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Jared Dillian


The Tomb Is Sealed

Posted: 10/14/11 01:45 PM ET

Earlier last decade, Alan Greenspan initially opposed (and later supported) what would eventually become a sweeping tax cut. In case you forgot, the government was running a sizable surplus and the logic was that the surplus would be returned to the taxpayers. The government, after all, is generally not in the business of running a profit.

Right-leaning people were pretty upset with Greenspan. If you're ever going to cut taxes, that was the time to do it. Lots of people thought that Greenspan was going all moonbat in his advanced age. He took a not inconsiderable amount of heat from the right for his radical idea that surplus tax revenue should be used to pay down deficits. But Greenspan knew then what people today still do not understand: it's not the absolute size of government that's important, it's whether it can finance itself.

Today, unhappily, the United States spends more than half again as much as what it takes in. This is not uncommon in the developed world. Japan's national debt is about twice the size of its entire economy, the worst in the world. The bond market has so far declined to impose any discipline in the G10 world (except Italy) which causes people to be exceedingly glib about the situation.

Liberals generally think that the deficit is not a big deal; a fiction dreamed up by the right to deprive services to those in need, and conservatives are in the absurd position of advocating tax cuts amidst pornographic deficits to oppose any further growth of the state. The only people who really understand how grave the situation is are the financial people, and there are hundreds of protesters camped out on their doorstep.

It is a big deal. Few people understand that to balance the budget, or even to bring down the deficits to the rate of growth would require cutting the size of government by at least half and/or nearly eliminating entitlements. It really is true. People like Glenn Beck (and others) were very early in this trade, which was actually unhelpful, because Beck's other polarizing views did not help anyone to achieve a greater understanding of how serious the problem actually was. You can't have unserious people have a serious discussion about debt.

The reason why ridiculously large deficits are dangerous is not because we (or anyone else) would ever default. As we are finding out with Greece, it is hard to have a meaningful restructuring because too much of it sits on bank balance sheets. If a country goes bankrupt, so do the banks, and that means depression -- unless you can find another way out.

The other way out is to monetize the debt, which is to say that the central bank will print money to buy government bonds. The central bank finances the government, becoming the lender of last resort. Consequently, there is more money sloshing around the economy, which will lead, in time, to very high rates of inflation. I cannot think of one historical example of a country that monetized its debt and everything worked out peachy, with low inflation (Japan does not count -- that story is not yet written). People have heard of Zimbabwe and Gideon Gono, but it remains an abstraction to most, because it is hard to believe that something like that could happen here.

It can and it will. The laws of economics are not to be conned.

In Europe, the authorities are currently trying to find a way to restructure Greece so that if it defaults, it will default gently. Who knows -- they might be able to do it. But even if they can, that still leaves Portugal and Italy and Spain, which are far too large to restructure and which have zero chance of growing their way out of it.

Imagine a fancy chess game, where, once checkmated, you can hit the eject button, and launch off the chess board to safety. That's what debt monetization is, and it can be very attractive.

There are protests in New York, which is unsurprising, because people are usually only against capitalism when capitalism fails to produce the desired results -- you didn't see any protests in 1999. If you see ants, it is likely there is a picnic nearby. But if you think this is bad, wait until you see how upset people get when there is inflation, which will hit poor people disproportionately.

The whole debt ceiling argument was about something known as austerity, where we would make an honest attempt to balance the budget. It is too late for that. The tomb is sealed, and we don't even realize it yet. Such a thing is not even possible, and it may not even be desirable. We are too far gone. The only option left for us is to aggressively monetize the debt, and hope that the inflation of the century never arrives, like it has every other time in history.