Friday, December 7, 2012

Where the Keynesian Solution Leads

Let's buy into Dr. Krugman's all in Keynesian solution.  The prescription to the problem is to increase debt (while interest rates are so low) to stimulate the economy to the point where economic growth (a new bubble) will eventually increase revenues.  The increased revenues would be used to reduce the deficit (while increasing the debt albeit more slowly).  I don't recall Dr. Krugman's specific position on Social Security and Medicare but I expect reductions in benefits are probably not a priority.  So demographics will continue to add to the debt as we monetize the Social Security trust fund I.O.U.'s.  And Baby Boomers will continue to make more demands on Medicare which will increase the debt much more than Social Security.

So while the debt continues upward the economy will pick up steam according to Dr. Krugman.  What happens next?  As the economy heats up the Fed will need to real in all that money it printed (with Dr. Krugman's blessing) to keep inflation low.  How?  By increasing interest rates of course.  What the consequence of increased rates?  The percentage of the federal budget that goes to paying interest on the debt goes up.  Currently net interest payments along with Social Security, Medicare and other “mandatory” spending make up 62% of annual outlays, so as interest rates rise the percentage of the annual budget for discretionary spending will go down.  Discretionary spending could be maintained or even increased but only at the expense of defense…not a bad thing in my opinion.  But it can’t go to zero.  There are people trying to kill us and all politicians say that protecting the American people is the number one priority of government.  It’s just not going to be the number one priority in the budget anymore.

But even you hardcore, irrational, arithmetically challenged leftists can’t deny where this will lead.  Social Security, Medicare, interest on the debt will become a higher and higher percentage of the federal budget.   Depending on where interest rates have to go to unwind all that Quantitative Easing it could consume 90% or even more.  This will force reductions in entitlements even more draconian that if we had addressed the problem sooner.

The other way out is a move to true free market capitalism coupled with smaller government (reduced entitlements, less defense spending, etc.), changes in corporate structure and a gradual return, perhaps initially, to a hybrid hard money financial system.  But Dr. Krugman would certainly not approve.

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