“The Day of Reckoning has come!”
So said New Jersey’s new governor-elect.
New Jersey is hardly unique. Practically every government in the developed world faces the same problem. National. State. Local. Expenses grew during the boom years. We all know why. Politicians prefer to spend then to save. They buy votes with other people’s money. That’s why they like programs for poor people. They come cheap. But the votes they buy on credit are even cheaper. Give a job…a handout…free drugs…housing subsidies – and send the bill to the next generation. With declining interest rates and an expanding economy, governments could get away with it. Low interest rates made deficits easy to finance and reduced the cost of refinancing existing debt too.
The trend was always unsustainable, even when things were going well. You can’t spend more than you can afford forever. Everyone knew that a day of reckoning would come. And guess what…here it is.
These new governors are no dopes. They have some room to maneuver. They can blame the problems on their predecessors. They can be heroes, solving them. In cutting spending now, they’ll be doing what has to be done. The smart thing to do would be to exaggerate the problems. But in the present case, exaggeration is hardly necessary. The financial problems are so grave, they don’t need to be puffed up.
Newly-elected governor Jerry Brown in the Golden State is in the same position. Hardly had the votes been counted when Jerry began taking more careful inventory. Naturally, what he found surprised him… He was shocked…SHOCKED…by the seriousness of the fiscal challenge. He pledged to come into the state capital with a broom the size of the Inland Empire…sweeping away unnecessary expenses and cleaning up state finances.
The story is the same in practically every Middlesex, village and farm community. States and municipalities spent more than they could afford. They ran up pension obligations. They borrowed for stadia and swimming pools. And now, like Ireland and Greece, they can’t keep up with the payments.
What are they to do? Default!
Yes, but before they do that they need to make a show of trying to be responsible. They need to talk about budget cutting and financial integrity. They will try to cut wages, close libraries, and renegotiate contracts.
Some will succeed. Many won’t. All we know for sure is that it will be fun to watch.
We also know that people who lent money to these governments will wish they hadn’t. In the US, as in Europe, there are bound to be debt crises. Cities and states will come to the brink of insolvency. There will be bailout initiatives. Austerity drives. Showdowns with unions.
New York City almost went broke in the ’70s. The mayor asked the federal government for a bailout.
“Drop dead,” said President Jerry Ford…or at least that was what was reported in the New York tabloids. The feds said no. New York had to get its own house in order. Of course, it succeeded, thanks in part to a huge boom in the financial industry that began in 1982.
Will there be another huge boom in the US? Maybe. But there’s a bust to live through first. And in the crises ahead, municipal bonds are almost sure to go down.
And more thoughts…
Mr. Ben Bernanke. Mythbuster!
“One myth that’s out there,” he told 60 Minutes, “is that what we’re doing is printing money.”
Ha. Ha. Ha. Can you imagine anything so laughable? So ridiculous? So absurd?
And to think that even we, at The Daily Reckoning, believed it. How could we be so credulous?
Of course, the Fed is not printing up money. How could we have been so naïve? The days of printing up money are long gone. Now, the Fed doesn’t do anything of the sort. Instead, it merely buys US government debt from banks. That’s not printing money. Nope. Not at all. Not even close.
But wait. How does it pay for the bills, notes and bonds it buys?
Oh, well, it certainly doesn’t print up money. Instead, it merely credits the banks with the money…electronically. No printing involved. The banks then have money that didn’t exist before.
The banks are supposed to lend it out. For every dollar they get from the Fed they can lend out 10. That’s how it works. So, IF anyone wanted to borrow the money, and IF the Fed had bought, say, $1 trillion worth of US government debt, the banks COULD lend ten times that amount…thus increasing the supply of money in circulation by $10 trillion.
Does that sound like printing money to you?
Nah… Of course not. Does it sound like it might cause inflation? Well, yes… It would be rather surprising if it didn’t. Consumer price inflation is now running at about 1% per year. Why so low? Because, so far, the banks aren’t lending. The Fed adds money to the system. But it doesn’t get passed along.
Why not? Because we’re in a Great Correction. The economy is saturated with debt. People are trying to dry out. And no matter how many times the Fed offers them a drink; they’re still on the wagon.
Of course, if the economy were to go on a binge again, the banks would lend, people would borrow, and all that money the Fed didn’t print would suddenly come out of hiding. Consumer prices would go up. Hyperinflation could come quickly.
Then what would Mr. Bernanke do? He says he would raise interest rates immediately, should the CPI hit 2%.
Well, dear reader, do you believe him? We do. At least as much as we believe he’s not printing money.
for The Daily Reckoning Australia