"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Friday, February 4, 2011

Bernanke: Failure to Raise Debt Limit "would be catastrophic"

I have often said that the US, barring complete incompetence, can never default on its debt. Well, it looks like Ben Bernanke is worried that the US Congress may be more incompetent (or self serving) than most think.

How else can one explain his recent statement:
"Beyond a certain point ... the United States would be forced into a position of defaulting on its debt. And the implications of that on our financial system, our fiscal policy and our economy would be catastrophic," he told the National Press Club.
But Bernanke also qualified this statement by addressing the budget deficit issue:
"I would very much urge Congress not to focus on the debt limit as being the bargaining chip in this discussion, but rather to address directly the spending and tax issues that we have to deal with in order to make progress on this fiscal situation," Bernanke said.

Ben Bernanke is right.  Failure to raise the debt limit would create the conditions for default. The debt limit however, is an artificially self imposed constraint for the US.  Why?  Because the US is not debt constrained like you and I are.  The US government, unlike us, can print its own currency to pay for the things it needs to buy.  It actually does this all the time.  But please, don't let the little people know about this.  This is a trick of the elites.  More on that later.

So this debt limit, an artificial construct, still has real world implications.  To exceed the debt limit would destabilize the sovereign bond market.  After all, it would signal a "default" on the part of the US, however real or imagined.  I say that because even though the US can, and does print at will, the system still needs to "look" sustainable.  We make the system "look" sustainable whenever we measure the economy or the US fiscal and solvency "crisis" using certain metrics like debt to gdp ratios, budget deficits, national debt figures, and entitlement expenditures.  And so, the market's perception becomes everyone's reality.  If the market thinks your country is insolvent, then you will pay higher interest rates for everything.  Unless of course, an outside source (IMF, ECB, in case of the EU) steps in to artificially manipulate the market.  Cause and effect.  Simple as that.

Thus, the US needs to raise the debt limit once again, as it has done countless times in the past.  But there is another issue that Ben Bernanke fears.  That's deflation.  You see, the private sector can not increase its savings or have extra money available to pay down debts unless the public sector takes on debt.  As I have said before, it's basic double entry book keeping.  If the US can not sell more debt due to the debt limit constraint, then the US Congress also in effect, imposes limits on its spending.  That means less money in the economy for you and I.  Unless you're a large bank.  Those critters always have sneaky ways of getting, or just creating money.

So what happens to the money supply if the US stops spending in this environment?  It stops growing.  To make matters worse, the US is a trade deficit country.  So it needs to "finance" its consumption through debt (money) growth. And finally, the US private credit market is still suffering.  Bottom line: there is no other source of money growth other than the US Government thru deficit spending and quantitative easing.

Economies, unlike say, the human body, need to grow forever.  But like the human body, an economy needs a blood supply.  You can't expect the economy to grow if you stop the blood supply from growing.  Things break down.  A deflationary debt collapse ensues as there is less money available to service existing debts.  Debt defaults spread, creating a feedback loop of further debt defaults, ending in a deflationary collapse: a severe contraction in GDP, much like the Great Depression of the 1930s.

So why is Congress bickering, and why is Bernanke (unsuccessfully) trying to paint a dire picture for the average person?  Because the average person has no idea about how the monetary system actually works.  The average person suffers due to this ignorance.

The elites, especially the banking elites, are well aware of this.  They know they can grow the money supply whenever they need a bailout.  But what of the upcoming entitlement programs? What about pensions, medical care for seniors, unemployment benefits, etc?

Well, even the US faces constraints.  The US can't grow the money supply faster than the economy can grow. That would invite strong inflation as there would be much more money available than things to buy.  I believe this is already happening.  So there are limits. And with those limits, things will need to be cut.

What things?

The things the little people need.  Like medical care for seniors, unemployment benefits for the unemployed, police forces, safe and clean parks, etc..  And so, the ignorance of the little people will lead to the demise of their own living standards.  

And they'll eventually accept these cuts evetually.  Why?  Because of their ignorance. Because they think the US Government is debt constrained the same way they are.  After the elites are finished plundering the government, "fiscal sustainability" will be the new catch phrase that the little people will adopt.  And they will welcome it, and the Stock Markets will continue to rise as poverty sets in.  But fiscal sustainability is not the real issue here.  The real issue is the value of the dollar.  You can't print with abandon without devaluing the currency. So there is a fine line here, a conflict.  You need to grow debt, but you need to maintain the dollar's value.

So in the end, the little people will be forced to suffer to maintain the value of the dollar.

Then the US will look like Egypt does today.

Doubt what I'm saying?  There is a chart that shows the wealth disparity found in most countries around the world.  It is called the GINI Coefficient.  From Wiki:
The Gini coefficient is a measure of the inequality of a distribution, a value of 0 expressing total equality and a value of 1 maximal inequality. It has found application in the study of inequalities in disciplines as diverse as economics, health science, ecology, chemistry and engineering.
It is commonly used as a measure of inequality of income or wealth.[3] Worldwide, Gini coefficients for income range from approximately 0.23 (Sweden) to 0.70 (Namibia) although not every country has been assessed.

(click on chart for larger image)

If you look at the chart, it shows that the US is already worse than Egypt.  Sure, the US standard of living is much higher than Egypt's and so, the average person in the US is still better off than the average person in Egypt.  That's true.

But as the US middle class gets decimated due to unfair trade agreements, lax immigration policies, a once again rising in strength parasitic banking system, the upcoming inflation that will hit the US Dollar, and diminishing entitlements, the average American will one day ask: "What happened to the American Dream?"  

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