Sunday, December 28, 2008

Canary in the Mine, Chirping

Few really bad ideas escape being floated in the New York Times:

In the case of the Treasury, the money comes from the same wellspring that has been financing American debt for decades: Investors in the United States and around the world — not least, the central banks of China, Japan and Saudi Arabia, which have parked national savings in the safety of American government bonds.

Americans have gotten accustomed to treating this well as bottomless, even as anxiety grows that it could one day run dry with potentially devastating consequences.

The value of outstanding American Treasury bills now reaches $10.6 trillion, a number sure to increase as dollars are spent building bridges, saving auto jobs and preventing the collapse of government-backed mortgage giants. Worry centers on the possibility that foreigners could come to doubt the American wherewithal to pay back such an extraordinary sum, prompting them to stop — or at least slow — their deposits of savings into the United States.

That could send the dollar plummeting, making imported goods more expensive for American consumers and businesses. It would force the Treasury to pay higher returns to find takers for its debt, increasing interest rates for home- and auto-buyers, for businesses and credit-card holders.

...But most economists cast such thinking as recklessly extreme, akin to putting an obese person on a painful diet in the name of long-term health just as they are fighting off a potentially lethal infection. In the dominant view, now is no time for austerity — not with paychecks disappearing from the economy and gyrating markets wiping out retirement savings. Not with the financial system in virtual lockdown, and much of the world in a similar state of retrenchment, shrinking demand for American goods and services.

Since the Great Depression, the conventional prescription for such times is to have the government step in and create demand by cycling its dollars through the economy, generating jobs and business opportunities. That such dollars must be borrowed is hardly ideal, adding to the long-term strains on the nation. But the immediate risks of not spending them could be grave.

“This is a dangerous situation,” says Mr. Baily, essentially arguing that the drunk must be kept in Scotch a while longer, lest he burn down the neighborhood in the midst of a crisis. “The risks of things actually getting worse and us going into a really severe recession are high. We need to get more money out there now.”

Had the government worried more about limiting spending than about the potential collapse of the mortgage giants, Fannie Mae and Freddie Mac, it might have triggered precisely the dark scenario that consumes those who worry most about growing American debt, argues Brad Setser, an economist at the Council on Foreign Relations.

The most frequently voiced worry about the bailouts is that the Fed, by sending so much money sloshing through the system, risks generating a bad case of rising prices later on. That puts the onus on the Fed to reverse course and crimp economic activity by lifting interest rates and selling assets back to banks once growth resumes.

...But that, as most economists see it, is a worry for another day.

This is wrong. I suppose its the price we pay for 1/3 of the US population being born since 1980. Most Americans, economists included, don't remember the bad old days of the 1970s.

The cutoff for the failure of the US bond market is NOT global disbelief in our power to pay back the bond. We're constitutionally required to do so, and so default is more than just a ministerial decision in this country.

The US bond market will fail when dollar inflation and dollar depreciation is so much higher than our interest rate, that, even after we've paid ten or thirty years of interest in full and on time, the Japanese or European investor comes close to losing money or breaking even, or, appears likely to do so. When we take valuable Euro or Yen and turn them into soft American dollars at a rate much lower than Bonn or London offers, then we're screwed.

And that's right where we're headed, even if we insist it's a problem for another day.

The experts have insisted for over ten years that interest rates need to be below 5% for sustained economic growth. That's nowhere near high enough to whip inflation. When inflation comes, and we waste a decade to fight it, then we're going to have very low growth and intense deficits.

Better a sharp recession now and for a year. We took that medicine in 1982 and our economy was better for it.

The other side of the coin is that it is NOT 11:55 on the Doomsday Clock, a nuclear war among the G8 seems remote, and nobody needs to keep America on all cylinders for their own survival.

I'm told I'm naive to think we can operate without our top tier of commercial lenders, that the private sector can't possibly do enough. It seems more naive to me to imagine that the rest of the planet will bury their wealth here, for our benefit, as we squander it faster than we can borrow.

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