The incestuous relationship of Obama's Treasury and the Fed

My last blog post was an email to my son about Obamacare and the deficit. I copied a couple of friends on the email. One of those friends, Gene, sent a reply to me and my son with some general comments about how both liberals and conservatives are to blame for the financial pickle we find ourselves in. Here is a new email I sent to my son commenting on Gene’s email and clearing up some of the things he said.

Dear Son,

Gene always likes to masquerade as a kind of Solomonic figure: fair, impartial, apportioning equal amounts of blame to both ends of the political spectrum. But, come November, he will toe the line and vote for Obama and the rest of the Democrats. And, whenever I point that out to him, he flies into a rage.

There is one thing, however, that I do agree with Gene about: the Federal Reserve, under the stewardship of Ben Bernanke and in conjunction with Obama’s Treasury Department, is continuing its massive devaluation of the American dollar. Here’s how they do it.

The Obama administration continues to spend dollars it doesn’t have, running up trillion dollar deficits. When it comes time to pay the bills, the Obama Treasury Department borrows money by issuing debt. That is, the Treasury prints up a bunch of fancy-looking, gilded Treasury certificates that say: "The Treasury Department solemnly promises to repay the face value of this certificate, say, $1000, with interest after 10 years." The Federal Reserve then buys a bunch of those certificates, crediting the Treasury Department’s account with $1000 for each certificate the Treasury Department sells to it. So now the Treasury Department has additional dollars in its account and the Obama administration can keep on spending.

Where, you might ask, do the dollars come from that the Fed credits to the Treasury Department’s account? Excellent question. The Fed creates them out of thin air, with the stroke of a pen (or, in this day and age, with the flow of a few bits over the Ethernet). In other words, the Fed simply declares that now the Treasury has $1000 more in its account, and, voila, $1000 appears in Treasury’s account. This is what is called "fiat money." The Latin word "fiat" means "let there be," as when God said "fiat lux" or "let there be light." So, "fiat money" is money that is created out of nothing; the Fed simply declares "let there be dollars" and the dollars are created.

If this sounds too good to be true, that’s because it is. As with anything, the more you have of it in the marketplace, the less it is worth. Likewise, the more dollars that are circulating through the economy, the less each individual dollar is worth (that is, the less it can buy). This is inflation. There are individuals, like Paul Krugman, who scoff at the threat of inflation, and, so far, they have had the better part of the argument, since inflation has remained relatively tame. But, the signs of increasing inflation are already starting to show up (for example, I spent $4.59 on a loaf of fucking Columbo French Bread in Sacramento the other day and I spent $3.65 this morning to buy your mother a Chai drink at Starbucks; also just look at how much the price of gas has soared over the last ten years). But, regardless of what the current level of inflation is, what normally happens when you flood the economy with enormous amounts of new money is: eventually, hyperinflation rears its ugly head. And, there is no good reason to believe that the Fed’s current actions will not have the same outcome.

Another consequence of the Treasury and Fed's incestuous activities is that, as the Treasury Department issues more and more Treasury certificates, there will be fewer and fewer outside parties that will be willing to buy them. This is already happening, as countries like China have cut way back on their purchases of Treasury certificates. Eventually, the only party that will be willing to buy these certificates will be the Federal Reserve. But, even the Federal Reserve’s capacity to absorb Treasury debt is limited since, as already noted, buying too much of this debt will flood the economy with dollars and trigger hyperinflation. Eventually, the only way the Treasury will be able to sell new debt to outside parties will be by promising to pay higher and higher interest rates. But this will just make potential buyers suspicious that the US will not be able to repay all this debt and will eventually default. And this suspicion, in turn, will just make those buyers even more reluctant to buy Treasury certificates and demand even higher interest rates. This is what’s called a “vicious circle” and is precisely what is happening in Greece, Spain, and Italy right now. Those governments need to keep borrowing more and more money to keep their governments operating, but fewer and fewer parties are willing to buy that debt because they realize how much debt is already outstanding and how shaky the governments already are. Consequently, interest rates for Greek, Spanish, and Italian sovereign debt spiral ever higher, weakening those countries even further.

