Tuesday, April 14, 2009

Another Trump O'Doom

I was able to sit in on the first session of Michael Medved's and Michael Gallagher's Townhall tour.

They had a lot of fun, and it was a wholly new experience to be surrounded by a couple hundred Conservatives in California. They remain upbeat and optimistic.

I'm not joining the party.

Fed’s Flood May Leave Democracy Needing Bailout: Kevin Hassett

Commentary by Kevin Hassett

April 13 (Bloomberg) -- The wise men of Washington keep finding more core beliefs that we have to give up. First it was free markets. Now it’s democracy.

The financial rescue may be the least popular big-ticket government program in history. If the U.S. Treasury decides it needs more money to keep the bailout going, it is anybody’s guess whether Congress would provide it.

As a result, Treasury and the Federal Reserve have been running what feels to this lifelong student of fiscal policy like a scam.

Many economists believe that helping financial institutions turn their less liquid assets into hard cash is a key step toward returning them to good footing. The best way to achieve that in a democracy would be for Congress to appropriate the funds to acquire the assets and for Treasury to borrow the money that it needs.

But Congress is unwilling to appropriate enough money, so Treasury and the Fed have cooked up a work-around: the Fed buys the assets instead. Since the Fed exists outside of the normal budget process, no permission from elected officials is required.

Here’s a sketch of how it works. Many financial institutions have reserve accounts with the Fed. If one of them shows up with an asset it wants to ditch, the Fed takes it and ratchets up the balance in the reserve account. This means that the Fed is effectively summoning cash out of thin air to purchase the assets.

In isolation, such a move might be inconsequential. But the scale of this end-around is enormous. The Fed’s balance sheet is closing in on $2 trillion and stands ready to skyrocket above that. Last month, for example, the Fed committed to buy more than $1 trillion in mortgage-backed securities.

Printing Cash

This means that the Fed is printing cash at a rate that, while not threatening historic records set in Weimar Germany, promises to create substantial inflationary pressures once the economy revives.

Therein lies the problem. At some point, when the economy begins to pick up again, the Fed will have to withdraw some of those reserves from the system before they ignite an inflation bonfire.

Traditionally, the Fed might withdraw reserves by selling some of the Treasuries it owns. But the scale of the money creation is so grand this time that the Fed might not be able to sell enough Treasuries to meaningfully affect inflation without running up against the debt limit that Congress sets when it gives Treasury the authority to borrow money.

The Fed could, in principle, sell some of the assets it has been buying -- but if these assets were liquid, the Fed wouldn’t have been buying them in the first place. Which means it may be extremely difficult to get the cash out of the economy before it is too late.

‘Fed Bills’

The Fed has cooked up a solution, though. Vice Chairman Donald Kohn, told an audience at the College of Wooster in Ohio that a possible solution would be for the Fed to issue its own securities, which might be called “Fed bills.” Kohn argued that a key attraction of these bills is that they wouldn’t be subject to the debt ceiling set by Congress.

In other words, the Fed wants to have unbounded authority to borrow money and buy assets without the inconvenience of having to explain itself on Capitol Hill.

The actions that have been taken already may indeed necessitate granting the Fed that authority. The cash is out the door, and at some point, the Fed will have to rake it back in. Congress may have to choose between giving the Fed the authority it wants, or having the mother of all inflation episodes.

Crowd Out Spending

Should the Fed’s balance sheet climbs to $6 trillion, then its losses might be enormous and threaten to crowd out spending on defense, education and health care. And it would do so without Congress ever voting on the increase in the debt ceiling that would have been required if Treasury were performing the rescue.

If the Fed receives the authority to issue debt whenever it wants to, then future bureaucrats can, in principle, play whatever financial games they want. The powerlessness of voters will be codified into law.

We can’t let that happen.

It might be that voters are too stupid to understand that government officials should get as much bailout money as they desire. The financial rescue might have been precisely what the doctor ordered.

But the public might be right as well. Our founders didn’t construct a democracy because voters are always right. Rather, they viewed democracy as better than the alternatives.

While fully legal, the steps that have been taken by Treasury and the Fed have clearly been designed to insulate those institutions from the will of Americans’ elected representatives. In that regard, the damage from these actions probably exceeds the benefits. If we accept the view that we can be democratic in some areas but not others, then democracy will wither and die.

(Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He was an adviser to Republican Senator John McCain of Arizona in the 2008 presidential election. The opinions expressed are his own.)

To contact the writer of this column: Kevin Hassett at khassett@bloomberg.net


Anybody who knows how Speer brought about German rearmament in the mid-1930s knows how practicable this can be. It is also wholly undemocratic, because there can be no legislative review nor repudiation of administrative currency without completely destroying the currency. Not just sparking a recession, but destroying faith in the issuing government and its currency.

The key fact of our times is that voters, given the power to choose, choose free money every time. And the idea we'll ever pay it back is merely ideology. Every cent of federal debt can be renounced by renouncing the issuing government. It's what we did in 1797 when the dollar wasn't worth a continental. It's taken 212 years to ignore the lesson learnt, but we've done it. There's bipartisan consensus that borrowing recklessly is NECESSARY, and I just don't believe we're going to elect successive governments and suffer repayment.

My focus is more towards preparing for the Revolution than conserving the present.

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