Tuesday, June 14, 2011

Fed Funding Gov Deficit

Many people understand that a government can not just print and spend money for most of its expenses or you get hyperinflation like Zimbabwe did when they tried it.   In fact, many people think Zimbabwe was stupid to even try that.

Many people realize that the Fed creating money and handing it to the US government for bonds is uncomfortably close to Zimbabwe's situation.  So many are expecting that this Quantitative Easing will stop.  However, there is a puzzle as to who else would put $100 billion a month into US government debt.

One popular theory is that banks will borrow money at 0.25% from the Fed and buy US government bonds at higher rates like 1.5% for 5 year bonds.  So the theory goes that the banks are funding the government, not the Fed.   This is foolish as it is really still newly created money from the Fed that is funding the government. 

People think that Zimbabwe just printed money and spent it.  But Zimbabwe had a central bank that financed the government just like the US.   At some point it became clear that the "loans to the government" were just an accounting fiction and what was really going on was they were printing money and spending it.   The same will become clear in the US.   At some point in the future people will think the US was stupid to try it.


  1. Vince,

    I agree 100% that today, US gov has a huge deficit and no
    credible plan to get it under control. However, I think that
    financial repression may still work. The reason why it may
    still work is that most people today still consistently under
    estimate true inflation rate.

    They do not yet
    understand yet the link between gov and Fed's policy and USD
    debasement. They think that because unemployment
    rate is high, high inflation is impossible. Or they think
    that because debt load is so high, high inflation is impossible.
    They blame increases in commodities price are temporary or
    caused by bad harvests. The high readership in Mish's and KD's
    blog to me indicate the prevalence of this kind of thinking.
    As long as this line of thinking is prevalent, the Fed has
    further room to go in suppressing rates below inflation rate.

    I welcome your further thoughts on this. Thanks.


  2. I have read most of your papers here and on other several other forums. In all cases, you are missing a fundamental understanding of historical cases of hyperinflation and no one has seen fit to correct your misunderstanding - until now.

    One of two conditions must be present for hyperinflation to occur - either substantial debt is owed in a foreign currency and/or the government has lost the ability to tax a substantial portion of the economic production. These are related conditions - often present together initially or, after the presence of one begins to initiate significant inflation, the other soon emerges.

    As you conceded on another thread, the Weimar regime had " questionable sovereignty,” and this often cited harbinger of US default, is actually a case study of the first required condition of owing debt in a foreign currency – which is not the situation for the US.

    The other most-often cited harbinger is Zimbabwe which is clearly a case of a sovereign's ability to tax economic activity – a condition that will always be derived from the state's loss of its monopoly on sanctioned violence.

    The next most-often cited harbingers are, of course, the Russian Ruble devaluation and the Asian Financial Crisis of the late 1990s. In both, involving several countries, the first condition of owing substantial foreign debt in other currency was present as well as policies of pegging their currency to a foreign currency (the US dollar) effectively turning over their currency sovereignty.

    If you take the time to really analyze any and all historical incidences of hyperinflation, you will find the presence of one or both of these required conditions. These conditions do not exist in the US now or for the foreseeable future. It is very difficult to imagine a scenario in which they would emerge (e.g. perhaps a civil war) without regressing to a mindset of survivalist or “world ender.”

    Once you have reconsider the historical events of hyperinflation and have absorbed the factual nature of the necessary presents of one or both conditions described, then you can begin the journey of improved understanding by asking why the null situation of these conditions (as in the USA) prevents hyperinflation.

  3. If a government had a balanced budget and foreign debts there would never be hyperinflation, they would just default on the foreign debt. Neither voters nor leaders really care that much about foreigners getting paid back. They would much rather default than destroy their country with hyperinflation.

    One could argue that the US only has the ability to tax for half of its budget. There is no way it can come close to taxing for the full budget. If a government can't tax for their budget and they are so far off that people won't lend them enough, then they will print money. The US is at this point. Most of the deficit over the last year was covered by the Fed printing money. This fits with your "inability to tax enough" idea.

    The Bernholz book on hyperinflation studied many many cases and found that debt over 80% of GNP and deficit spending over 40% of spending together was the indicator for hyperinflation. Foreign debt is not the key or even necessary.

  4. I think if you can stick with looking at historical incidence of hyperinflation and seeing that one or both conditions are always present, then you might have a breakthrough.

    Questions of how much foreign debt or how much domestic production not subject to tax are both already within the existence of the two conditions.

    The amount of US foreign debt is minuscule particularly in relation to the proper benchmark - not GDP, but net worth with estimates ranging from $350-400 trillion dollars.

    That leaves the ability to tax economic activity which serves to destroy money supply (disinflation) as opposed to the often-misunderstood notion that it is necessary to support government spending. While there may be a policy choice of how much to tax, very few question the ability of the government to tax - most who have bet on the latter are in jail.

  5. Do you agree that with a budget of twice their taxes that the US does not have the ability to destroy money? Do you think the US could double tax collection? You think they could even do 50% more? Revolutions happen when governments try to take too much from people. The US is in a situation where they must keep creating more money.

    I have looked at the historical record. Have you read Bernholz's book on hyperinflation? Do you have any book on hyperinflation you like better? This one covers many cases and looks at the common characteristics. Foreign debt is not part of the pattern. Taxes are important only in relation to spending, so in the size of the deficit. The US has the 40% of spending is deficit spending that few countries (outside of war ending type things) ever recover from.

    MMT people just try to look at a few cases. You need to look at many.

    The US hyperinflation during the revolution and also during the civil war were not the result of foreign debt. They were the result of deficit spending over 40% of spending.


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