But in a fiat money system, survival is based on the adage, "Inflate or Die!" One does not get on the Federal Reserve board unless one has testified to Congress of the willingness to inflate to couteract a Kondratieff Winter event, which is something we've entered. Deflation destroys the welfare state as it destroys the entire fiat-based economy. This is why the natural tendency of politicians is to reflate any burst bubbles.
Paul Volcker has been lauded for "breaking the back of inflation", but all Volcker really did was move the inflationary bubble in consumer prices to stocks, setting off a 25-year secular bull market. The money also went into real estate. Confidence in the private sector had been restored, so money left government hands (cash and bonds) for assets in the private sector (stocks).
Over 25 years, that bubble got moved around, from real estate to stocks to real estate again. Now the bubble is in Treasuries, which are producing a negative rate of return as people run into the government's arms. As long as this continues, we will follow Japan's path into zero-rate hell. Survival of the system requires inflation, which is why we're trying one "stimulus" concept after another. The bubble needs to be moved into private assets again.
But if the supply of future bonds is to explode, where does the money come from to finance stimulus? The Chinese are altready discreetly moving out of bonds and into gold. Once we have our first failed auction and the rest of the world understands that the dollar can no longer be relied upon as a reserve currency, how do we finance our reflation efforts?
The answer comes from a scholarly paper published by the Fed in 2004. It suggested that because the government has a prior claim on IRA's and 401(k)'s due to their tax defered status, the government could seize those accounts and place them under the control of the Social Security Administration, which would create a huge pool of capital to finance government borrowing. This has already been brought to the attention of Congress but under a different guise. The argument is that because 401(k)'s are shrinking into 201(k)'s, government might need to take control of these accounts "for good of the people" to guide them into good, safe, reliable government bonds which will never lose value. Of course there will be a popular outcry.
This is where Richard McHugh and his "money drop" idea come in.
McHugh has argued that bailing out banks, Wall Street and Big Business are all well and good, but nothing will improve until Main Street is bailed out, and Main Street's problem is excessive debt. McHugh has suggested that Congress refund 5 to 10 years worth of income taxes to individuals and small businesses with the proviso that the money be used to pay down debt: credit card debt, student loan debt, car loan debt and -- most importantly -- mortgate debt. The remainder could be spent or invested. Those who were wise enough to avoid debt could spend or invest the full amount.
Denninger argues that this would lead to a hyperinflationary environment, which is true. But it would also solve the deflation problem that threatens to undermine the welfare state.
If McHugh's money drops were added to the mix to sweeten the seizure of people's retirement accounts, if would make the seizure acceptable politically. Your left hand gets robbed, while you get a money drop in your right hand. This is why I suspect both ideas will have a longer shelf life than Denninger suspects.
One of the reasons that Card Check is geting a good reception in Congress is to give workers more pricing power to support a more gentle inflation rather than find all the money running to stocks, gold and real estate.
Bottom line: Congress has to reflate this bubble unless it is willing to accept a return to the harsh discipline of the gold standard (or some other hard money standard), the end of the welfare state and the general shrinkage of the US government until it is small enough to fit into the constitutional prison that Madison designed for it. Congresscritters will never vote themselves out of a job, and the American people want nothing to get between them and their government checks.
In this political environment, deflation cannot be tolerated.
Cue the scary music and screams. I wish this were a joke. It's not. It's deadly serious. Just damn.
65 is brilliant. I am on my feet applauding.
I had to go and look:
The phases of Kondratieff’s waves also carry with them social shifts and changes in the public mood. The first stage of expansion and growth, the “Spring” stage, encompasses a social shift in which the wealth, accumulation, and innovation that are present in this first period of the cycle create upheavals and displacements in society. The economic changes result in redefining work and the role of participants in society. In the next phase, the “Summer” stagflation, there is a mood of affluence from the previous growth stage that change the attitude towards work in society, creating inefficiencies. After this stage comes the season of deflationary growth, or the plateau period. The popular mood changes during this period as well. It shifts toward stability, normalcy, and isolationism after the policies and economics during unpopular excesses of war. Finally, the “Winter” stage, that of severe depression, includes the integration of previous social shifts and changes into the social fabric of society, supported by the shifts in innovation and technology.
“McHugh has suggested that Congress refund 5 to 10 years worth of income taxes to individuals and small businesses with the proviso that the money be used to pay down debt: credit card debt, student loan debt, car loan debt and — most importantly — mortgate debt. The remainder could be spent or invested. Those who were wise enough to avoid debt could spend or invest the full amount.”
I don’t see as how Congress would ever possibly vote to refund 5-10 years of taxes, even if it were to their long-term advantage. If they were to pass a massive money drop, they’d do what they always do, which is raise taxes on rich people.
Great analysis. Thanks for your insight.
Obama is going after a political solution, not an economic one. In doing so, the pain is forestalled, but when it finally comes, it will be the harbinger of a fatal illness.