Criminal State, Washington Politics

Deflation, Inflation – Take Your Pick

U.S. stock markets rallied to recent highs on news that the U.S. Federal Reserve planned to pump up to $900 billion more cash into the economy. Financial markets reflect today’s appraisal of tomorrow’s cash flows. More cash means more flows.

Fed Chairman Ben Bernanke conceded early on in 2008 that the Fed was “printing money.” With a computer entry, $1.2 trillion in toxic mortgage-backed securities were taken off the books of the banks by crediting their reserve accounts at the Fed. That candor proved unsettling. This latest cash infusion is “quantitative easing” or “QE2.”

“QE1” stabilized financial firms that cross-collateralized massive layers of debt and derivatives in a creative scheme that was destined to collapse without…more cash flow. Washington’s Troubled Asset Relief Program (TARP) authorized $700 billion for that purpose.

Insurance giant AIG booked profits by selling more than $440 billion in credit default swaps, a form of insurance, without setting aside reserves. That’s when the Fed stepped in with QE1.

Voicing his admiration for “financial creativity,” former Fed chair Alan Greenspan enabled this pyramiding of debt-on-debt with low interest rates and lax oversight during his 19-year tenure.

Greenspan concedes his high regard for Russian philosopher Ayn Rand (né Alisa Rosenbaum) who famously wore an oversized dollar mark as a broach. Her philosophy: grant money the freedom to work its will worldwide and everything will work out just fine.

Reflecting on the debt-induced financial carnage he helped create, Greenspan recently marveled that financial markets were not, as he and Rand believed, “self correcting.” How could this True Believer have been so mistaken? Why does his successor not yet see the problem?

Answer: both men share a mindset from which the problem cannot be seen because that mindset is the filter through which they do their seeing.

This money-myopic perspective, imbedded in American education over decades, first appeared in the U.S. as the “Chicago model.” The late University of Chicago Professor Milton Friedman, a Noble laureate economist, remains the patron saint of this “monetarist” perspective.

As this dollar-centric ideology was taken to global scale, it became the “Washington consensus.” Generally accepted truths are seldom revisited even when, as now, a reappraisal is long overdue.

Dollar Infatuation = Deflation or Inflation

The Fed is rightly worried that the economy is slipping into a debt-induced deflation akin to Japan’s “lost decade.” As the U.S. deleverages, it could face a similar fate. QE2 is meant to counter deflation yet it could trigger expectations of inflation. That’s the risk when banks start printing money. History offers reasons to worry.

WWII was triggered by an onerous reparations burden imposed on Germany at the Treaty of Versailles ending WWI. British economist John Maynard Keynes left those negotiations to publish a warning in 1919 titled The Economic Consequences of the Peace.

The resulting indignities of widespread poverty and hyperinflation fueled a hyper-nationalism from which emerged the fascist forces that ravaged Europe. The U.S. emerged with an industrial base that ensured its bonds would become the world’s preferred gilt-edged security.

Keynes resurfaced in the 1930s to advocate the debt-financed stimulation of demand. The 1980s saw a debt-financed “supply-side” successor—to stimulate investment. Both deployed public debt to boost private-sector cash flows.

With lower tax rates and faster depreciation, the supply-side program was projected to reduce government revenues by $872 billion over five years. With this stimulus, the Reagan era catalyzed a three-decade debt binge further enabled by the easy credit era of Alan Greenspan.

When Reagan was elected in 1980, securitized U.S. debt totaled $900 billion. The total is now on track to top $15.4 trillion. By 2020, annual interest payments alone could top $1 trillion.

Monetization of What for Whom?

Will this cash infusion fuel inflation?  QE2 differs from QE1. With the mid-term elections signaling political gridlock, Fed-induced liquidity relieves pressure on the federal budget with, in effect, an interest-free loan.

In the interim, are we seeing another skimming of financial value from yet another Fed-lifted equity market?

By fixating solely on how debt-backed dollars can revive a deflating economy, those who induced the U.S. to embrace this monetarist mindset may yet induce a crippling inflation. The year 2013 is the 100^th anniversary of the Fed. The way out may well be found in a willingness to view “monetization” anew.

Who decreed debt as the only way to catalyze demand? Who says monetization must be limited to one-size-fits-all Federal Reserve notes? Why not encourage complementary currencies attuned to the needs of regions and communities?

Are Americans expected to shop their way to sustainable prosperity with debt-backed dollars? Rather than debt, why not monetize the physical capital required for a clean energy economy?

Americans are witnessing record-breaking disparities in wealth and income. Why continue on the same path that enabled this fracturing of U.S. society where the top 1% possess more net worth than the bottom 90%? Why not monetize a sustainable future with means that ensure a shared prosperity?

To solve this problem, first we must acknowledge how the U.S. was induced to embrace a mindset that requires more debt to create more purchasing power.

This problem can only be solved “upstream” commencing with a candid reappraisal of its origins in a shared mindset.