The current Depression

The accumulated debt run up by the central government and its provincial subsidiaries is going to be monetized and diluted out of the economy through inflation. Given the current political setup, it cannot be otherwise. Thanks to employer withholding of taxes, most employee/voters do not directly notice the cost of government themselves. This leads to all sorts of difficulties.

For starters, it means that spending cuts are politically impossible. Every program has those who benefit from it directly, and those people will fight like wildcats to protect their place on the gravy train. (SocSec and Medicare are perhaps the primary examples of this; this was visible back in the days of the Pepper Riots [1982].) Those who do not directly benefit will generally not feel strongly enough about the imposed costs of those programs to take action to reduce them. As it stands now, there are enough distinct programs, each with their own set of direct beneficiaries, to constitute a working majority of all voters.

Tax increases are also unlikely; they are more likely to be imposed on the larger corporations and wealthier individuals than on the average commoner (“Don’t tax You/Don’t tax Me/Tax that Fellow Behind the Tree !”). As we are seeing in states like New York and Maryland, tax hikes on the wealthy have the baleful effect of driving said wealthy out of whatever jurisdiction is doing the taxing. This causes a near-term revenue loss to those jurisdictions, and since most provinces have laws mandating balanced budgets, this causes near-term legal and political problems. Such taxes that are increased will likely be “special purposes” taxes or fees, like the proposed “soda taxes” in New York, or increased fees for parks entry or on professional licenses. They are more easily enacted than broader-based income taxes, but they have a much smaller tax base to draw revenue from.

That means that there are only two other choices for the raising of revenue: borrowing or debasement of the currency. The provinces are likely to resort to borrowing (“revenue sharing”) from the central government to solve their finance problems; most provincial charters do not specify how the budget is balanced, only that it is to be balanced. Indeed, we are likely to see California do this in the next few weeks. New York and Illinois will likely resort to this once California sets the precedent. In addition, provincial governments cannot coin money; thus debasement is a closed door for them.

The central government can also borrow or inflate. Given that the domestic economy is out of available borrowable funds, it must borrow from overseas, as it has been doing for decades. However, there is a limit to how much foreign lenders will provide absent a rise in interest rates (the higher the interest rate, the more attractive the bond, other things being equal). We are seeing the first hints of these limits with the recent statements by Chinese and Asian financial authorities. The current Administration has already committed to avoid. hiking interest rates; this would dampen an already much-reduced level of economic activity.

Let us also note that the incentives for the political leadership cadre are against any of these three options: political history clearly shows that presidents who preside over rising interest rates lose their jobs. (See J. Carter, 1977-1980.) The current dominant party is publically committed to maintaining and increasing the current level of State spending, spending cuts in any area other than defense would alienate their base. In addition, the current Administration is proposing increasing spending on several new programs, including nationalizing the health care system, as well as imposing new costs on the “private sector” economy through carbon taxes and financial regulations.

To the political mind seeking to retain its power and tenure in office, the choice is clear. Run those printing presses, blame the Chinese and the Bush Administration, and full speed ahead.

The next few years, financially speaking, are NOT going to be at all pretty for those commoners not members of politically-favored groups.

You Have Been Warned.

Your servant,

Lord Karth

It would be interesting to see what sort of future Lord Karth would have predicted for the USA in the late 1940s, when we had a truly phenomenal debt load, had committed ourselves to rebuilding Europe and Japan, were facing the need for continued massive military spending due to the onset of the Cold War, and also found ourselves with our non-productive dependent population (the first wave of the Baby Boom) exploding, requiring lots of both public and private spending. Surely the 1950s should have made the Great Deression look like a cake walk when viewed through the lens of Doom and Gloom we have been presented with here.

Re: The differences between the USA of 1949 and the USA of 2009 are manifest and manifold

True, but none of that means arithmetic operates differently, and we are dealing with numbers here.

Re: In 1949 the USA had just emerged victorious from a war. In 2009, the USA is mired down in not one, but two “wars of choice” that show no signs of ending.

In 1949 the US was on the verge of a war of choice (Korea) and as I mentioned it was ramping up military spending in response to the Cold War. Our military commitments at that period were far from minimal.

Re: In 1949 the USA was the only significant industrial power that was untouched by the war.

Nonsense. Canada, Australia and Sweden were also untouched. Britain had suffered fairly minimal damage. And by the mid 1950s even Germany and Japan were back up and humming. More to the point though exports were not a major factor in the US economy, then or now. Unlike Japan or China (now) we did not export our way to prosperity in the 1950s.

Re: In 1949, the USA had a far smaller central government than it does in 2009.

In some other world's history perhaps. The main expansion of the US government occured during the Great Depression and WWII. Those were done deals by 1949. The Cold War moreover was already driving further expansion. And in some ways the US economy, for good or ill, was more tightly regulated then than it is now.

Re: In 1949, the USA did not have an entitlement-spending burden

In 1949 we had the Baby Boom beginning. That meant a sharp rise in the number of non-productive consummers, just as the looming Baby Boom retiremnt does today. From an economic perspective what matters is the ratio of pridcers to consummers, and the age structure of the population does not really matter. So yes, we had an entitlement burden since all those children were entitled to being supported one way or another in return for which they provided nothing material to the economy.

Re: In 1949, marriages and families were far more cohesive than they are today

This is true, but I'm not sure I see any larger relevance to it.

Re: In 1949, the USA was a major creditor country. In 2009, the USA is the world’s largest debtor.

Are you claiming there was no national debt in 1949? That, I believe, is completely false. I don't have the figures at hand, but in 1945 at least our national debt was far larger, proportionally, than it is today, or is likely to become.