefinitely is a bit complicated, so just trust the history.  Trust that America is not Greece and never will be.

We Americans are consuming enormous quantities of goods and services currently.  But we are not consuming goods and services that would otherwise be available to us in the future, and we are not consuming "beyond our means."  No one can consume beyond one's means, pretty much by definition.  For the most part, we are consuming only those goods and services that are being produced right now, either by we ourselves, or by others around the world.  In fact, we can consume only goods and services available right now; we really don't save up goods for future consumption, and services can't be saved at all.

Our future consumption possibilities will depend on future production that we or others around the globe accomplish in the future.  Future production possibilities at home and around the globe will depend mostly on the rate of technological advances, just as they always have.  Consequently, we need not worry about our future consumption possibilities, unless something we are doing today is retarding the advance of technology and the formation of what economists call "capital goods."

Capital goods are machines, tools, and infrastructure in which we embed our technology.  Capital goods are what makes us humans more productive.  Without capital goods, we are essentially the same sort of humans that have been around for centuries.  Yes, some people know more these days than people knew centuries ago, but that's just part of advancing technology embedded in some of us --- what economists call "human capital."  We might be a bit taller and a bit stronger, but that's mostly due to better nutrition, due of course, to better technology --- notably, the agricultural revolution and the industrial revolution.

The Chinese and the Japanese will not own us.  I doubt that they want to own us, even if they could.  But won't the Chinese, the Japanese, and other persons who have bought U.S. Treasuries demand to be paid back with interest due?  Yes, but we need not worry about that.  Suppose they demand to be paid back in pictures of dead U.S. presidents.  What then?  No problem.  The Fed can and will generate all the pictures of dead U.S. presidents anyone cares to hold.  Such pictures, after all, are only slightly more substantial than the zeros and ones in computers that currently signify external ownership of U.S. Treasuries.

What if "dem ferners" demand to be paid back in real stuff --- real goods and services? What then?  No problem.  We Americans would simply have to produce real goods and services, which we can and will do as demanded.  Presently, the Chinese and Japanese appear to be more interested in producing stuff for American consumption.  But just think of all the jobs that future American production would generate, should the Chinese and Japanese want real stuff!  Actually, all that production wouldn't come mostly from labor.  That expanded production would come mostly from application of advanced technology embedded in capital goods --- machines and know-how.  That is simply an empirical observation; it's what's happened throughout all of history.

The ability of ever advancing technology to enable ever greater production of goods and services with ever diminishing quantities of human labor shows absolutely no signs of going away.  That fact is all that's ever saved us from our own political folly.  I predict it will save us again.

Still, rising annual federal deficits and the expanding national debt that results are worrisome.  But the real problem with rising annual federal deficits and expanding federal debt is expanding federal government.  Expanding government could very well be what retards advancing technology and capital formation that our future consumption possibilities definitely require.  By far, most dollars spent by the federal government do nothing to advance technology or grow our stock of capital goods.  In fact, something around 60 percent of federal expenditures are transfer payments --- Social Security payments, Medicare payments, and Medicaid payments --- to name the big dogs.  Transfer payments are dollars extracted from Peter to pay Paul.  Transfer payments are not necessarily bad.  After all, most recipients of Social Security did pay FICA taxes all their working lives.  But regardless of the just desserts of any particular transfer payment, they do not usually enable advancing technology or capital formation.

Worse still, much of the 40 percent of government expenditures that are not transfer payments may actually impede the advance of technology and capital formation.  Regulatory burden (Dodd-Frank, to name but one example), misallocation of resources (the housing bubble, to name the most recent example), subsidies to inefficient businesses (ethanol in gasoline, to name a particularly egregious example), and waning entrepreneurship (the Y generation, to name a cultural example) all have the definite potential to retard advancing technology and capital formation.

Most thoughtful people understand that some government --- even some federal government --- is desirable.  We all want national defense (at some level), police, firemen, courts, roads, and bridges (provided they go somewhere).  We all want to extend a helping hand to people who really need it.  I haven't heard too many folks complain about federal dollars spent to help victims of hurricane Sandy recover, and I haven't heard much complaining about Medicaid, many of whose recipients are children.  But the merit of these few, limited roles for federal spending in no way justify or excuse the Ponzi scheme called Social Security, militaristic intrusion around the world that keeps the military-industrial complex alive and well, and the ever-advancing expansion of the welfare state. 

Let's face some simple facts.  Federal spending must be financed in one of four ways: taxes, borrowing, fees, or money creation.  Of the four, many politicians prefer borrowing, for fairly obvious reasons.  Borrowing seems to be getting something for nothing, which explains politicians fascination with federal debt.  The method of financing government expenditures is actually fairly innocuous, compared to the real problem, which is placing control of scarce resources in the hands of government operatives.