So, financial Armageddon is coming. As noted, it is already happening in Europe. The Europeans are better off than the Americans, however, in that at least the Europeans are already standing at the edge of the abyss and consequently are actually trying to implement austerity measures that will keep them from plunging in. As Paul Krugman points out, these austerity measures will cause tremendous short term pain in Europe since the European economy will contract and there will be a recession or even a depression there as the governments cut back on their spending and borrowing. But, at least there is some recognition (primarily in Germany) of the problem and some hope that over the long term Europe will eventually get its fiscal house in order and emerge from the other side of this economic minefield. Americans, on the other hand, still delude themselves into thinking that somehow they are special, that the normal laws of economics don’t apply to them. They mock the Germans for fearing hyperinflation and for insisting on austerity. They laugh at Greece and Spain and Italy and say things like: “Nothing like that could ever happen over here.” Americans are like people who have smoked, drunk, and eaten fatty foods all their lives and think that, simply because they have not yet gotten cancer or sclerosis of the liver or had a heart attack, they are healthy. Ha!

The only people who really sense the impending doom are Republicans like Ron Paul, who has been preaching the evils of the Federal Reserve and fiat money for years, or Paul Ryan, who, unlike the Democrats in power, actually proposes a budget, or Grover Norquist, who sees through the "one dollar in new taxes for every three dollars in cuts" bullshit the Democrats always try to pull (they add the one dollar in taxes, but the three dollars in cuts never materialize). So, don't believe for a moment anyone who, like Gene, tells you that the Republicans are just as responsible for the fiscal mess we find ourselves in as the liberal, tax and spend Democrats.

Loving you always and firm in my belief that as your mind ripens you will abandon the liberal path (LYAAFIMBTAYMRYWATLP),

Dad

Update:

Gene replied: "The Fed does not buy Treasury notes directly from the Treasury. That is illegal. Likewise it cannot "credit" the Treasury"s account by purchasing notes directly."

My response to Gene: Technically, that is correct, but the outcome is the same as I described even if the transactions take place in the open market. The Fed is monetizing Treasury debt like crazy. Lawrence Goodman, a former Treasury employee, wrote in WSJ in March:

Last year [2011] the Fed purchased a stunning 61% of the total net Treasury issuance, up from negligible amounts prior to the 2008 financial crisis. This not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized budget deficits. … The Fed is in effect subsidizing U.S. government spending and borrowing via expansion of its balance sheet and massive purchases of Treasury bonds. This keeps Treasury interest rates abnormally low, camouflaging the true size of the budget deficit. Similarly, the Fed is providing preferential credit to the U.S. government and covering a rapidly widening gap between Treasury's need to borrow and a more limited willingness among market participants to supply Treasury with credit.

The fact that the Fed and the Treasury conduct their activities through open market operations is just an enormous money laundering scheme.

Obamacare reduces deficit. Indeed!

My son, whose mind, I fear, is still afflicted by the liberal virus, sent me a link to a New York Times story with the headline "Budget Office: Obama's Health Law Reduces Deficit" and asked me what I thought. Here is my answer.

Dear Son,

Start by asking yourself a common sense question: Is it possible to add tens of millions of people to the insurance rolls at no additional cost?

Now, reread the article closely. The CBO’s only finding is that Obamacare will not “increase the deficit,” not that it will not “cost the taxpayer a lot of money.” Look at these quotes from the article:

The law's mix of spending cuts and tax increases would more than offset new spending to cover uninsured people, Elmendorf explained. … Thirty million uninsured people will be covered by 2022 … That brings the total cost of expanding coverage down to [a mere] $1.2 trillion, from about $1.3 trillion in the previous estimate. … Actually, the government will spend more. It just won't go onto the national credit card because the health care law will be paid for with a combination of spending cuts and tax increases. [emphasis and sarcasm added]

So, "thirty million" new people will be added to the insurance rolls at an additional cost of "$1.2 trillion" and these costs will be paid for by "new spending" by the government. But the additional money the government is going to pay out has got to come in from somewhere. The CBO assumes it will come from a mix of "spending cuts" and "tax increases." So, yes, according to the CBO’s model, the deficit will not increase because the additional money going out will be offset by additional money coming in.

