Double Barrel: The Debt Bomb and Bernanke

By: 
Sep. 21, 2012

“The Fed has made a desperate bid to perpetuate a fatally flawed government by propping up their debts as well as those of a fatally flawed banking system by means of a fatally flawed currency. They have chosen to do so by issuing an unending stream of Federal Reserve Notes (aka U.S. Dollars). A Federal Reserve Note is itself a debt — a promise to pay. To expect the open-ended emission of ever greater quantities of these debts to 'cure' an existing debt problem of monumental proportions is the acme of absurdity.”
— William Buckler
The Privateer, Sept. 16

No one knows exactly when, but every day Congress and the president don't CUT spending meaningfully — actually reducing spending below the previous year — the federal Debt Bomb explosion grows nearer.

And then there is Federal Reserve Bank Chairman Ben Bernanke. Last week, he made economic calamity a certainty, placing a tank of gas next to the bomb and standing ready to light the fuse.

We know what the leadership gurus say: If you're CEO, you need to project optimism to your troops, not doomageddon. But when you see the guy standing with a lighter next to the bomb and gas can, it's difficult to look as if there is going to be a good outcome.

CEOs, business owners — all Americans — are worried, especially if there is no change in behavior in Washington and the Federal Reserve Bank. While we all carry on our day-to-day business activities, there's a palpable feeling that something bad is in the offing without a dramatic change. It's inevitable, probably unavoidable.

And here's another sad truth: Even with our national debt rocketing past $16 trillion, a debt-to-GDP ratio near 100% and Bernanke printing more and devaluing the dollar, Americans for the most part seem oblivious that their standard of living and way of life are on the verge of calamity and their freedoms curtailed.

It's akin to when the banks foreclosed on all of those homeowners. When you can't make your debt payments and lose your home, you are forced to lower your living standards. This is what awaits all of America — and the pain will be universal.

The 'Debt Bomb' explained
To see this picture clearly and understand it in layman's terms, read “The Debt Bomb: A Bold Plan to Stop Washington from Bankrupting America,” by U.S. Sen. Tom Coburn of Oklahoma.

Talk about a reality show. Coburn spells out where we are (see charts) and what is going to happen on that day when foreign governments and investors stop buying our government debt. And they're going to stop, be assured of that. Writes Coburn:

“In 2022, tax revenues will only cover the cost of Medicare, Social Security and interest payments on the national debt,” Coburn writes. “We'll simply have nothing left to fund every other function of government. That means we'll have to do one of three things: 1) Shut down every federal agency and scuttle our aircraft carriers; 2) borrow a couple trillion dollars every year to fund the other government functions — if we can even borrow the money; or 3) enact massive tax increases, which will further slow economic growth.”

And that hardly explains the economic catastrophes that will affect every U.S. family when the bomb explodes. The value of the dollar will shrivel; everyone and every company's savings and assets will shrivel to a fraction of their current value; inflation will be unbearable. You should be watching Greece. That's just the beginning.

And let's be honest about something: As the chart above explicitly depicts, the U.S. is in this predicament because of Republicans and Democrats alike. They are equally to blame — presidents and Congress alike. Congress, after all, controls the purse. Presidents have veto power.

When Barack Obama asked at the convention for patience and for four more years to fix the U.S. economy, we thought: Get real. In business, any CEO worth his pay and facing the spending and debt crisis that faces America would have taken to cutting expenses with a vengeance on Day One! When the life of the business is teetering, an effective CEO acts decisively, courageously and with the moral conviction to do what he must, however painful.

Alas, Washington politicians as a body have demonstrated for a generation, more now than ever in our history, they are more concerned about their careers than their constituents and constituents' children and grandchildren.

And this is where Ben Bernanke believes — misguidedly — his policies can help come to the rescue.

How the Fed is devaluing us
In the wake of Bernanke's announcement that the Federal Reserve will engage in monthly purchases of more mortgage-backed securities, eyes glazed over mainstream America. Such monetary-policy announcements are quantum physics to many.

