When Will Keynesian Policies Lead to Another Default?
The massive levels of government debt and even larger government unfunded liabilities, much of which have not been properly accounted for, are weighing down on the economy. Today across America many cities and states stand on the edge of default. The Federal government which has seen it debt levels explode over the last number of years to 20 Trillion Dollars and a debt to GDP ratio at 103% and climbing. (see: DebtClock)
These are very dangerous times in the world of debt fueled economics. Of course this massive debt problem does not just exist in the US. Both Europe and Japan have thrown out the book on fiscal responsibility. They are in full debased currency mode, while buying markets higher. They have placed their futures at the roulette wheel, betting it all on red. What could go wrong with this strategy of gambling the global economy on irresponsible debt expansion and socialize capitalism. Heck when it all goes to hell in a hand basket just print more money. It has just worked wonders since 2008.
Today the US economy, as is much of the western world, is saddled with massive levels debt and absolutely no ability or desire to repay. In fact if you look at the behavior of many of the largest central banks the solution has been to fuel reckless government spending with nothing more than a printing press. Buy up government treasuries and keep interest rates low is right from the Keynesian playbook. Once again what could go wrong with massive unchecked monetary expansion. The big brains at the central banks call it Quantitative Easing or QE for short. Its their magical solution to make up for decades of catastrophic monetary and fiscal management.
Of course none of this should come as a surprise. It was this kind of reckless behavior by central banks which led the US off the gold standard in the first place. Once the US removed the backing of the dollar with gold in 1971, the cat was out of the bag and it was a free for all as the monetary base exploded and the dollar plummeted in value.
Perhaps at that time the media was not equipped to understand what was truly occurring, until years later, but the consequences were very destructive. With that said the mainstream media today are mostly ignoring the current red flags as the economy teeters on the edge.
None of the occurrences which lead to the current economic state happened overnight, nor did it happen in a vacuum. There has been a slow and methodical corrosion of fiscal and monetary responsibility throughout the land. It has been a steady system debasing currency through massive expansion of the monetary base in order to replicate real economic growth. But instead of facilitating growth through conditions that encourage business expansion leading to increase capital investments and thus increase productivity per capita , we have instead choose the path of encouraging share buy backs through massive expansion of corporate debt, while discouraging capital investment and watched business run from a once envied fiscal climate and surging business environment. What we have left is a very broken domestic economy. Luckily the Fed has been there to attempt to paper over the fiscal mess created by our political leaders, with Keynesian hocus pocus. As a last ditch effort to spur some economic growth from this tired economy, they have done everything in their power to encourage a massive expansion of debt. So today we have an economy flooded with debt and very little real growth to show for it and a central bank (The Fed) looking to raise rates.
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| The S&P Stock Price Index has moved in lockstep with the expansion of the Fed's balance sheet. |
Looking back there has been a long been a struggle between those who wanted a structured monetary system with a currency back by something of intrinsic value such as gold and silver versus those who wished the currency expansion not be restricted by physical assets. Politicians have always been aware that limitless monetary expansion is the much easier option to keep the population happy short term. You can just paper over bad policy decisions if you have access to limitless debt expansion and then kick that can down the road for the next generation to handle. So they keep making bigger and bigger promises and keep driving the debt levels higher and higher to pay for them. Even today maintaining the debt ceiling at current levels is considered completely insane. Screw the future generations, because we want our stuff now. Sorry kids, but your happiness needs to take a backseat so the baby boomers can live well. They just borrow on the backs for their children and forget all about it. No wonder there is massive disillusion among our youth and it will only get worse moving forward.
The genesis of this mindset came in the 1930's when after the election of President Roosevelt, the United States aggressively pursued Keynesian endorsed deficit spending at a pace never seen before. The expansion of government expenditure ripped to all time highs, as did the expansion of government debt. The Keynesian theory was a huge gift to the political elites who no longer had to worry about, or even consider balancing the books and could ignore long term fiscal responsibility. They could focus in on making big promises and not bother worrying about tedious things like cost. It was a period of mass government spending on government wish lists with little to no concern about the books and how to balance government revenue with exploding government expenditures. Encouraging economic growth through investment and expansion of American productivity was largely ignored. It was spend, spend, spend on government programs and rest will take care of itself, somehow, someway.
The US industrial base and thus the US economy benefited greatly from the tragic development of the Second World War. It profited from mass production of weaponry and other products as the industrial capacity of Europe was steadily in decline and demand for safe reliable industrial production increased. The United States then profited greatly from the rebuild of Europe and Japan, post war, through the Marshal Plan. The US industrial expansion post war was fueled by a world in need of products in order to rebuild. This reality catapulted the US to the top of the economic food chain and any negative impact of irresponsible government policy was masked by global demand.
After the end of World War II the world's largest economies entered into a new global monetary model called the Bretton Woods Agreement, where the US dollar became the reserve currency of the world. The dollar, which was to be backed by gold was to provide stability to the world's other economies recovering from a devastating war. Everything was set to create a stable global monetary system.
