Austan Goolsbee, chairman of the U.S. Council of Economic Advisers, said if Congress fails to raise the debt ceiling, the “impact on the economy would be catastrophic.”
“I don’t see why anybody’s playing chicken with the debt ceiling,” Goolsbee said today on ABC’s “This Week” program. “If we get to the point where we damage the full faith and credit of the United States, that would be the first default in history caused purely by insanity.”SOURCE
Austan Goolsbee is right - up to a point. Either politicians don't understand our monetary system, or they are risking an immediate deflationary collapse of the US economy in order to score points with an economically ignorant constituency. The United States, thru Congress, has a self imposed debt ceiling that has been moved up higher multiple times since its inception in 1917. The debt ceiling is a construct of the gold standard era, when government spending and the price of gold were managed together. Today, however, it is a political hot potato that no politician wants to be seen holding for long.
But if we look to Modern Monetary Theory (MMT), the debt ceiling should not be something to be concerned about in times of severe economic and credit contraction. However, our trading partners may think otherwise. MMT sounds like a great way to manage a monetary system when viewing the domestic economy, but viewed globally, trading partners and the market in general, ultimately decide the value of a currency. Thus China is increasingly entering into non-dollar denominated trade agreements, and the role of the US Dollar, as reserve currency, is diminishing. Furthermore, the currency wars are still ongoing, as well as the institution of capital controls. These cannot be ignored in my opinion, They are a direct result of the US's management of the US Dollar.
But back to the debt limit, and why it is important that it should be raised. Money is created by both lending in the private sector, and by government spending. If the money supply is contracting, a deflationary force begins to grow, impacting the ability of people and companies to service their debts. Debt defaults commence, and a feedback loop of money destruction begins. This is what worries those that understand our monetary system today. An economy, unlike a private person, can not be told to cut spending to "balance the budget." If a person gets a pay cut, he must cut down his expenses. But if an economy gets a cut in the money supply, a debt destruction spiral begins as less money is available to pay the growing interest in an economy.
As I said earlier, money is created by the private banking sector's generation of loans (out of thin air) and Government Spending via the relationship between Congress, the Fed and the Treasury. So we must ask ourselves, how strong is private credit growth? Let's look at some charts:
(click on charts for larger image)
Pretty scary, right? The last chart tells us this global to a large degree. But here's the other issue: As money is created in the current environment, there is a diminishing rate of return on every dollar created:
And GDP has been growing at a much slower rate than the total debt and corresponding interest payments. And so, the US Government, through deficit spending, and the Federal Reserve, thru QEx, where "x" is the latest version of electronic money creation, need to both step in to pick up the slack.
Nonetheless, people need to understand that the government's actions, although contributing to a small bump in GDP growth, are mostly successful in delaying an inevitable collapse and not creating a sound, organically growing economy.
I know that MMT'ers believe in the sound stewardship of money, and they too disagree to a large extent with the bank bailouts. But their theories rely on political, fiscal, and monetary leadership that does not exist in the real world. And they, like modern Keynesians and Monetarists neglect to understand the role of credit in a purely fiat system that never allows debt to be truly extinguished. Debt between nations under a gold standard was truly extinguished. Gold, unlike government bonds, settled accounts in a way that extinguished debt completely. Today's fiat is always born of debt and allows both debt and trade imbalances to accumulate to such a degree that only collapse is the inevitable and unavoidable endgame.
And so, the debt must grow. It is the only option we have left that allows us to continue this charade of "wealth creation" and maintaining the status quo. At this point, to be honest, if I were a politician, I would be doing the same thing. The masses are too economically ignorant. And to force a depression, or to force a tumultuous change in the monetary system for a better future would be an act of political suicide. My only contention is that our current leaders are still selling out to the same vested interests that to a large degree, caused this crisis. Whereas basic mathematics tells us the system needs to grow until it collapses by itself, morality does not have to be ignored. Who gets the money and why has been a major issue for me. Whereas the top 1% have prospered in this crisis, the bottom 90% has felt the most pain.
My next post will be on the three things to watch for 2011: The Ten Year Treasury Yield, the Price of Oil, and the Price of Gold. These are the three canaries in the coal mine, and so far, they are not looking too healthy, that is, their costs are rising. This tells me that a major crisis is brewing for 2011.