Death by deficit by Tony Blankley

Today’s article of the day comes from the Washington Times:

The ancient Latin historian Livy famously described the terminal plight of the late Roman Republic. “Nec vitia nostra nec remedia pati possumus” (“We can bear neither our shortcomings nor the remedies for them”).

As I reread this phrase in Christian Meier’s biography of Julius Caesar this weekend, I couldn’t help thinking of America’s current fiscal profligacy – which has been growing for years at an ever-accelerating rate.

Of course, since last fall’s financial/economic crisis, the rate of profligacy has become supercharged. Like the Roman Republic’s lament, we think we can’t survive without deficit spending – but soon we won’t be able to survive with the deficit spending, either.

In 2012, federal debt will be higher than $15 trillion. Annual interest probably will be between $1 trillion and $1.7 trillion – depending on whether long bonds remain at about 3.5 percent or go to recent historic rates (6 percent to 7 percent). Deficits will average about $1 trillion a year: $22 trillion by 2019. Yearly interest payments then will be more than $2 trillion. That’s the good news.

That assumes the world continues to buy our Treasury notes at plausible rates. We had a slight foretaste of the future last week when 10-year U.S. Treasury bond yields shot up 60 basis points on soft demand and a Standard & Poor’s warning of a possible ratings downgrade of British bonds. The bond market may well rebel ultimately against our government’s excessive borrowing and spending (insufficiently supported by adequate national economic strength).

The “good news” of only $22 trillion in debt supported by purchasable bonds also assumes that our economy recovers this year and we then have continued steady economic growth. Of course, the more the government borrows, the less will be available for the private sector (the part of the economy that produces things). And the less available borrowing there is for investment and consumption in the economy, the slower the economy will grow – if it grows at all.

The not-so-good news on top of this astounding and growing indebtedness is that we will have to borrow even vastly more than the current budgets propose. Starting in 2017 (just eight years from now) the Medicare trust fund will be depleted. We will begin to experience a Medicare revenue shortfall that ultimately will total $35 trillion to $40 trillion over those next 60 years. Social Security’s depletion begins 20 years later and will have a shortfall of a little less than $10 trillion over the same period.

Oh, and the current budget projects that defense spending will decrease as a percentage of the federal budget. While the overall budget is slated to grow 75 percent over the next decade, defense is to grow just 17 percent. Only imminent and eternal peace would permit such low defense expenditures. The administration’s health plans also will add a currently unfunded $1.5 trillion per decade.

Not only does continued, increased government borrowing ever more sap our economy, but as the baby boomers retire, we will move from what recently were four workers to each retiree to two workers for each retiree. That means a weaker economy with fewer workers and more retirees will not produce enough to support all of government’s costs – even with massive and persistent tax increases.

And if, as seems possible, sometime in the next decade the world resists lending our government enough money (because our economy will be too small to produce enough to pay the ever-growing interest on the debt) – we finally will be forced to make choices of what to buy and what to forgo. Maybe only subsidized pain pills rather than medical treatment for old people? Just 50 percent Social Security payments? Default on federal debt payments? Or what the Chinese are already worried about – monetizing the debt leading to hyperinflation?

But the Roman Republic’s experience hints at an even more profound danger. The political tasks flowing from the growing demands of the republic’s empire were of a magnitude and type that could not be managed by its form of government. However, the Roman Republic was prepared neither to give up its growing empire nor to modify its government to deal with such challenges.

Similarly for the United States today, we are not prepared to forgo what all this soon-to-be unavailable deficit spending can buy us (health care, bank bailouts, defense spending, food stamps, etc.). Nor can our governments (and the publics who elect them) stop the spending.

Eventually for the Romans a contradiction arose between concern for the tasks that needed to be performed and concern for their form of government. The contradiction was resolved and the problems solved at the price of their republic: Came Gaius Julius Caesar.

Surely (presumably?) for the next decade, the United States will bungle onward with both our form of government and our deficit spending. But sometime soon after 2017, when Medicare’s trust fund begins its depletion (or earlier if the world stops buying our bonds) the shocking reality of being forced to do without borrowing will shape – and probably misshape – both our way of life and our form of governance.

