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Debt Trap

by Archives January 13, 2009

One could almost hear the pulling of hair and gnashing of teeth, as the rate of unemployment in the United States rose to a 16-year high of 7.2 per cent, amidst moans of recession, depression and Gotterdammerung!
Congress, the Treasury, and President-elect Barrack Obama certainly heard it – as they engaged in all manner of Keynesian chicanery to stifle the wailing of the hoi polloi. It’s too bad that instead of bailing out the economy, their proposed stimulus will actually quench growth for a generation.
According to the latest numbers from the Obama transition office, his administration is looking to spend $775 billion on infrastructure, tax credits and “job creation.” This commitment comes on top of the $700 billion Troubled Asset Relief Program (TARP), the nationalization of Fannie Mae, Freddie Mac and AIG, any future auto industry bailout, and Bush’s $150 billion tax rebate.
These kinds of counter-cyclical policies are frequently applauded by New York Times columnist and Nobel Prize winner, Paul Krugman. Evoking Depression Era economist John Maynard Keynes, he argues for the unrestricted expansion of government in order to stabilize aggregate demand and thereby end the recession. But as Milton Friedman notes in his works, one major problem exists with this approach; the money for increased federal spending won’t simply materialize out of thin air.
Since neither the ascendant Democratic Party, nor the American people, have the stomach for fresh taxation, the traditional means of paying for government is out of the question. In any case, economists of all ideological colours agree raising taxes in a recession is a major no-no. Thus, the only way for the federal government to meet its rapidly multiplying obligations is to issue more debt.
At the moment this isn’t a problem. While stocks, bonds, and real estate have crumbled, scared investors continue to pour their money into relatively “safe” United States Treasury bills (T-bills). Demand for these sovereign debt instruments has been so strong the Treasury actually issued three-month bills with a yield of 0.0 per cent – effectively borrowing money for free.
Now, if this state of fiduciary bliss were to continue ad infinitum, then the United States government would have nothing to worry about. Eventually, however, the credit crisis will ease, asset prices will stabilize and demand for T-bills will dry up. Therein lays the rub.
Already, the bipartisan Congressional Budget Office is predicting a $1 trillion federal deficit for the 2009 fiscal year. This number is likely to grow. What will happen in six to 12 months if the Treasury tries to turnover its debt and the market balks? What if China, Japan, the Gulf Monarchies and Russia, lose their appetite for more ultimately worthless fiat United States currency?
In this not-unlikely scenario, the Federal Reserve will have to navigate a veritable Scylla and Charybdis of economic doom. Will they jack up interest rates to Reagan era levels, spurring demand for United States debt, while causing a deep, unforgiving, recession? Or, will they print trillions of American dollars, take the debt onto their own books, and give us another lost decade of “stagflation” akin to the Nixon-Carter 70’s? Neither option is particularly inviting.
And yet, the rabble continues to cry for bread, butter and Medicare benefits. So the representatives of both parties will continue to pander – ignorant of the monolith of debt wobbling over their heads. Eventually, I fear, we’ll all be forced to dine on the fruit of their fiscal irresponsibility.

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