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May 27, 2009

And It Gets Worse: The Coming 100% Inflation

Ten percent inflation over ten years will help Obama out of the mess he's made for us without curing it; the dollar's value will be cut in half, and everything will cost twice as much.

Second article here.

A government debt burden of that [100 per cent] level, if sustained, would in Standard & Poor's view be incompatible with a triple A rating," as the risk rating agency stated last week.

I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor's considers. The deficit in 2019 is expected by the CBO to be $1,200bn (859bn, 754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth - probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.

The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.

On top of that: I don't believe one can simply decide to inflate by 100%. Money is worth precisely what people think it's worth -- and if they are shocked by a sudden devaluing of their cash, they might decide it's worth less than the targeted half-value the government has decided upon. After all, the government can always decide to devalue it still further, right? And the government isn't candid about these plans.

And the fun continues:

The Oxford-educated Mr Fisher, an outspoken free-marketer and believer in the Schumpeterian process of "creative destruction", has been running a fervent campaign to alert Americans to the "very big hole" in unfunded pension and health-care liabilities built up by a careless political class over the years.

"We at the Dallas Fed believe the total is over $99 trillion," he said in February.
"This situation is of your own creation. When you berate your representatives or senators or presidents for the mess we are in, you are really berating yourself. You elect them," he said.

His warning comes amid growing fears that America could lose its AAA sovereign rating.

I think the AAA rating is gone -- its passing is as foreordained as a boring eight-guitar jam at the end of a Rock 'n Roll Hall of Fame Ceremony -- and we're looking at worst possibilities than that.

Is the recession maybe drawing to a close?

A survey of 45 top economists concludes that the recession will probably end by the second half of this year. But the poll from the National Association of Business Economics also suggests the economy will stay soft and the labor market won't improve until next year.

Those surveyed believe the U.S. economy is showing signs of stabilizing.

Chris Varvares, the association's president, says the survey contains good news. "We do expect economic growth to turn positive," he says, "and the pace of jobs losses is expected to narrow sharply over the remainder of this year, with job gains returning in early 2010."

But Varvares says the rebound won't be as strong as it normally is after a deep recession.

The survey suggests the economy will grow by a weak 1.2 percent during the second half of the year and that unemployment will continue to climb to 9.8 percent by the end of the year.

My answer: No, it's not over. The economy is driven partly by psychology. In the current situation, people have gotten over their initial "oh my God we're going to lose everything" panic, and they are now into their "This feels about the right length for a recession; things should be getting better now" phase.

Psychology usually creates a self-fulfilling prophecy. Economies improve partly because people expect them to.


People expect the economy to improve because in the past it historically has after a year or so. The problem is that, in this case, the government has been doing what it historically hasn't previously done before -- it's pursuing decidedly anti-growth and anti-recovery policies.

The economy will most likely improve a bit, largely due to psychology. But people will expect a positive feedback -- they'll expect greater improvements, thus affirming their initial notion that the economy was due to mend.

But those expected additional improvements will not come, because Obama and the Democrats have been pursuing policies well-nigh expressly designed to sabotage the chance of such improvements.

And thus, people's nascent hopes having been dashed, they'll fall into a fresh funk of pessimism and futility, and a new recession will begin.

That's sort of what happened during the Great Depression, several times. The economy would improve a bit for a time, then there would be a new crash and new spike in unemployment. Japan, I'm imagining, saw this happen a lot during its Lost Decade. That light was frequently at the end of the tunnel, and yet... the end of the tunnel kept moving further and further away. As happens during nightmares.

I believe Dick Morris is right on this point: Obama's policies are doomed to fail, whether we "hope" he fails or not. The question really isn't whether Republicans will claw their way back to power; they will.

But that's almost a trivial concern. The problem is what sort of an economy we will wind up inheriting from Obama. And bear in mind Obama has been considerate enough to use up all of the typical bullets fired into a recession, handing an empty gun to his successors.

It also doesn't really matter whether we put forward moderate or conservative candidate, at least in terms of getting them elected. When the next shoe drops -- whether it's before the 2010 midterms or after -- Republicans are going to pick up a lot of seats. Because the election will not be about us at all; it will be a referendum on Obama and Liberalnomics.

That being the case, we might as well start pushing more conservative candidates.

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posted by Ace at 01:20 PM

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