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US Economy Still on Life Support

The Tea Party and the Looming Financial Cataclysm

Politics / Government Spending Jun 14, 2010 - 03:33 AM GMT

By: Gary_North

Politics

Best Financial Markets Analysis ArticleThe phrase "Tea Party" is synonymous these days with the politics of spending cuts. The big one is the compulsory health insurance law. Tea Party people want it repealed. Yet in the grand scheme of things fiscal, that law is a drop in the tea cup.


In my previous report, "A $600+ Billion Spending Cut," I suggested a sure-fire way to cut a big chunk of spending out of government budgets: local, state, and federal. Stop funding all education. The typical voter reads this and thinks: "But that would end all progress." There is no constituency for such an across-the-board spending cut. The Tea Party has not recommended it.

There are other cuts possible – much larger cuts: end both Social Security and Medicare. Same response, only louder.

This is why Keynesianism is always popular with a majority of voters. Voters have accepted the Keynesian premise: government spending is a productive thing. So, in a financial crisis, there is never any effective resistance to new emergency spending programs. On the other hand, there is well-organized resistance by favored special-interest groups against cutting existing programs at all times, This process is the basis of the government's spending ratchet. Spending by the national government keeps increasing. So does the national debt.

Yet this acceptance of ever-more Federal spending may be changing, as economists say, "on the margin" – or as politicians say, "on the fringe." The Tea Party movement is the indication of a change of opinion.

THE DREAM OF A MAGICAL FIX

The Tea Party gets a lot of media attention these days. Two Republican Party primaries on June 8 got coverage because of victories by Tea Party candidates: South Carolina and Nevada.

This coverage cheers me. My first recorded vote was for Barry Goldwater in 1964. I read John T. Flynn's book, The Roosevelt Myth, at age 16 in 1958. I know about deficit spending. I know this: it is popular politically. Why? Because it is a way to defer spending cuts. The voters really do believe that something will turn up, so that they will not have to pay off the Federal debt. They don't know what, but something. So does Congress.

To make tax cuts for higher income voters without making unpopular spending cuts is the dream of Republican politicians. To make tax cuts for the middle class – the working poor pay only Social Security's FICA tax – without making unpopular spending cuts is the dream of Democrat politicians.

In the Reagan era, the President tried to achieve this by promising rising revenues as a result of reductions in the income tax rates in all brackets. Unfortunately, he neglected to veto any major spending bills that were placed on his desk by Congress. The economy also got hit by a major recession in 1981–82 as a result of a slowdown in Federal Reserve inflation. In 1983, the Federal deficit went above $200 billion.

Also in 1983, Social Security technically went bankrupt. The President assembled the Greenspan Commission, which recommended FICA tax hikes. The President signed a law implementing the Commission's recommendations. In 1986, the President signed another tax increase, called TEFRA. The deficit increased anyway.

What Reagan faced was piddling compared to what Obama faces. The Federal deficit is obviously out of control. This means that Federal spending is out of control. Do we have legitimate hope that spending will be brought under control in time to avoid a crisis in the capital markets?

No.

I see how far down the road that the West has traveled when it comes to debt: government debt, corporate debt, and household debt. I look at the zones of modern life that have become dependent on ever-larger quantities of government debt. Then I look at which programs Tea Party politicians say they will vote to cut. Well, "look at" is not quite correct. "Look for" is more like it.

NON-SHOPPING LISTS

Let's see their non-shopping lists. Let's see what cuts the Tea Party candidates will recommend. Put differently, let's see which entrenched constituencies for government subsidies they are willing to write off. Let's see which cuts will be so substantial – enough to balance the Federal budget, let alone run a surplus – that their very advocacy in public will bring out voters to support the candidates the Democrats run.

The Democrats are not political fools. They know how their bread is buttered . . . and where. So do the Establishment Republicans. All that the Democrats' candidates need to say is this: "Where do you intend to cut Federal spending? Be specific. Publish this as a campaign document. How do you intend to reduce the deficit?"