While everything started off well, the cracks in the new monetary system eventually began to appear, as it became evident that the US was not living within the parameters of the agreement. As it became apparent that the US did not have the gold to back its endless deficit spending on such things as new wars and its new space program. As a result nations started to demand their gold reserves back from the US and then converted their dollar reserves back into gold, as per the Bretton Woods Agreement. This lead to a devaluation of the dollar, as the trust in the world reserve currency continued to decline.
The decline in the trust of the US dollar resulted in more nations questioning the Bretton Woods system. In a famous press conference in 1965, Charles de Gaulle, President of France called into question the US currency as the world's reserve currency, as it created an unfair US advantage.
A new independent secondary gold market opened called the London Gold Pool, which saw the actual price of gold deviate from the pegged price of the US dollar. Even after attempts by the US treasury to manipulate the price of gold back in line, the government found it more and more difficult to keep the value of the dollar equal to its $35 per ounce of gold peg price, as more more and more people and institutions looked to profit from the price deviation between the US Dollar peg value and the open market price of gold.
This lead to August 25, 1971, a very important date in US economic history. It marked the US decoupling of the US dollar from the gold standard and thus defaulting on its debt obligation. Up until then each and every US dollar was supposed to be backed by gold and each dollar could be converted back into gold, as set out in the Coinage Act through the Gold Standard and again in the Bretton Woods Agreement Act of 1945.
In 1971, all US currency and thus debt denominated in US currency, was no longer backed by gold. The government unilaterally decided that it could no longer maintain the gold standard, as the desire to massively expand the monetary base outweighed the benefits of a stable and equitable economic base. The promises made by the US government to repay its obligations in a gold backed dollar worth 1/35th an ounce of gold been defaulted on. By 1980 the US dollar was worth only 6% of gold standard value. Any way you want to put it, repaying 6 cents on the dollar is a default on debt.
In the place of the gold standard we were given a fiat monetary system, which aims to devalue the currency annually through inflation. Of course initially the target was to keep inflation between zero and 1.5%, but that has been replaced by a hard target of 2% inflation every year. Any semblance of stable currency has long been forgotten. Today the US Fed pushes harder and harder to generate what seems to be smaller and smaller economic growth, fueled by larger and larger levels of debt and debased currency.
Furthermore market risk has been largely socialized by central banks, who buy up bad debt, as a means to keep the ever growing debt bubble alive a little longer. Centrally planned crony capitalism has replaced actual free market capitalism. There is absolutely no confusing the two. Market volatility has been eliminated, as has true price discovery via massive QE programs around the world. Why should the markets feel fear, when its just a matter of the Fed and other central banks printing a few more trillion dollars and thus large amounts of market risk can and has been simply consumed by government.
Under this system, the super wealthy have been able to reap massive benefits without absorbing any of the risk of excessive leveraging, while markets keep climbing without any sense of market risk. Huge levels of risk taking is firmly endorsed by the Fed's policy, while volatility risk itself have been monetized away. Nearly a decade of ridiculously low interest rates have allowed massive debt bubbles to form and none of the risk has been priced into the markets.
When I say the super wealthy I am not referring to the so called 1% which the left leaning protesters blindly want to crucify, which would include doctors, moderately successful entrepreneurs and many seniors who saved their whole lives for retirement. I am referring to those who hold the most economic influence in society. Those who are most able to influence government policy through lobbying and social engineering.
As strange as it might sound, many people suggest that not every mass social outburst we see on TV is exactly what it seems. That perhaps there is "big money" pulling the strings behind the curtains. That there are funded organizations who have the ability to guide social narrative to reach the masses in pursuit of certain goals. Once the US dollar was taken off the gold standard the path was set to where the average Joe or Jane had little to no chance as the game was firmly fixed in favor of those holding the balance of power.
The creation of massive debt bubbles have allowed debt fueled consumption to occur, but those days seem to be coming to an end. Consumers are tapped out and the levels of delinquent loans are on the rise. Surely raising interest rates will not help the situation.
The problem is when market risk is forced to be repriced back into the market, people will be forced to acknowledge the the Keynesian fantasy has brought the nation's economy back to the brink of collapse. Massive debt bubbles have a tendency to do that. This will result in the Fed falling back to its desperation move. The next time the Fed chooses to debase its currency and initiate another round of QE to backstop the markets, bond holders will be left holding the bag, as debt is further monetized. Continuous rounds of debt monetization is just another form of default. Until then we can pretend all is well as the Fed prepares its quantitative tightening.
Seeing that we recently passed the anniversary date when President Nixon "temporarily" took the US off the gold standard, we should take a moment to mark the day the US default on its obligations.
As President Nixon said " A strength of a nation's currency is based on the strength of that nation's economy."
Today the US currnecy is based on an economy that is crippled by a massive levels of debt and unfunded liabilities. The very tip of the iceberg is only beginning to show, but the damage has already been done. The time to manage this problem has long since passed and QE4 will be the go to move when this debt bubble starts to lose air. The US Dollar is based on an economy that is destined to further monetize its debt and further debased its fiat currency.
