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Guy's take on the cause and effect of our current economic debacle.

(1.)  There will not be any inflation until the economy heats up.  Bank reserves are at an all time high but they are not attempting to loan and are very cautious about the future, thus there is no increase in demand on the part of the consumer.  This is perfectly consistent with the Austrian model.  However, if the economy begins to heat up then the enormous monetary base has to be withdrawn from the banking reserves.  To give you an idea of the monetary base's increase, in September 10, 2008 to March 10 of this year, the monetary base has increased from 850 billion to 2.1 trillion, an increase of 2.5 times in just 18 months.

   (2.)  One can assume that the debt is simply not important, but I fear that is not the case.  As you know, Social Security is now factually broke, meaning that each month the Social Security Fund must take out of Al Gore's "Lock Box" the IOU's that represent the money the Federal Government has borrowed and already spent.  Very soon both Medicare and Medicaid will have to do the same.  That means that the three largest portions of the Federal Budget will be daily borrowing to meet their requirements. 

   (3.)  Mr. Bernanke, with Mr. Greenspan, Mr. Rubin, and Mr. Summers, all asserted, without pause or caution, that the economy, including the housing market, were safe and secure.  They deprecated anyone who dared challenge the more Keynesian warnings that the whole financial world based upon sub-prime mortgages was volatile,  They may be right now, but their track record has more than a few minor scratches,

   (4.)  I have read at least two different figures concerning our national debt.  The common number is 12.68 trillion, an amount that the CBO believes will reach 17 trillion by the end of 2019.  That is 82% of GDP.  The predictions from the OBM indicate that our debt will continue to rise until the end of this decade.  If this occurs then we will increasingly look like Greece.  At some point other countries will begin to hold less in US Treasury Bills, and the only way to entice them to lend us more is to increase interest rates.  If the economy would take off on a lengthy growth period of 4-5 % per annum, then this eventuality could be put off.  But we have so many other drags on the economy that I sincerely doubt if such will occur.  For example, as Gary Becker, a Nobel winner recently noted, "For years federal spending remained level at about 20% of GDP.  Now federal spending has risen to 25% of GDP.  On current projections, federal spending would soon rise to 28%.  That concerns me..a great deal."  Mr. Becker is not a "supply-side" advocate. 

   (5.)  The Keynesian can argue that several important indexes have shown important gains. But government support accounted for roughly 75% of economic growth in the third quarter of 2009.  But government funded GDP growth is not real growth.  Its the national equivalent of a credit card buying spree, with the bills in the form of debt service and unfunded liabilities, to be paid off later.  It is a faux recovery.  And it cannot be repeated without enormous increases in debt. 

   (6.)  Hamilton's Paradox has arrived like a river in spate.  One of the arguments for federalism is that the spending habits of the States could be held in check by a more conservative Federal Government.  However, we now have a Federal Government that cannot control its appetite, and at the same time numerous State Governments that are doing the same (California, for example.) 

   (7.)  One obvious way out is a significant new tax, for example, a VAT tax.  But a significant new tax will repress economic growth, not increase it.  And this is without the additional burdens that the new Health Care Bill will add to the mix.

   In retrospect three things need to be said.  One,  I strongly believed, for over three years before it occurred, that a significant crash was coming.   Secondly, I believed that the resulting recession would be both deeper and longer than that predicted by the Washington DC crowd, and I believe both of those point have proven to be true.  Finally, I believed that the attempt by Government to solve the problem would do two things, not significantly reduce the economic downturn, and would add additional problems (debt, unfunded liabilities, etc.) that would exacerbate the already numerous problems.  I still believe that claim is true, but it is not empirically evident to an honest observer as of yet.  So I will simply wait with patience and watch the passing scene with more than just curiosity. 

Disclosure: No positions