The Tea Party candidate is the equivalent of the dude who is dressed in his best East Coast wardrobe, who steps out of an Arizona stagecoach in a 1948 Western. The guys sitting around the saloon spot their mark. "Let's have a little fun with the dude!" They pull out their six-guns. They start shooting at the dude's feet. "Dance, dude!" The dude dances, unless he's Gregory Peck.

We are going to find out this fall how many Tea Party candidates there are whose role model is Gregory Peck. Unlike the 1948 Western, we will get to see if Mr. Peck is gunned down 20 minutes into the movie, with the rest of the film devoted to the final takeover of the county by Charles Bickford.

OVER THE CLIFF

Three things are driving the West's economy toward a cliff: government debt, bank leverage, and fiat money.

The increase in national government debt since early 2008 is unprecedented. This is because, in a recession, politicians vote for bailouts, which increase the government's deficit. Meanwhile, central banks buy assets of any kind in order to flood the economy with newly created fiat money, thereby saving the banking system.

This two-fold policy response – deficits and fiat money – is promoted by all schools of economics except Austrianism. The school of economics that is most prominent today, and which gets good media publicity for promoting the two-fold policy response, is Keynesianism. Members of the other schools of thought meekly ratify what the Keynesians promote openly, mumbling that "there is no other choice in this crisis." The Austrians protest, but until 2008, hardly anyone paid any attention to them or their protest.

Keynesianism's solution to recessions is always the same: to have the national government borrow money that would have been lent to the private sector. The theory is that when governments spend borrowed money, this increases economic growth, because the government spends the money rather than private producers and borrowers.

The Keynesian system rests on two unstated assumptions, which are illogical and therefore never stated plainly for the public to see.

  1. Government spending of borrowed money that supports unemployed workers or funds corporate bailouts is economically productive and will restore economic growth and end the recession.
  2. Private sector spending of borrowed money enables consumers to buy what they want and also enables businesses to purchase capital goods, labor, and raw materials in order to produce consumer goods and services. This is economically wasteful and extends the recession.

When I state it this way, a normal person thinks: "This makes no sense. Why should government borrowing to pay people not to work and also to pay for government bailouts be productive, while allowing consumers and producers to choose their own level of debt is destructive?" So, non-Austrian School economists never go into print with the two assumptions. As well-paid designers of fine new wardrobes for emperors, they prefer not to let voters inside the weaving room.

The Austrians' policy recommendations are part of a four-point program. First, governments should cut spending enough to produce a fiscal surplus, despite major tax cuts. Second, governments should cease borrowing. Third, the central bank should cease buying assets.

The Austrian camp is divided on point four: whether the budget surplus should be used to pay down the national debt, or whether the money should be returned to taxpayers, accompanied by an outright default on the national debt.

How popular with politicians is this agenda? It isn't. How popular is it with voters? Not very, especially when a crisis in the stock market is taking place, and over-indebted banks and corporations are going bankrupt.

No politician has ever run on this platform: "Abolish the FDIC!" The FDIC guarantees the bailout of depositors, up to $250,000 per bank. It also guarantees that the money supply will never shrink because of failing banks, the way it did in the United States, 1930–33, when about 9,000 banks went bust – but no large bank. Large banks had the support of the Federal Reserve System. Voters love the FDIC. There are well-organized permanent political constituencies for the latest designs of clothing for emperors. There are hundreds of millions of believers in the wisdom of emperors. This is why non-Austrian School economists always have good jobs.

This is also why Austrian School economists are relegated to the fringes: websites and podcasts. They are ignored by newspapers and network TV. They are especially kept out of university economics departments. Nobody in academia wants to let an Austrian School economist get close to impressionable children, who have perceptive eyes and who might call out something embarrassing from the sidelines in the middle of the big parade.

RUNNING OUT OF TIME

The idea that the debt markets are running out of time is now gaining attention. This is the first time in my lifetime that this idea has penetrated the consciousness of the general public.

It is still being denied by the chattering class. Non-Austrian School pundits are still fervently repeating the Party Line, to wit:

The debt of the United States government is essentially risk-less. A 90-day U.S. Treasury bill is the closest thing in history to a risk-free investment. This debt is AAA-rated, and should be.

