Sunday, April 5, 2009

We Can't Afford it Anymore!!

The U.S. is the predominant economy in the world. As such, our primary responsibility to ourselves and by extension to the rest of the world is to maintain a strong economy. The U.S. dollar, even in its relatively weakened state is still the reserve currency (China’s desire to use the IMF’s SDR, notwithstanding), but is under significant pressure. Maintaining a relatively strong dollar and a strong U.S. economy is in the best interest of our selves and the world. But we can’t do it on our own and we may have to take radical decisions to bring our economic and physical security into equilibrium.

The U.S. economy is currently in recession with almost $11T of debt. It’s hard to keep up with the number; it changes so often. We will add another $1.3T in debt in the current fiscal year. It’s conceivable that a year from now our total debt could equal 90% of our GDP, which is currently about $14T, although it may not be that high a year from now. The CBO recently predicted that the national debt in 10 years will be close to $20T. This debt and the unfunded future obligations of social security and medicare (about $54T) are the biggest threats to the U.S. economy and therefore to the world economy. It is no wonder that President Obama sees his first priority to be the viability of our economy. His policy prescriptions, however, will probably not be helpful in alleviating these long-term problems.

The conventional wisdom is the continued viability of the U.S. economy takes a higher priority over its debt. And in the short-run (the only time span of a politician) this is an arguable, albeit wrong-headed, position. The long-run implications are not in doubt. Lots of fiscal stimulus combined with a significant expansion of the money supply is a recipe for one of two outcomes: significant, perhaps hyper-inflation with one or more bubbles or if we’re lucky a return to the stagflation of the 70’s. Representative Barney Frank (D, MA.) said on February 4, no problem. The Fed can deflate the money supply as quickly as it had inflated it. True, but I guarantee Congressman Frank will not like the economic consequence, another recession.

There has to be a recovery for inflation to manifest itself. With the amount of stimulus in the recently passed bill, it’s very plausible that we will have a recovery. Once a recovery begins the Fed, typically, will be vigilant to keep inflation in check. It will do this by artificially increasing interest rates. Parenthetically, it is by artificially reducing interest rates that the Fed has contributed to the bubbles that created the current problems. But the concern now is a slight recovery will ignite significant inflation due to the amount of money that had been pumped into the economy. If the Fed is incapable of accomplishing this in a nuanced way it will have to increase rates to the point of driving the economy into another recession as Paul Voelker did in the late 1970’s and early 1980’s. I don’t envy Mr. Bernake. His job will be all the harder when our ability to borrow becomes impossible due to a lack of lenders. At that point the political pressure to “print money” may be irresistible. This would lead to a significant debasing of the U.S. dollar with extremely deleterious affects to the world economy the worse being severe world-wide inflation.

Debt is at the root of most of our problems. There is simply too much debt, but then the entire world financial system is based on debt. No debt, no money; literally. But such is what the world-wide financial system has evolved into. How we establish economic equilibrium in a debt-ridden, fiat money based world economy is the question to be resolved. At one time we had a gold standard, which was found to be too restricting. It was gradually replaced with a debt standard beginning in 1933 but culminating with the closing of the gold window by Richard Nixon in 1971. It was at that point that the inconvertibility of foreign reserves to gold established a world-wide “fiat” monetary system which is backed by the strength of the various economies and nothing else.

The world needs to be engaged in saving the world economy and the key is to insure we save the most magnificent economic engine in human history, the United States. We are about 25% of the world GDP, while we are only about 4.5% of its population. Is it good for the U.S. to be disproportionately that much richer than the rest of the world? This is not a moral question. It is not immoral for the U.S. to be so rich and it didn’t happen by accident. It happened because the U.S. is, relatively, freer than the rest of the world. It therefore grew disproportionately and thereby became a world power both economically and militarily. But we became, in the language of psychologists, an enabler of bad habits in the rest of the world. The West and others in the world became dependent on us for security. It now has to end because we simply can’t afford it anymore. We can’t afford to consume conspicuously and we can’t afford to be engaged in the world except economically. Militarily we need to disengage.

This is a radical position to take. But, the fact of the matter is, in additional to our fiscal distress, there is little stomach in the U.S or Europe to engage our enemies aggressively. The way we’re fighting we’re bound to lose eventually, anyway. And in the meantime we’ll waste billons of dollars in the effort.

The U.S. has been the protector of the world for 70 years. As the only surviving economy after WWII, it was logical that the U.S. should take the lead protecting the West from Communism. But we are in a new situation. Traditional Communism has been defeated. Our profligate spending, both governmentally and personally, have brought us to the precipice. We must step back. Others must step forward.

Our enemies will get much solace from our withdrawal and we will put ourselves and Europe at risk. But a significant number of people believe the U.S. is the source of all evil in the world. By withdrawing, with the caveat that if attacked we will respond in like kind without concern for “collateral damage”, we give our enemies the opportunity to act on their often pronounced rhetoric that if the U.S. would withdraw they would have no reason to fight us.

Personally, I’m not at all sure that they would not proceed with an effort to acquire a nuclear weapon and explode it in a major European or American city. If they don’t the world may usher in an era of peaceful, economically based relations. If they continue their belligerence and explode a nuclear device 100,000 people or more could be killed. As someone who lives near a major American city, it’s a risk I’m willing to take.

Should they do so, any action we take will clearly be in self-defense and we’ll have the sympathy and support of the world and perhaps the backbone to eliminate our enemies once and for all.