A very Clever Article, and on the Virtues of Poverty

As we speak, the yield curve is getting savaged(many smart folks figure the 10yr yielding 4% is irrelevant: I tend to agree there, so long as NIM persists), and many are fretting about the State's ability to finance huge deficits into a recession. Of course, there is plenty of wealth to redistribute, but to do declare a crusade without a mandate from the Church is just bad cricket.

This clever article gave reminded me that, yes folks, this is just another, "managed crisis":

Sorry, Larry Summers. It’s looking more and more likely that you’re going to be stuck in the West Wing for the duration.

See, if your boss fails to reappoint Ben Bernanke as Federal Reserve chairman come January, it would be a public betrayal worthy of the television reality show “Survivor.” For President Obama has no greater ally: Bernanke is truly the gift that keeps on giving.

The latest evidence came on Wednesday during Bernanke’s testimony before the House Budget Committee. The Fed chairman offered a stern warning about America’s huge budget deficits.

“Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance,” Bernanke said.

Tough, but hardly atypical Fedspeak.

Then Bernanke went a step further. He gave significant credence to the view that the recent rise in long-term Treasury yields and mortgage rates was caused by deficit jitters:

“These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings.”

Bingo! We have Fed confirmation: those inflation-hating “bond vigilantes” have time warped to 2009 from 1994 and are hot on the hunt for countries that can’t manage their finances.

Now when talk about the return of the bond vigilantes got louder last week, some were quick to declare it bad news for Obamanomics.

Rising rates, the theory goes, could force the White House to trim its future spending plans and return more quickly to a sustainable fiscal path. So long, universal healthcare. Bye-bye, green investments. And Bernanke playing deficit hawk only adds to that momentum, right?

Not really. Chatter about budget deficits and fiscal responsibility is exactly what Team Obama needs right now.

Here’s why: If you buy the theory of bond vigilantism — that credit markets will force interest rates higher in reaction to unsustainable national budget deficits — then you also have believe the White House needs to raise taxes sharply to pay for all its spending programs or risk a bond revolt.

Indeed, plenty of White House staffers, particularly if they worked for Bill Clinton, probably do believe in the theory. It was Clinton, after all, who chucked his investment agenda in favor of a “bond market strategy” to boost growth by persuading credit markets that the administration would balance the books.

As Clinton nicely boiled it down, “You mean to tell me that the success of the program and my re-election hinges on the Federal Reserve and a bunch of [expletive] bond traders?”

Now Obama has no intention of following a Clintonesque bond market strategy. Rates are already low. He just needs them to stay there until the economy recovers. And he also needs more tax revenue to pay for healthcare reform, alternative energy investments and his other investment priorities.

Maybe even a carbon tax to keep gas prices high enough so consumers will want to buy General Motors’ pricey electric vehicle, Volt.

Unfortunately for the White House, there are few signs that Americans want to pay higher taxes, especially during a recession that has eviscerated their net worth even if they have stayed employed. California voters, for instance, just voted down their state’s efforts to raise taxes to close a yawning budget deficit.

Yet the recent experience on the national level is that gigantic budget deficits often lead to higher taxes. That was true in 1982, 1990 and 1993. So if Team Obama wants a value-added tax, higher payroll taxes to fix Social Security or higher incomes taxes on wealthier American, it needs Americans to start fretting more about America’s fiscal condition.

Bernanke’s sharp warning contributed to that effort. So not only has Bernanke’s unprecedented monetary stimulus allowed Obama to focus on pushing forward his policy agenda rather than a pure stimulus effort (such as a temporary suspension of payroll taxes), but the weight of his authority is now being used to help persuade Americans that the budget deficit is the Next Scary Problem.

In short, Bernanke is effectively preparing the battlefield for Obama tax initiatives to pay for Obamacare and who knows what else. What more could a Fed chairman do for a president?

http://blogs.reuters.com/great-debate/2009/06/04/bernankes-deficit-warning-he lps-obama/#comments


Now, onto the Virtues of Poverty:

Because the US is such a dire debtor, it only makes sense that she needs to retrench hard and dig herself out of her hole. There are 4 ways to sort this out:

1) Higher taxes: no inflation, no debt
2) bond sales: no inlation, but debt
3) fiat money: inflation, no debt
4) bank credit: inflation, debt

The above are the main tools in the Fed's/.gov's arsenal. So far, we have used #2 and #3 extensively, and their sustainability has been questioned. Now, it is time for #1, to allow for further stimulus spending to, inshallah, permit #4, often associated with "economic growth".

The truth is, US consumers will have to export more than they import, and this implies US consumers will pay more for a given good than their export market would. Thus, by suppressing US demand by impoverishing its consumers, the US government can slowly rebuild the foreign exchange reserves in the country, just like china did after Deng Xiaoping's reforms. The process, though, requires free access to markets, and here's the sticky wicket for all the rosy prognostications for the future.

2010 is going to be grim.