By the end of
March, Barack Obama's administration will face its destiny, its Brutus a pawn
of the fates.
In Jimmy Carter's
presidency, the Wall Street Journal editorialized
about "Ratcheting to Ruin." The title derived from the fact that each cycle
high in unemployment was higher than previous ones, and each cycle high in
inflation was also. "Stagflation" was the neologism coined to describe what up
until then was believed to be impossible in the Keynesian world. This period
ushered in a new era in both politics and economics. Carter was replaced by
Reagan, and Keynes was replaced by Friedman.
Thirty years
later, Keynes is back in vogue, Obama has ascended to the White House, and
times are reminiscent of the Carter era. The economy is awful. Fear and
dissatisfaction prevail. Politicians are held in contempt. There is one
major difference -- Carter did not face an "ides of March" event.
In Shakespeare's
Julius Caesar, a soothsayer warns Caesar to "beware
the Ides of March." The prescient warning did not help Caesar. As Obama
approaches his March moment, no warning can change his fate.
Ben Bernanke
promised to end Quantitative Easing (the
printing of money to stimulate the economy and fund the deficits) by the
end of March. Some believe his commitment was a "campaign promise" to ensure
his Senate reconfirmation. Others believe it was a real commitment,
necessary to maintain a stable dollar. Shortly, the world will find out.
Mr. Bernanke,
quite unintentionally and through no fault of his own, will be Obama's
Brutus, regardless of his decision. To understand why, some numbers are
necessary. Government needs
funding this year of $2.0 trillion (that includes the federal budget
deficit, off-budget spending, and state and local needs). Private industry
needs about $0.5 trillion. Part of the funding will come from the country's
savings. Total gross savings (new savings) is estimated to be $1.5 trillion.
Assuming all savings is available, a shortfall of $1.0 trillion exists.
This shortfall
can be met from two sources:
-
Foreign lending
-
Quantitative
Easing (QE)
Another possible
source could result from a reallocation of existing savings, as would happen
in a major
stock market decline. That outcome cannot be quantified. Furthermore, a
stock market rise would produce a drain of funds from debt markets. Either
effect is one-time, therefore not a continuing source of funding.
As the need for
foreign
investment increases, foreign willingness to lend is declining. Two
reasons are apparent: worries about the sustainability of our
deficits/dollar and large foreign needs for capital at home.
Martin Crutsinger
reports:
The government
said Tuesday [last week] that foreign demand for U.S. Treasury securities
fell by the largest amount on record in December with China reducing its
holdings by $34.2 billion. The reductions in holdings, if they continue,
could force the government to *make higher interest payments at a time
that it is running record federal deficits.
The Treasury
Department reported that foreign holdings of U.S. Treasury securities fell
by $53 billion in December, surpassing the previous record of a
$44.5-billion drop in April 2009.
Accuracy in fund
flows is difficult to obtain. Foreign investment of all types appears to
have increased about $500 billion last calendar year. If all of that were
for government debt, then our Fed would have bought, directly or indirectly,
another $500 billion. That amount of QE is significant, representing about
25% of government tax receipts. It represents a rise of over 60% in Fed
assets using a pre-crisis base. In a normal economy, a monetarist would
likely claim that continuation of that expansion rate would result in annual
inflation of at least 60% per year. Another 140% increase resulted primarily
from Fed purchases of distressed assets from the banking industry.
Foreign funding
was insufficient last year and will be even more so this year. The deficit
will be larger, and foreign funding will be smaller. QE must be larger.
There is no way to fund these deficits without QE.
The problem is
bigger than the numbers above might suggest. Budget forecasts show that the
problem increases over time. In addition, 40% of existing debt matures in
the next year. That means $2.8 trillion of debt has to be refinanced. The
Treasury must sell on average $90 billion of debt a week! In five weeks, we
need to sell $450 billion. That is equal to the largest full-year deficit in
history, at least until Obama's first year.
There are no
plans to curb spending or cut deficits. President Obama just increased the
debt ceiling by $1.9 trillion. To outsiders, we appear like a banana
republic with ICBMs. Does anyone seriously believe that funding based on
"the kindness of strangers" is workable much longer?
Bernanke has two
options, neither of them good. He can do what he promised and stop QE. Or he
can renege on his promise. Either alternative has radically negative
consequences for the country, Bernanke's role in history, and Obama's
presidency. If Bernanke stops QE, he fulfills his role as an independent
central banker. Presumably, that action stops the decline in the dollar and
reduces the risk of future inflation. It was the course that Paul Volcker
chose in the late 1970s.
Volcker's action
was bold, highly controversial, and highly criticized. Volcker's action had
the support of President Reagan, who was willing to face short-term
unpopularity to fix the economy. Bernanke's task is harder than Volcker's.
Volcker stopped the economy dead in its tracks. If Bernanke ends QE,
he will stop both the economy and the federal government
dead in their tracks.
Without QE, the
government will be unable to honor its obligations. Non-payment of Social
Security or Medicare or federal payroll or welfare checks or
retirement checks, or military payroll, etc., etc., would show up almost
immediately. That would jeopardize foreign (and domestic) purchases of
additional federal debt, exacerbating the problem.
Bernanke's
second option enables the government to continue operating irresponsibly
until market forces eventually stop the profligate behavior. Market
discipline would likely be imposed in the form of a collapse of the dollar
or raging inflation (or both).
Under either
scenario, the Obama presidency is destroyed. Obama probably prefers the
second option, because it might extend the period before sovereign
bankruptcy. However, it might not extend it very much. Foreign bankers have
chastised our behavior regularly. If the Fed is perceived as "The Great
Enabler" rather than as protector of the currency, a run on the dollar and
the dumping of Treasuries could result.
From Bernanke's
standpoint, it is not clear which option he might prefer, or if he even has
a choice, given Congress' involvement. If he behaves like a central banker
and pulls the biggest punch bowl in history away, it would force the
government to address its problems before they became more serious.
History will not
look kindly on this period regardless of Bernanke's decision. Bernanke never
had a chance for a favorable legacy. If he plays his role as a central
banker, history may be less unkind, stating, "He did what he had to do." If
he chooses to continue QE, it likely will judge him as "The Great Enabler,"
rating him even less favorably than they did his predecessor.
Obama loses
either way. He inherited a difficult situation, but then, via foolish
policies, he turned it into a terminal one. At this point, Jimmy Carter may
be the happiest person in the country. His lead position in the Pantheon of
Shame is in jeopardy thanks to Obama.
For the country,
times equivalent to the Great Depression are likely ahead. My guess is that
Bernanke chooses (or is forced into) continuing QE. Courage is a rare and
dangerous commodity in Washington. Hard decisions occur only in crisis.
When the country is perceived and treated by
the world community as the wastrel it has become, then remedial action will
take place. Hopefully, something is still salvageable.