Tony Blankley is the author of “American Grit: What It Will Take to Survive and Win in the 21st Century” and executive vice president for global affairs of the Edelman public relations firm in Washington.

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Published in: on June 3, 2009 at 6:04 pm  Leave a Comment  
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While we all lose money, the Fed makes money?

This from the Economist:

“Last year the central bank reported a whopping $43 billion in operating income. That was more or less the same level as in 2007, but meanwhile short-term interest rates had plummeted, ending the year near zero. That should have clobbered Fed income, as rate cuts did in the early days of the last recovery in 2002-04 (see chart).

But it did not, for two reasons. First, to shore up financial markets the Fed has pumped up its balance-sheet—its total assets were $2.2 trillion on December 31st, more than double their level of a year earlier. Second, it has been trading in low-risk, low-return Treasury debt and buying higher-yielding private debt—discount loans to banks, commercial paper, and mortgage-backed securities, for example.”

Are you kidding me? Not only the Fed can debase our currency, print as much money as it wants, cause booms and busts at will, but they also make money on the recession. Tell me if this makes any sense! Oh wait, they can print as much money as they want, so how can they ever lose money?

~Marxsevelt

Published in: on June 2, 2009 at 12:38 pm  Leave a Comment  
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The Obama Motor Co. from WSJ

Today’s article of the day comes from The Wall Street Journal:

Back in December, in an economy far, far away, then-CEO Rick Wagoner tossed out the scary cost to taxpayers of $100 billion if General Motors wasn’t saved by the government. Well, GM was saved in December and again in March, and as early as today the feds will rescue it a third time in a prepackaged bankruptcy that is already costing at least $50 billion, and that’s for starters. Welcome to Obama Motors, and what is likely to be a long, expensive and unhappy exercise in political car making.

Taxpayers have so far put up nearly $20 billion, which was supposed to be a loan at market rates but under Treasury’s forced restructuring will mostly be converted into equity in the new GM. The feds are also putting up $30.1 billion in “debtor in possession” financing and will effectively nationalize the once-mighty auto maker by taking roughly 60% ownership. (That’s not counting $12.5 billion to save GMAC, the company’s financing arm.) The Canadian government will go along for the ride for 12% of the new GM, the UAW will get about 17.5%, and the hapless bond holders have to settle for 10%.

The Obama Treasury is portraying this as the best solution to the mess it inherited, leaving GM with much-reduced legacy costs for health care, a cleaned-up balance sheet, a humbler UAW that has forgone some performance pay, and a more efficient dealer network and product line. GM, we are told, will now be able to make a profit and some day even return money to taxpayers. If you close your eyes and imagine that GM’s private managers would be able to make decisions based solely on business judgment, you can even start to believe.

But then you snap out of it.

Every decision the feds have made since December suggests that nonpolitical management will be impossible. First they replaced Mr. Wagoner — whom they are nonetheless still paying — with the more pliable Fritz Henderson as CEO and Kent Kresa as Chairman. The latter are good at playing Washington but unproven in making popular cars. Then Treasury bludgeoned the bond holders in both Chrysler and GM to take pennies on the dollar, which will not make creditors eager to lend to the companies in the future.

There’s also the labor agreement that the UAW approved last week, which goes some way toward reducing costs but probably not enough to make the new, smaller GM competitive. The new agreement simplifies some work rules and job descriptions but makes no reductions in hourly pay, pensions or health care for active workers. The agreement must also be renegotiated in two years by an Obama Administration running for re-election and weighing the need to keep Big Labor happy against the risks to taxpayer-shareholders. Who do you think wins that White House debate?

The Administration’s concessions to the UAW also restrict the company’s ability to import smaller, more fuel-efficient cars that it already makes overseas. UAW President Ron Gettelfinger boasted on PBS’s “NewsHour” last week that “we, quite frankly, put pressure on the White House, the [auto] task force, the corporation” to bar small-car imports from overseas. GM is also selling its Opel operation in Europe as part of this restructuring, and the Washington Post reports that one of Treasury’s sale conditions is that Opel’s new owners must stay out of the U.S., and even out of China, where GM’s business is strong.

This is raw trade protectionism. It is also textbook cartel behavior and would be an antitrust violation if practiced by a business. But the benefits for GM are illusory because the import limits mean the company will have to spend even more to retool its domestic plants to make the little green cars that President Obama and Congress are demanding. No one knows if Americans will buy such cars, even if GM can make them competitively in the U.S.