But within hours of Bernanke's announcement, the economic blogosphere and analysts were humming with criticism. In the Sept. 17 Wall Street Journal, five senior fellow economists from Stanford University's Hoover Institution — no slouches, mind you — collaborated in a column entitled, “The Magnitude of the Mess We're In,” devoting a third of their analysis to the economic risks and dangers the Fed has been creating for the U.S. economy.

William Buckler, quoted at the beginning of this column and editor of The Privateer, a newsletter that monitors the world's economies and the effects of public policies, minced no words for Bernanke and his associates:
“The Fed — and along with it the U.S. government — has locked itself into a strait jacket of monetary debasement in perpetuity. It has also made it certain that the entire idea of 'central banking' is going to be exposed beyond the power to ignore as the pernicious enemy of freedom and prosperity that it has always been.”

One of the best and most understandable interpretations of how the Fed's new policies will affect all of us came from another Fed critic, Peter Schiff, CEO and chief investment strategist for Euro Pacific Capital, based in Connecticut.

In his commentary a day after the Fed's announcement, Schiff said, “Going further than he has ever gone before, (Bernanke) made it clear that he will be permanently binding the American economy to a losing strategy. As a result, Sept. 13, 2012, may one day be regarded as the day America finally threw in the economic towel ...

“The set of policies announced yesterday will do so much more damage than 'Operation Twist,' they should be dubbed 'Operation Screw.' Because, make no mistake, anyone holding U.S. dollars, Treasury bonds or living on a fixed income will have his purchasing power stolen by these actions.”

As Schiff explains, the Fed's purchases of mortgage-backed securities (i.e. bundled groups of mortgages and the same investments that led to the housing meltdown in 2009) is expected to push mortgage rates even lower than they are now, supposedly encouraging people to refinance their existing mortgages or buy homes.

This in turn is expected to help generate enough demand to increase home prices and values, making consumers feel wealthier and thus more willing to take out new home-equity loans that will be used to make more consumer purchases.

And these purchases are then expected to translate into employers hiring more people to fill the consumer demand.

At the same time, the Fed hopes that cheap money will push up stock prices so investors feel wealthier and also begin to spend more freely.

It sounds so rosy and plausible.

But as Schiff notes: “(Bernanke) won't admit this directly, but rather than building an economy on increased productivity, production and wealth accumulation, he is trying to build one on confidence, increased leverage and rising asset prices. In other words, the Fed prefers the illusion of growth to the restructuring needed to allow for real growth.

“The problem that went unnoticed by the reporters at the Fed's press conference (and those who have written about it subsequently), Schiff says, “is we already tried this strategy, and it ended in disaster. Loose monetary policy created the housing and stock bubbles of the last decade, the bursting of which almost blew up the economy.”

Status quo must go
If you watched Bernanke's press conference, you also may have noticed reporters failed to ask another fundamental question: Where is the Federal Reserve getting the cash to buy the mortgage-backed securities?

It prints it.

And where is the Federal Reserve getting the money to buy U.S. government bonds (debt) that it has been buying for years? (The Federal Reserve now holds nearly 10% of the U.S. government's bonded debt.)

It prints it. Out of thin air.

This is inflation. As the late Milton Friedman described in his book, “Money Mischief”: “Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation.”

Or, the more you print, the faster the dollar loses its value.

Bernanke defended his strategy as one designed to lower unemployment by spurring consumer spending. But in his press conference, he said the Fed doesn't expect unemployment to fall to 6% until 2015. And he further said the Federal Reserve would walk carefully the tightrope of trying to boost economic growth and jobs versus flaming inflation.

But late Austrian economist Ludwig von Mises would take issue with Bernanke's loose-money approach: “The expansionists are quite right in asserting that credit expansion succeeds in bringing about booming business. They are mistaken only in ignoring the fact that such an artificial prosperity cannot last and must inextricably lead to a slump, a general depression.”

It's a double-barreled threat: the federal government's growing Debt Bomb and the Fed's devaluing the dollar. This makes it difficult to be upbeat about the prospects for business and the economy in 2013.

This much is certain: Metaphorically, if a bomb is to explode, the target should be the policy makers' behavior in D.C.