There is no possibility that Asian central banks will ever cease buying U.S. Treasury debt, let alone sell their existing portfolios. Asian manufacturers cannot possibly do without American consumers. This is why Asian central banks buy U.S. Treasury debt by inflating their own domestic currencies: to hold down interest rates in the United States, thereby enabling American consumers to borrow money to buy Asian goods, rather than letting Asians buy these goods. American consumers are vital to Asia. Asian consumers are not. Thus it has always been. Thus it will always be.

With the Greek government's announcement on April 23 of the threat of non-payment of its debt, the Party Line has met a growing skepticism. It is possible for a Western government to default. The non-response of the Northern European politicians for two weeks was followed by a frantic weekend announcement of a bailout worth $900 billion. This was not the response of politicians who are in control. It was a Hank Paulson "the sky is falling" performance.

The acronym of the busted budget nations – PIIGS – was surely one of the more delightful aspects of these recent events. The PIIGS's politicians and bankers resent this, but they cannot do anything about it. The mental image of pigs with their snouts in a trough is made to order for skeptics of the Party Line.

Serious analysts are beginning to waffle on the Party Line. There is no full-scale revolt within what we can accurately identify as the Davos-Bilderberg axis, but there are people who serve as advisors to people inside this axis who are raising doubts in public. The most notable is the Harvard University/Harvard Business School professor of financial history, Niall Ferguson. His May 13 lecture to the Peterson Institute for International Economics, "Fiscal Crises and Imperial Collapses," is by far the most persuasive of recent efforts. Read it here.

Ferguson has compared the U.S. fiscal crisis to the fiscal crisis of the Ottoman Empire in 1875. In mid-December, 2009, he published a paper, "An Empire at Risk." His assessment is both accurate and relevant.

. . . This is how empires decline. It begins with a debt explosion. It ends with an inexorable reduction in the resources available for the Army, Navy, and Air Force. Which is why voters are right to worry about America's debt crisis. According to a recent Rasmussen report, 42 percent of Americans now say that cutting the deficit in half by the end of the president's first term should be the administration's most important task – significantly more than the 24 percent who see health-care reform as the No. 1 priority. But cutting the deficit in half is simply not enough. If the United States doesn't come up soon with a credible plan to restore the federal budget to balance over the next five to 10 years, the danger is very real that a debt crisis could lead to a major weakening of American power.

The precedents are certainly there. Habsburg Spain defaulted on all or part of its debt 14 times between 1557 and 1696 and also succumbed to inflation due to a surfeit of New World silver. Prerevolutionary France was spending 62 percent of royal revenue on debt service by 1788. The Ottoman Empire went the same way: interest payments and amortization rose from 15 percent of the budget in 1860 to 50 percent in 1875. And don't forget the last great English-speaking empire. By the interwar years, interest payments were consuming 44 percent of the British budget, making it intensely difficult to rearm in the face of a new German threat.

Call it the fatal arithmetic of imperial decline. Without radical fiscal reform, it could apply to America next.

This sort of talk was beyond the fringe in 2007. It was far outside the bounds of acceptable discourse within the Davos-Bilderberg axis. It remains a fringe idea, but inside the circle, not outside.

As this idea spreads, it will penetrate into the highest level of the Peoples Bank of China and the Bank of Japan. When it does, the scenario sketched by Ferguson will be perceived as valid. Then there will be a change of central bank policy – there and here.

CONCLUSION

The Tea Party's main function today is to bring to the average voter a sense that Ferguson's scenario is no longer crackpot. This will not lead to budget cuts. It will not lead to tax cuts. But it will produce voters who will say – after Ferguson's scenario has come to pass – "never again."

Gregory Peck will be gunned down, but Charles Bickford's empire will not survive the financial cataclysm.

We will see who picks up the pieces, county by county.

Gary North [send him mail ] is the author of Mises on Money . Visit http://www.garynorth.com . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

http://www.lewrockwell.com

© 2010 Copyright Gary North / LewRockwell.com - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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