Taxing to finance the same level of federal spending we have today (about $3.5 trillion per year) would be every bit as worrisome as borrowing to finance.  Of course, taxing instead of borrowing would tend to limit government spending, simply because people notice and object to taxes more than they notice or object to borrowing.  But in the end, taxing to finance federal government spending has pretty much the same effects as borrowing.  The main difference is who bears the immediate incidence of federal spending and who bears the long-term burden.  Short-term incidence of government finance has to do with whose income pays for government spending immediately.  Long-term burden of government spending has to do with  whose consumption opportunities are diminished in the fullness of time.

Incidence and burden of government finance change over time, as people adjust their behavior to government spending and the method of financing government spending.  The true incidence and burden of government finance are difficult to track, regardless of whether financed by taxing, borrowing, or outright money creation. But tracking the incidence and burden of debt financing and finance by money creation are much more challenging than tracking the incidence and burden of financing with taxes, which goes a long way toward explaining why politicians favor debt financing so much.
 

Everyone knows that money creation at too fast a clip --- a la the Fed --- is a really bad idea.  Just ask the Germans or the folks in Venezuela.  But slow-paced money creation isn't as serious --- certainly not a game-stopping problem.  In fact, some economists believe that a mild rate of inflation --- money creation --- is preferable to zero inflation, and certainly preferable to deflation.  The Board of Governors of the Fed certainly believes that proposition.  As it happens, money creation proceeds through federal borrowing, as students of money and banking know.

If the U.S. Treasury sells bonds directly to the Fed or some government agency (like the Social Security Administration), the U.S. Treasury is the first and immediate spender of the new money.  That's definitely a worry, but mostly because it places scarce resources in the hands of government operatives (operatives who produced nothing of value to get the new money and who will not pay a cost if they spend the money badly) instead of in the hands of private citizens.

If the U.S. Treasury sells bonds to anyone other than the Fed or another part of the government, the results are more convoluted.  But regardless of who first spends new money, if the rate of growth of new money exceeds the rate of growth of production of real goods and services, the end result is inflation --- an increase in the average of all prices sustained over a long period of time.  In America, the long-term rate of inflation has averaged somewhere between 2 and 5 percent per year for many years. 

The real burden of the debt --- the real reason we should worry --- is the transfer of the use of scarce resources from private hands to the hands of government operatives.  As Milton Friedman noted, no one spends the money of someone else as carefully or efficiently as we spend our own money.  That proposition seems especially true of government operatives and the 545http://econoblast.blogspot.com/2019/08/the-545.html.

The real problem of financing government spending by borrowing can be summarized as (1) placing bountiful amounts of scarce resources in the hands of government operatives who are not accountable for their decisions (our getting to vote every two or four years does not yield accountability, obviously), (2) obfuscating who is paying for the spending immediately and who bears the burden of reduced personal consumption due to the transfer of scarce resources, and (3) the reduction in technological advances and capital formation that results from transferring scarce resources away from private decision making to decisions made by government operatives and the 545.

This brief essay attempts to summarize some fairly challenging ideas in simple, terse terms.  I doubt seriously that it succeeds.  The most terse summary statement of the whole issue is this:

The real problem and worry about the annual federal deficit and the growing national debt is the government spending the debt permits.  The problem and worry would be pretty much identical if the same level of federal spending were financed by taxation.

Readers of this final summary statement will find themselves in one of three groups, more or less: (1) those who agree, (2) those who disagree, and (3) those who don't know whether to agree or disagree.  Pick your group.

Welcome to the Union of Socialist States of America

Now that the Supreme Court has upheld the constitutionality of the ObamaCare act and its individual mandate that requires all Americans to purchase health insurance, I challenge anyone who happens to read this post:  name anything whatsoever that the federal government cannot do.  You and I have no rights; the Constitution is dead.

Given the Supreme Court's decision today, June 28, 2012, it appears that the federal government can do anything the 545 decide to do.  The Supreme Court will not defend the Constitution.  If you have not read it already, I highly recommend The Road to Serfdom, by Friedrich Hayek.

As Judge Nepolitano said, the Supreme Court today "drove a camel through the eye of a needle" in the tortured logic of John Roberts's opionion.  Roberts argues that the requirement that citizens purchase health insurance is a tax.  Really, Chief Justice Roberts?  What has happened to the meaning of language?  I guess language has the same meaning as our Constitution; none whatsoever.