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Federal financial fascism on the march: a federal government backstop to the states and localities is being contemplated. Sooner or later America’s fiscal policies will cause a sell-off of the dollar, at which time it will be probably unbearably tempting to trick up some international chaos in the form of some sort of war or terrorist event to drive investors back to the good old greenback. In this context, Paul Krugman’s lecturing of the Chinese on currency valuations (who took us off the gold standard, Paul?) is truly bellicose. See Krugman in China for this story.

In the context of our working hypothesis that the American social contract is broken and heading toward a crisis in about ten years, the implications of federalization of state and local debt (“financial fascism”) are these: the states and localities are invited into moral hazard, just like Fannie (FNM) and Freddie (FRE), as the article points out; the Constitution is further abrogated, as the states are strong-armed into obeying the federal government; the potential for vastly misguided macro policies at the national level is elevated and macro volatility increased (the Founders seemed to understand that sparsely connected networks are more stable than densely connected ones); ultimately, even after we’ve tried to scare the world into greenbacks, the BRICs, Euroland and Japan will figure out a way to go around us, and we will run up a good inflation to depreciate the debt while the BRICs are taking it out of our hide in currency devaluation; and without further change in the income distribution (see Debt and income inequality for some graphs suggesting that the real reason for our current collapse of effective demand is that income inequality has become so great most people simply don’t have enough money to spend to support recent levels of output)—that is to say, without a fundamental renegotiation of the American social contract such as occurred miraculously during World War II, that America a generation from now will be a banana republic with a tiny ruling class who will send their children to the right schools to get the right jobs in the right businesses and government agencies with the high pay that will be denied to the vast majority of working stiffs, who will be locked out of this calcification of the American dream in a class system that will be effectively feudal. There will be lords and ladies, and serfs serving them, is the way it will feel. Sound familiar? Could get much worse.

How might a new social contract come about, when our elected representatives lie to us so easily (“Yes we can!”), so powerless themselves to change the status quo? (I credit President Obama with making health care his top priority, as the bottom half are going need help as the depression matures.) How we truly change America is the question for the next decade. Think about it, and please don’t hesitate to let us know your thoughts. For background see this and this.

Via: Market-Ticker hat tip: orlingrabbe.com

Warning: United States Credit Risk

Yes, it really is at risk.

Through the first seven months of the fiscal year, the federal deficit has mounted up to a record $802.3 billion, compared with $153.5 billion at the same time last year. Income-tax receipts are down nearly 31% for the fiscal year so far.

People who are not making money - who are either unemployed or if self-employed are not profitable - don't pay taxes.

Ramping spending into such a situation is idiotic. It is similar to you losing your job and going on a spending spree, running your credit cards to the moon before they are cut off.

You may rest assured that they WILL be cut off if you continue this behavior for very long.

Source: Implications of U.S. Debt