The Administration promises to wield a light ownership hand, but it’s only a matter of time before Congress starts to micromanage GM’s business judgments. Every decision to close a plant will be second-guessed, much like a military base-closing. And what about buying parts from foreign suppliers? Will those also be banned when Mr. Gettelfinger demands it, even if the costs are lower? GM’s managers and directors will have one eye on enhancing shareholder value, but the other on pleasing their political minders in Washington.

The Obama Administration has been whispering to the press that it could start selling its stake within a year to 18 months, and that it hopes to be out of the business entirely in five years. But even assuming that the taxpayer investment stops at $50 billion, GM would have to be worth a cool $80 billion for taxpayers to break even on their 60% stake. By way of comparison, GM’s market capitalization at its recent peak in 2000 was only $56 billion.

The larger corruption will be when government tries to vindicate its ownership by favoring GM over Ford and the other auto makers that aren’t wards of the state. The TARP legislation contained one blatant example in the form of a $7,500 tax credit for consumers who buy GM’s new electric car, the Chevy Volt. Expect more such favoritism, including huge new subsidies for green cars if consumers prove resistant to their charms.

Mr. Obama likes to say he’s a pragmatist who only prefers a government solution when it will work. But in resurrecting an industrial auto policy that even the French long ago abandoned, the President has made himself GM’s de facto CEO. Our guess is that he’ll come to regret it as much as taxpayers will.

Published in: on June 1, 2009 at 6:02 pm  Comments (2)  
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Why me and you are unemployed…

The old joke goes what is the difference between an graduate in Economics and a graduate in another degree and the answer is the Economist knows why he is in the unemployment line. With the current recession most new college graduate are having a hard time finding a job. I am one of those so here I am living the old joke and tell you why you do not have a job.

First, Education is the only thing in which you can spend your money on and not be taxed. At the same time, it is provided with a lot of federal funds. This is called a subsidy. In Economics, a subsidy always causes an overproduction. Think of it in this way, if the government pays the corn farmers more money than they are bringing in from the market then the corn farmers will create more corn then the market needs. So the important thing to note is that the subsidy causes an overproduction driving the price down.Next, the government usually buys up much of this excess in order to keep the farm prices high.

Since education is heavily subsidized and not taxed at all then that means there are more people earning college degrees then the market is asking for. As in their are less high skilled jobs than high skilled workers. This is also why the demand for graduate level degrees is going up as well. So during a recession it is much worse than just a surplus of students. The government solution in the farming industry solution is to buy up the excess. The government tries to do the same with the Americorp, Peacecorp, and the Military. Obama has realized that this is more of a serious issue and since he knows stopping the subsidies is political suscide his plan is to create more government jobs.

Many do not see this as a problem but there is one major one. First, as there becomes more workers in the public sector, which derives its income from taxpayers we have lesser and lesser people paying for more and more. This causes more and more debt. The next problem is that when the economy does pick up, now the government and the private sector will bid for employees. This is a major distortion in the market.

Everybody in America has noticed the growth in immigration both legal and illegal. Many of the arguments for immigration is that they do the jobs that Americans do not want to do. Some of this is true. The government has encouraged people to go to college more and more, thus they cannot take a job doing lesser skilled work or they will constantly be in debt. The more we subsidize education the more we will have to bring immigrants to fill in the lower skilled jobs.

The correct policy in this situation would be to only allow private subsidization of college students. This would allow the market to match up exactly how many skilled workers would be demanded. This would allow college students to make more when they came out. What about those who were on the margin? They would spend time working their way up in a corporation instead of wasting their money on education. My father was one of those. He could have went to school and gotten a business degree and then went into McDonald’s corp. or he could have started as a crew person and worked his way up. He choose the latter and there is nothing wrong with that.

~PCCapitalist

Published in: on May 29, 2009 at 2:35 pm  Leave a Comment  
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Home Values Fight Back

This from the Wall Street Journal:

“Officials at a Citigroup Inc. office in St. Louis placed a call to this desert town recently. The bank had caught word that Indio was coming after the lending giant with fines and threats of criminal charges. The offense: an algae-infested swimming pool at 79760 Eagle Bend Court.