But, ask yourself if you believe the spending cuts will really take place, or whether a couple of years down the road Obama and the Democrats will tweak the law to eliminate these spending cuts. Since many of these planned cuts are cuts to Medicare, it is highly likely that the government will change the law and rescind the cuts. After all, what politician wants to cut Medicare for old people?

So, what you are finally left with is this: the $1.2 trillion cost of adding tens of millions of people to the insurance rolls will be borne by new taxes on you, me, and everyone. Even if you assume that the spending cuts will, in fact, be made, you are still left with the best case scenario that Obamacare's additional spending will be paid for through some cut in current services and some increase in taxes.

Obama and the Democrats have always made a big deal of how Obamacare will be “revenue neutral.” In making this argument, they assume that the American people are so stupid that they don’t realize that “revenue neutral” is not the same thing as “it won’t cost them anything.” All “revenue neutral” means is that the additional spending that results from Obamacare will be offset by additional revenues coming into the government. That way, the deficit (the national credit card) will not increase. But that doesn’t mean that these additional revenues are going to magically materialize out of thin air! Someone is going to pay. And that someone is you, son.

Finally, consider how utterly misleading the Times' coverage of this story is. The headline reads: "Budget Office: Obama's Health Law Reduces Deficit." The lead sentence is: "President Barack Obama's health care overhaul will shrink rather than increase the nation's huge federal deficits over the next decade, Congress' nonpartisan budget scorekeepers said Tuesday, supporting Obama's contention in a major election-year dispute with Republicans." Sounds pretty good, no? It's not until the end of the article that the reader finds out that the government is, in fact, going to "spend more." And people say that Fox News is biased!

Loving you always and firm in my belief that as your mind ripens you will abandon the liberal path,

Dad

Who is the real "outsourcer-in-chief?"

Mr Obama says: Mitt Romney is the "outsourcer-in-chief," meaning thereby that Mr Romney is responsible for the outsourcing of American jobs overseas.

Mr Romney should reply to Mr Obama by explaining to him some basic facts about the modern global economy.

American jobs are outsourced overseas because products for the American market can be produced by overseas labor at the same or better level of quality or for the same or lower price than they can be produced by American labor.

Why are American workers not more competitive? One of the main reasons is because of the inefficiencies and rigidities introduced into American labor markets by unions.

Every American industry that has a highly unionized workforce eventually founders. What has been the most pernicious influence in the automobile industry over the last several decades? The unions. Why has the American steel industry shrunk to a shadow of its former size? The unions. What is bankrupting state and municipal governments? The extravagant salaries, pensions, and benefits of workers in government unions.

Aside 1: (According to WSJ, the annual cost of pay and benefits for a member of the United Steel Workers union averages $170,855 per year: "Charles Bradford, an analyst with Bradford Research Inc. said the larger integrated mills that make steel by melting raw materials, including iron ore and coal, need to cut production costs "or they just won't be able to compete," he says.)

Aside 2: (On GPS this week, Fareed Zakaria, hardly a hard-hearted conservative, described the situation with public service employee unions as follows: "At its heart, the [municipal] bankruptcies you keep hearing about these days aren’t about taxes being too low or spending on city services being too high – they're about pensions. California's pension-related costs rose 20-fold in the decade since 1999. This frightening trend is true almost everywhere in America. And it’s simply not sustainable. A recent Pew research survey found that the gap between state assets and their obligations for public sector retirement benefits is $1.38 trillion. It rose by 9 percent in 2010 alone – and it will likely keep rising until these obligations are renegotiated. The truth is America is sacrificing its future to pay for its past. To keep up with burgeoning pensions, states and cities are slashing services. It's also feeding into the unemployment problem. State and local governments have 445,000 fewer workers today than in 2007. For decades now, local governments have doled out patronage by increasing pension benefits – these costs impact the budget years later, when the officials who gave the benefits are safely retired themselves. We're now having to reckon with those choices. I'm not saying bankruptcies are a good thing. But they are a mechanism that allows us to admit an emergency and renegotiate the deals that are, well, bankrupting the country." In other words, one of the main factors contributing to unemployment in America is the fact that pensions and benefits for public workers are too rich.)

