What is Going on in Washington?

Interest-Rates / US Debt Aug 30, 2010 - 01:57 PM
By: Michael_J_Kosares

What if you earned half of what you spent in a month and put the other half on your credit card? What if you did that month after month, year after year until your debt was six times your annual income? Would you consider yourself to be in deep financial trouble?

As daunting as that might seem, it is precisely the situation in which the U.S. federal government finds itself as we enter the second decade of the 21st century. It spends roughly twice what it collects in tax revenues.* Most of that difference is raised by selling government debt obligations, but unlike the ordinary citizen, what the government is unable to borrow it covers by printing the money. Now with a wave of the hand, the Federal Reserve has institutionalized printing money (monetizing the debt) as part of public policy. At this juncture, the projected monetization is small compared to the overall additions to the national debt, but whatever the amount it sets a bad precedent.

So let’s consider for a moment the prospect of repealing the Bush tax cuts. When it sinks in that government is spending twice what it brings in, it also sinks in that the government would need to double its revenue to balance the budget. That would mean everyone’s taxes would need to double. Thus, repealing the Bush tax cuts amounts to the equivalent of launching a pea at a charging bull moose. It isn’t going to get us anywhere and amounts to another meaningless political exercise aimed at garnering support in the upcoming mid-term elections.

Since doubling everyone’s taxes essentially would amount to bankrupting the citizenry in order to make the federal government whole (for just a single year), the next option would be to raise money from our trading partners, the two largest being China and Japan. That door seems to be closing slowly. China has become a net seller of U.S. Treasury paper and Japan has markedly slowed down its purchases. The rest of the world has displayed a marginal appetite for U.S. debt -- at least when compared to what has become a monumental need.

Thomas Hoenig of the Kansas City Federal Reserve, who was the lone dissenter on the Federal Reserve Board’s recent decision to leave rates at near zero and monetize a portion of the government’s debt, calls current Fed policies a “dangerous gambleâ€