Citigroup wound up in charge of the foreclosed home, one of thousands of such properties it was managing across the country. But last year, Indio passed a law that allowed it to charge banks with a criminal misdemeanor if they allowed a home to fall into disrepair.

“If I need to do it, I’ll say, ‘Mr. Bank President, if you don’t come and take care of your property, we’re going to come arrest you and take you to court in California,'” says Brad Ramos, Indio’s long-serving police chief.

The hard-line approach is part of this town’s attempt to gain leverage over some of the nation’s largest lenders. A couple of years ago, Indio was a real-estate bonanza. Old date farms were closing down, sprouting subdivisions in their places. Today it’s a different scene with one in 10 houses either in default or foreclosure.”

At first glance, this seems like a good way for homeowners who have done everything right and made their payments on time to prevent their home values from going down. As the neighbors upkeep can have negative externalities. The next question is the property rights one. Should other homeowners be allowed to sue other homeowners for upkeep.

The solution may be that if they all entered a social contract like the ones James Buchanan lays out, then it is an unianimous decision that the homeowners would be held against. Obviously, if your neighbor who you never entered a contract with decides that you do not keep your home nice enough for him, then he cannot do anything to you. This is why there are homeowner’s associations.

The rest is here.

~PCCapitalist

Published in: on May 28, 2009 at 1:17 pm  Leave a Comment  
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Anti-tax crusade to storm Capitol by David Lambro

Today’s article of the day is from the Washington Times:

The grass-roots “tea party” movement that swept across the country April 15 to protest federal tax and spending hikes will hold demonstrations in Washington and elsewhere this summer and fall when Congress will be battling over President Obama’s biggest budget proposals.

Leaders of the Tax Day rallies that drew an estimated 600,000 people in nearly 600 cities and towns say the seemingly spontaneous local protests have grown into a more muscular movement concerned that the escalating growth and cost of government threatens to undermine economic freedom.

Organizers say rallies are planned here and around the nation on the Fourth of July to tie the movement’s goals to the nation’s founding principles; on Sept. 12, when Congress is expected to be in the midst of debate over Mr. Obama’s plans on health care, energy and global warming; and on Oct. 2, when supporters expect that debate to be continuing.

“There is no central governing body behind this,” said Tim Phillips, president of Americans for Prosperity and one of the movement’s many informal leaders.

“It’s a genuine grass-roots movement, so I think you will continue to see an array of grass-roots protests giving voice to their concern that they have of losing their freedom, specifically their economic freedom.”

There appears to be no unanimity among the disparate groups around the country about the various rally dates.

“Some will say July 4, or Sept. 12, while others will have a rolling series of events in their localities,” said Mr. Phillips, who has been speaking at numerous gatherings since the tea party protests and has chosen Oct. 2 for his organization’s focus in Washington.

Since the protests made headlines around the country, the thousands of little-known, first-time protesters who organized and promoted the events appeared to have faded back into obscurity. But leaders monitoring these anti-tax-and-spend groups say they actually have been busy organizing themselves through a spurt of new Web sites and local meetings. Many have become involved in local politics.

“In some areas we’ve noticed tea party activists are getting involved in local government in school boards, town councils, and a lot of national Web sites are popping up to organize for another massive tea party day push,” said Adam Bitely, director of new media at Americans for Limited Government.

The Web sites have names like “TeaPartyPatriots.org” and “TaxDayTeaParty.com.” Mr. Bitely runs NetrightNation.com, which aggregates all of the Web sites and reports on the movement’s progress. “It’s kind of a general post on what everyone’s doing,” he said.

Nearly a month after the protests stunned the traditional conservative community by their sheer size and spontaneity, veteran organizers here are still taking stock.

“I was surprised by the number of people willing to go out and demonstrate in public against spending too much [and] the spark of tax increases. It’s a much more sophisticated, philosophical electorate than I had believed existed,” said Grover Norquist, the veteran tax-cut crusader who runs Americans for Tax Reform.

“Nobody issues orders to this group, no one institution, no one person. This is the future of parallel organizing, person-to-person organizing, everything the Internet allows you to do,” he said. “This is a ‘leave me alone’ coalition.”