And yet, instead of attempting to break the stranglehold the unions have on American businesses and government, President Obama lines his pockets with union contributions and does everything in his power to strengthen them and prop up union pay and benefits.

He hands over to the United Auto Workers union tens of billions of dollars in bailouts, all paid for by American taxpayers. And then he has the audacity to claim that these bailouts were a great success. Yes, they were a great success for the workers of the UAW, who gave up nothing, but they were a disaster for American taxpayers in general, who footed the entire bill.

State and municipal governments have been cutting government jobs like crazy for the last several years because they can't afford to pay their current employees while at the same time funding the extravagant benefit and pension packages given to retired union workers. What does this President have to say about this? Instead of working for the reform of government unions (as Republican governors Chris Christie of New Jersey, Scott Walker of Wisconsin, and Mitch Daniels of Indiana have), the President says the "private sector is doing fine; we need to send more money to state and local governments to hire more government union workers."

Why is the economy in Silicon Valley booming these days? Could it be that for all intents and purposes unions do not exist there, management and workers are not adversaries, and instead their interests are aligned through the distribution of stock options?

So, instead of insisting that American workers man up and improve their competitiveness in either quality or cost, Mr Obama would rather spoil and coddle them. His attitude can best be summed up in the whine: "American businesses have an obligation to support American workers, even when it isn't the best financial choice. Profits and efficiency should not trump generosity. After all, we are all in this together."

This is, simply put, sheer madness. In a fast-paced, quickly changing global marketplace, unless businesses focus laser-like on profits and efficiency, they rapidly perish, and all jobs are lost.

In all my years in Silicon Valley, I have never heard anyone say: "I have an American software engineer in Palo Alto who is producing low-quality software, for which I am paying him a high salary. There is an Indian software engineer in Bangalore (or a Czech in Prague, or an Irishman in Dublin) who is just as well educated, writes software of better quality, and is willing to work for less. Nevertheless, I'll keep my American software engineer instead of hiring the Indian (Czech, Irishman) because we Americans are all in this together and I have an obligation to be generous to my fellow American." If American businesses adopted this attitude, they would all rapidly go belly up. Every person who works in the business world understands this intuitively. But, our President, whose only prior experience is as a community organizer and college professor, cannot seem to grasp this point. He would rather spoil and coddle American workers, doing everything he can to preserve their "purchasing power." But, by propping up union salaries, Mr Obama only makes American labor too expensive relative to the cost of labor elsewhere in the global marketplace and thereby actually hastens the flight of jobs overseas.

So, let's be clear about the reason why so many American jobs are being outsourced overseas these days. American labor cannot compete because it is being made more expensive and less productive by the frictions and bloat introduced into labor markets by unions. The "enabler-in-chief" of these unions is Mr Obama, aided and abetted by the entire Democratic Party, bankrolled by the unions themselves. So, if anyone is responsible for the loss of American jobs overseas, it is Mr Obama and the Democrats, not Mr Romney.

The monstrous machines created by good-intentions

According to my Thesis 8:

If the government decides to spend money on some noble-sounding program, there will step forward countless businesses and organizations that will be all too happy to "assist" the government in achieving its "noble end." These businesses and organizations will figure out a way to channel a large portion of the government dollars into their own pockets. They will then use a portion of these monies a.) to produce "research" purporting to demonstrate that the government funding is achieving its noble end and that "catastrophic" consequences will ensue if the funds are cut off; and b.) to lobby and influence politicians to continue and even expand the program. Oftentimes, the businesses and organizations involved make use of the latest technological and financial innovations available to maximize the flow of as many government dollars as possible to themselves. In the end, the well-intentioned government program is transformed into a monstrous machine that spins out of control with pernicious results for all of society.

