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Scylla and Charybdis

Ok now I want to explain why a couple of statements that you hear frequently are misguided.  This should help in understanding the claim I made earlier about the potential for inflation or deflation (and the respective economic ailments associated therewith) being entirely at the whims of a handful of politicians and bankers.

Fallacy number 1:  “At some point, people will stop buying our debt and we will be faced with a European-style debt crisis.” 

I’m actually guilty of making this claim int he past.  However, the Federal Reserve is a borrower of unlimited capacity.  When everyone else stops buying our debt, the Fed can just buy it all.  How do I know this is true?  It’s already happened.  The Fed now buys 70% of new government debt, despite previous assurances that they would never “monetize the debt” (more on this later).  If the government wants to run bigger and bigger deficits and nobody thinks they are good for it, the fed can just print up more money and loan it to them.  There is nothing preventing them from doing this forever causing larger and larger deficits until the end of time.  If China decides to sell their debt the Fed can just print up dollars and buy it from them.  The only downside to all of this is that it could cause inflation.  But remember that all that money they print goes back with interest so we have to be careful about assuming just because they are printing money like crazy that a severe inflation is coming.  It could be that this amount of printing is required just to make up for the long-run contraction inherent in this system.  In fact, as I have been saying, this is the reason (I believe) that we have such a big debt because it is necessary to counteract this deflationary tendency.

Fallacy number 2: “The government can just inflate the debt away.”

This is wrong because the government does not control the printing presses.  The Fed does.  This means that in order to cause inflation (or avoid deflation) the Fed must get somebody to borrow.  If private people and foreign governments are willing to borrow enough at positive interest rates, then it is possible to cause some inflation and reduce the debt.  However, this is not generally the case, at least not for very long due to the contractionary long-run effects of monetary expansion.  This means that if they want to cause prolonged inflation they need the government to borrow.  This means that causing inflation causes the government deficit to grow not shrink. 

The big Picture

So to sum up, the Fed and the government need each other to cause inflation and this requires expanding public debt.  So should you fear inflation or deflation?  I don’t know.  And that’s the big picture.  The Fed (a group of private bankers with a government granted monopoly on printing money) and the federal government have the power to drive the economy in either direction they wish (so long as they work together).  The Keynesian line is to trust them to carefully steer a middle course between these two dangers.  Personally I have no confidence in their ability to do this.  But the more important question is this: is it responsible to put the fate of the entire economy in the hands of a few elite bankers and politicians even if we do think it’s possible for them to manage it in a benign way?  Is it that inconceivable that they might use this position to increase their own wealth and power at the expense of the rest of us?  I’m looking at you “liberals.” 

This economy, while not being centrally planned, is certainly centrally manipulable.  Supporters of this arrangement (which seems to be most people) seem to make the argument that for some reason we can’t trust an economy where every individual owns his own property and is free to trade and contract as they wish and accept the gains or losses of their own actions.  You see in that scenario the greedy fat-cats and bankers will surely trick the poor working man out of all of his money.  Therefore we have to create a body with the power to control the money supply by printing as much as they want at any time and setting the interest rate for the whole economy at whatever level they wish.  Also they must confiscate the gold of all the citizens and we will require everyone by law to use their notes.  And who are we going to give this power to?  Obviously the rich fat-cat bankers….who else?  But don’t worry, we will make a big deal about them being “independent” from the government so that nobody will have any real oversight over what they are doing.  After all we wouldn’t want those two bodies who we are trusting to jointly steer us between Scylla and Charybdis to be able to coordinate their efforts too well.  If they could, they might use the power to screw us by debasing the currency…..Come on America, does this make any sense?

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