Early signals suggest that a large political head of steam is building under the upcoming demonstrations.

“I am amazed by the energy created by all of this and I think that is what you are going to see in Washington, D.C., on Sept. 12,” said Brendan Steinhauser, a coordinator for the free market advocacy group Freedom Works, chaired by former House Republican leader Dick Armey of Texas.

“Congress will be back in session after its August recess, talking about budgets. We’ve got 3,000 people signed up so far on our Web site, but it’s early and the energy level is high,” Mr. Steinhauser said.

The April 15 tea parties have already had an influence on Washington officials. Just days after the rallies, President Obama asked his Cabinet to find $100 million in spending cuts in their department budgets – a hastily-crafted initiative that Republicans ridiculed as a minuscule fraction of his $3.5 trillion budget.

Republicans, however, have been just as unsuccessful in tapping into this group of voters Mr. Steinhauser describes as “sort of a mixture of libertarians, independent-minded people who lean conservative and even Democrats who are leery of all this spending in Congress.”

“I’m not sure Republicans have learned how to tap into this group yet,” said James Sibold, the former DeKalb County Republican chairman in Georgia.

The Harding Way by Thomas E Woods Jr.

Today’s article of the day comes from The American Conservative:

When Barack Obama urged passage of his so-called stimulus measure in February, he claimed that only bold government action would prevent the economy from slipping into a deep depression. In making that argument, he was only repeating the conventional wisdom, according to which markets are not self-correcting—except in the very long run—and state intervention is necessary to revive economic activity.

Economic theory can tell us why these claims are incorrect and why, in fact, even the appearance of prosperity that those measures can produce causes still greater damage and leads to a more severe correction in the long run. But we can also refer to the testimony of history. In particular, the depression of 1920-21, which most people have never heard of, is an example of the resumption of prosperity in the absence of government stimulus, indeed in the face of its very opposite. If economies cannot turn around without these interventions, then what happened in this instance should not have been possible. But it was.

During and after World War I, the Federal Reserve inflated the money supply substantially. Once the Fed finally began to raise the discount rate—the rate at which it lends to banks—the economy slowed as it started readjusting to reality. By the middle of 1920, the downturn had become severe, with production falling by 21 percent over the next 12 months. The number of unemployed people jumped from 2.1 million in 1920 to 4.9 million in 1921.

From 1929 onward, Herbert Hoover and then Franklin Roosevelt tried to fight an economic depression by making labor costlier to hire. Warren G. Harding, on the other hand, said in the 1920 acceptance speech he delivered upon receiving the Republican nomination, “I would be blind to the responsibilities that mark this fateful hour if I did not caution the wage-earners of America that mounting wages and decreased production can lead only to industrial and economic ruin.” Harding elsewhere explained that wages, like prices, would need to come down to reflect post-bubble economic realities.

Few American presidents are less in fashion among historians than Harding, who is routinely portrayed as a bumbling fool who stumbled into the presidency. Yet whatever his intellectual shortcomings—and they have been grotesquely exaggerated, as recent scholars have admitted—and whatever the moral foibles that afflicted him, he understood the fundamentals of boom, bust, and recovery better than any 20th-century president. (more…)

“The night of the living government,” coming to a tax-increase near you! by Roger Kimball

Today’s article of the day comes from Pajama’s Media:

My PJM colleague Andrew Klavan has just delivered a brilliant performance on PJTV. (What, you’ve not subscribed? Do it now!) “Night of the Living Government” is at once the most rousing, the funniest, and the scariest reflection on big government’s depredations since Ronald Reagan took to the campaign trail. Our government, Klavan says, has become like the zombies out of a horror movie:

[Government] doesn’t start businesses, it doesn’t create wealth, it doesn’t invent anything. It just devours all the stuff that you make. You bar the door against property tax, they come in through a sales tax, you board the windows against income taxes, they reach in through an energy tax.

But surely there are important differences between creatures from the “Night of the Living Dead” and the actions of the U.S. government. Of course there are! In the movie, Klavan observes,

zombies didn’t try to tell their victims being devoured was good for them. They didn’t say: “Let me devour your flesh, it’s patriotic.” Or, “Let me devour your flesh because we all have to make sacrifices.” Or — my favorite — “Let me devour your flesh because I know how to use it better than you do.” Also, when you try to stop the government zombies, when you say “No, zombie, No! Don’t devour my flesh,” they get pissy. “Well, that’s very selfish. You’re being greedy. You’re acting out of self interest.”