We have seen several examples of this phenomenon over the last several years:

1. The government decided that not enough low- and moderate-income families were able to afford homes. So, the government changed its affordable housing (AH) goals and saw to it that abundant credit was made available to these families. As Peter Wallison and Edward Pinto write:
   The AH goals required Fannie and Freddie to meet certain quotas when acquiring mortgages. The GSE Act had initially specified a quota of 30 percent; that is, 30 percent of the GSEs’ mortgage purchases had to be loans that were made to low- and moderate-income (LMI) borrowers, defined as borrowers at or below the median income in their communities. During the Clinton administration, HUD increased this quota to 42 percent in 1995 and 50 percent in 2000. HUD’s tightening continued in the George W. Bush administration so that by 2008 the main LMI goal was 56 percent, and a special affordable (SA) subgoal had been added requiring that 27 percent of the loans GSEs acquired be made to borrowers who were at or below 80 percent (and, in some cases, 60 percent) of the median income in their communities.

   The banks were all too glad to help out, creating exotic subprime loans and packaging them into mortgage-backed securities and collateralized debt obligations. What was the result of the massive increase in credit that the GSE's brought about? Housing prices soared, making them even less affordable to LMI borrowers, and those LMI borrowers who did manage to obtain loans were financially devastated later when the housing bubble burst. The American economy still has not recovered from the debacle that ensued.

2. The government decided that not enough low-income students were able to afford college. So, the government made available low-interest loans to those students. Predictably, education mills, like Apollo and Corinthian Colleges, sprang up, who were less interested in educating our young people than they were in soaking up all the loan money that the government was putting in students's pockets. The results have been that the cost of a college education has skyrocketed and many students end up graduating from college with a mediocre education and crushing debt.
3. In the last couple of days, several news stories have surfaced about food stamps. Now known as the Supplemental Nutrition Assistance Program, or SNAP, food stamps are another government program designed to achieve a noble-sounding end, namely, that of putting food on the table of low-income families. But, a significant side effect of this program has been that the giant food and beverage companies of America have benefited handsomely. Time magazine reports:
   Sure, poor Americans who get food on the table for dinner, partly with the assistance of SNAP, must appreciate the program. But major corporations and food groups, including Pepsi, Kraft Foods, Kroger, Coca-Cola, and the Corn Refiners of America, also warmly embrace SNAP. All, in fact, have lobbied Congress and/or various states to expand SNAP and make sure that recipients have the most freedom possible in deciding how to use their allowances, including the unlimited purchase of soda and junk food.
   The government has replaced the old food stamps with new high-tech debit cards, so that it is easy and stigma-free for Americans to participate in the program and so that the money from the program flows at the speed of light into the coffers of the food and beverage companies (with a little slice flowing to JP Morgan, the bank that administers the debit cards). Government agencies run ads encouraging Americans to apply for food stamps and giving them instructions on how to do so. One can even find information about SNAP on Facebook. As Time reports:
   Roughly 46 million Americans now get SNAP benefits, up from just 17 million in 2000, and the costs associated with the program have risen from $17 billion in 2000, to $30 billion in 2007, way up to $78 billion last year.
   The end results? An American tragedy. As food and beverage companies grow ever richer, 1 in 7 Americans is now dependent on food stamps and an epidemic of obesity has broken out among those low-income families who use the program.

Progressivism always starts with good intentions. The devil is always in the implementation. There are always businesses and orgranizations out there that are all too happy to soak up all the money the government wants to spend. In the process, well-intentioned government programs are transformed by cutting-edge technology and finance into monstrous machines that accelerate the flow of goverment dollars into their own pockets. These machines eventually spin wildly out of control and threaten to destroy the entire society.

These are the monstrous machines created by the good intentions of Progressivism.