The Still Echoing Wisdom of Stein and Minsky: Is Anyone listening?
Few seem to be. At least not in the Administration they aren’t, nor among the spenders in Congress or the government-employee unionists who are manning the barricades (in some cases, quite literally) in state capitals throughout the country.
Herb Stein was Chairman of the Council of Economic Advisors under Presidents Nixon and Ford and coined Stein’s Law -- “Something that can’t go on – won’t.” How’s that for simple eloquence? Applied to our current economic circumstance it tells us the nation’s widely escalating deficit, and the widely climbing debt that is its legacy, are going to stop because this double-headed Ponzirama obviously can’t go on forever. That’s why everyone from the Chairman of the Fed to the janitor who mop’s the central bank’s floors calls this spending orgy unsustainable. But if it stops involuntarily (the bubble of all bubbles) as compared to being brought under control by responsible public initiative, there is going to be an awful oversupply of misery in the land.
Hyman Minski, celebrated University of Chicago Professor of Economics, left us a prophetic warning as well. “Each state nurtures forces that lead to its own destruction.”
Minski understood (and warned) that excess liquidity, the type that prolonged availability of very cheap debt creates, always results in greater risk taking that, in turn, results in a greater need for debt which, in turn, always results in great instability leading to what (in the vernacular) we call a bubble.
Let’s see. We’ve been flooding the economy with money by printing enough to buy our own debt offerings, which is supposed to keep interest rates very low. The strategy is intended to force investors (the small fry as well as the big fish) to make riskier investments (think equities) and increase wealth as the prices of equities and other assets rise, and, thus, stimulate the economy. The real barometer of success would, of course, be improvement in the housing market, which should respond to all of this increased wealth. Well, QE1 (quantitative easing) and QE2 certainly have increased the value of equities (some would say “distorted” the value of equities) but, alas, no real discernable improvement in the housing market and not much improvement in the unemployment picture either.
Well, let’s not be unfair. The Fed can step in and adjust rates at precisely the right moment to prove Minski wrong. Surely the Fed can do that. A nuclear engineer can even insert uranium-moderating rods into the core of a nuclear reactor at exactly the right moment to stop a chain reaction and avert a nuclear disaster. Okay, not a great analogy.
Now the administration is pushing for further modification of mortgages to keep people in their homes, even though the first found of mortgage modifications has been a colossal failure with extremely high rates of foreclosures within a year of the modifications. QE2 is scheduled to end in June and no one knows for sure whether there will be a QE3, but the smart money is betting against it. With an election looming in the near future, however, a rash of mortgage foreclosures would be a major political liability so we think a massive new mortgage modification program is quite possible. We also think that type of vote buying may seem like smart short-term political strategy, but we think it is awful public policy.
Here is what Neil Barofsky, the special investigator in charge of overseeing TARP spending, had to say about the Home Affordable Modification Program (HAMP) less than a year ago: "The American people are essentially being asked to shoulder an additional $50 billion of national debt without being told . . . how many people Treasury hopes to actually help stay in their homes as a result of these expenditures," Barofsky also noted that HAMP "has not put an appreciable dent in foreclosure filings," because, among other reasons, "the number of trial and permanent modifications that have been cancelled substantially exceeds the number of homeowners helped through permanent modifications."
In addition to teaching us what is the speed of light, didn’t Einstein also teach that doing the same thing over and over again and expecting different results is the definition of insanity?
We’re not writing this week to predict economic Armageddon. We’re writing to simply say we’re concerned, very concerned. And we’re in good company. Since we last wrote on this subject, about a month ago, the somewhat chastened Standard & Poor’s and Moody’s, the agencies whose sole purpose is to advise the investing public on the safety of various public debt offerings have warned that the country is beginning to skate where the ice isn’t so thick. The country, they tell us, is approaching the edge of the AAA ice, and heading toward the thinner and riskier AA ice.
Now we don’t, for a moment, think there is a scintilla of a chance of the United States defaulting on its debt. That’s not really the great issue. What concerns us, and what should concern every American, is that great spikes in inflation generally lurk behind great spikes in capital supply, and the Fed is mightily spiking the capital supply. If serious inflation is visited upon us, capital can go from being very cheap to becoming very expensive, almost overnight.