This brings us to my favorite part of Klavan’s skit. I like the pallor of Nancy Pelosi and Harry Reid: they’re every bit as creepy as the Hollywood monsters with which they share the screen. And what about that malodorous atmosphere of liberal guilt? What do you do when your liberal friends decry the “greed of Wall Street,” the “selfishness of Republicans”? You’re supposed to feel guilty. Do you? Klavan can help:

Now it always makes me feel really bad when a politician tells me I’m acting out of self-interest because everyone knows that politicians act out of a radiant love for all mankind. Or wait, maybe it’s an insatiable hunger for power! . . .

And now for the denouement:

Power is what this is all about. Power and Freedom. Every dollar the government takes is one less dollar of freedom for you and one more dollar of power for them. It’s your freedom to choose what you do with the fruits of your labor, whether you buy a TV or donate to charity or build your business or pay down your mortgage. It’s their power to finance make-work jobs and incompetent projects and corrupt programs which they can distribute as they will in order to buy votes and influence. And of course every citizen who feeds on those jobs and projects and programs, who doesn’t pay the taxes but benefits from the taxes paid by others becomes a zombie just like their government masters. Part of the the army of the unproductive undead that’s coming after you.

Klavan’s performance is half dramatic oratory, half Hayekian common sense. It is one hundred percent accurate in its description of what Chief Justice John Marshall warned about when he observed that “the power to tax is the power to destroy.” The moral? There are two: 1. Be afraid, be very afraid. 2. Get mad, then stand up for yourself, and join one of those tea-parties that U.S. Rep. Jan Schakowsky described as “descpicable and shameful.”

Published in: on April 28, 2009 at 6:00 pm  Leave a Comment  
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The Charlotte Tea Party Speech by John Lewis (April 20, 2009)

The article(speech) of the day comes from Capitalism Magazine:

This is a slightly revised version by Dr. Lewis for printed publication. Permission is given to read this in full, wherever defenders of liberty may gather.

It is high time for a tea party in America! But to do this right, we need to understand what it means. So I want to think back for a moment to what happened over 200 years ago, at the time of the original Boston Tea Party. The Founders of this nation brought forth a radical idea. It was truly radical, practiced nowhere before this time. This idea was the Rights of Man.The Founders saw each of us as endowed with certain inalienable rights, rights that may not be separated from our nature as autonomous beings.

These inalienable rights are: · The Right to Life–the right to live your own life, to choose your own goals, and to preserve your own independent existence. · The Right to Liberty, which is the right to act to achieve your goals, without coercion by other men. · The Right to the Pursuit of Happiness, to act to achieve your own success, your own prosperity, and your own happiness, for your own sake. · And the Right to Property—the right to gain, keep, and enjoy, the material products of your efforts.

Unless I’m mistaken I don’t see anything here about a right to happiness. I see a right to the pursuit of happiness: the right to take the actions needed to attain one’s own happiness. Nor do I see any rights to things at all—no rights to food, clothing, healthcare or diapers. There is only a right to act to achieve those things. This is called freedom. These rights to act—the rights to life, to liberty, and to the pursuit of happiness—are founded on a certain view of man. Each of us is an individual, autonomous, moral being, with the right to choose his own values and capable of directing his own life. Look at the person next to you, and look in the mirror—do you see the individual sovereign human being, existing for his own sake, with the right to live, to love, and to act?

This idea—the Founders’ idea of the individual Rights of Man—led to a radical view of government. Government was not to be inherited by the force of an entrenched aristocracy as in Europe, imposed by the divine right of kings through generations of oppression, or enforced by the force of a club. Government in America was to be designed and instituted by thinking men, for a single purpose: to protect and defend the Rights of Man. This is what the American Declaration of Independence says: “To secure these rights, governments are instituted among men.” Thinking men, armed with the idea of rights, created a government limited to the protection of individual rights. (more…)

Inflation is looming on America’s horizon By Martin Feldstein

The article of the day comes from the Financial Times:

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.

So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases. (more…)