The certainty of the US dollar’s status as the international reserve currency (the money that every serious trading country holds in generous supply) has never been as tenuous as it is today. Major trading countries are voicing concerns, and some are reportedly scheming, to defrock the dollar of that coveted position (think France, China, Russia, etc). Such a development would not merely result in a loss of status, but, far more important, it would result in a horrific loss of wealth, as we would have to begin using poorly valued dollars to buy the new replacement currency of international trade in order to do business abroad.
A deflating dollar (not to be confused with inflating prices which are the result) is always a sobering prospect for those who lend us the money to appease our glutinous appetite for spending. This is no small matter to be dismissed out of hand. True, the holders of our debt know they will be repaid, but they also get nervous at the prospect of getting paid with dollars that are worth much less than the dollars they loaned. That’s when some investors begin buying very solid, tangible assets that are in limited supply to hedge against the shrinking value of dollars that are (or can be) in unlimited supply. Mother earth can yield only so much gold, while government printing presses can yield as many dollars as the government wants to flood into the economy.
Jeremy J. Siegel, Professor at the Wharton School of Finance put it more bluntly. Professor Siegel observes that inflation is the insidious, though technically legal, way in which the government defaults on its obligations.
So just what did the rating agencies tell the Obama Administration, or more accurately, those who invest in its debt? Well, to be exact, they said, that...“Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected, the federal financial picture as presented in the projections for the next decade will, at some point, put pressure on the AAA government bond rating.” To be blunt, the rating agencies think we have less than five years to get ourselves into substantially better shape than we are now.
Steven Hess, senior credit officer for Moody’s Investor Services and the author of the Moody’s report said “Although no rating action is contemplated at this time, the time frame for possible future actions appears to be shortening, and the probability of assigning a negative outlook in the coming two years is rising.”
While the government has a prodigious appetite for borrowing, the more borrowed money it vacuums into its own coffers, the less money there is to be loaned to other borrowers, in other words, the private sector which, after all, is what we are supposed to be stimulating. To compete with the massive government borrowing, everyone else has to fork up more and more in interest charges, which, of course, get passed on to you and us. It becomes a tax on everything and to everyone. Sooner or later growth is choked off, people lose jobs and everyone suffers...all over again.
And no, it’s not just the federal behemoth’s appetite we must assuage. As readers of our essays know, we are among those wringing their hands over the growing level of other government debt. States and local governments have a pretty hearty appetite for borrowing money too. About $3 trillion worth, when last we looked. Because these governments can and, in fact, must, raise taxes if necessary to meet their obligations, they are generally considered preferential borrowers as compared to private firms that must ultimately make a profit to service their debt.
To be sure, not everyone shares our concern about the compounding impact of state and local debt piling up in tandem with the ever-increasing levels of federal debt. Iris J. Lav, Senior Adviser at the Center on Budget and Policy Priorities, observes that almost all state and local borrowing is for long range, non-operating, purposes and not driven by short-term operating needs of local government. Nice try Ms. Lav, but at the end of the day an over-stretched tax payer begins not to care once he or she feels the tightening pinch of increased local and state sales taxes, property taxes, income taxes, additional inheritance and estate taxes and other transaction fees and taxes.
Fed Chairman Bernanke is quite candid when addressing the need for Congress to take seriously our mounting deficit and debt. When asked during a recent Senate hearing when the current level of U.S. budget deficits would “become a major problem in terms of the economy,” Bernanke responded: “It could become a problem tomorrow if bond markets are not persuaded that Congress is serious about bringing down the deficit over time.”
That’s the primary difference between public sector borrowing and private sector borrowing. To be borrowing money in the private sector, one has to actually be proficient at their business. If the private business isn’t run well, it won’t be able to pay its debts, a circumstance of which the prospective lender is keenly aware. When a government agency isn’t run well, like when it pays its employees far more than it can afford from operations, well, not to worry, they can just raise taxes. That is, until the people have had enough, and begin to fire the elected officials who they hold responsible.
That’s when, as old Herb Stein observed, we learn that something that can’t go on...won’t. Sadly, it seems to be a hard-learned lesson.
By Hal Gershowitz and Stephen Porter