Wednesday, March 28, 2012

The ‘new’ normal, part 2

By Bill Wilson

In the first part of “The ‘new’ normal,” we analyzed the dilemma faced by fiscal reformers seeking to make budgetary cuts or even balance budgets in advanced economies that have active central banks.

Namely, if central banks around the world can just engage in unadulterated monetary expansion to enable profligate governments to perpetually refinance new and existing debt obligations — hardly a new practice — what need is there to ever cut spending?

Beyond that, we previously noted that even though too much debt can inhibit economic growth, and that a debt-induced funding crisis can even bring a society to its knees as in Greece, the world central bank cartel possesses a trump card.

So dependent are governments (and other financial institutions) on this unlimited financing scheme that, if the printing presses were shut off, it would likely crash the world financial system as governments and banks defaulted on their borrowings. That is because the large bulk of debts, particularly by governments, are never paid. They are simply rolled over via refinancing.

In addition, financial elites argue that cutting government spending and borrowing would have a deflationary effect, increasing unemployment, causing a recession or worse.

This creates something of an impasse to adopting responsible fiscal reforms in Washington, D.C. and other capitals the world over.

But since that is more or less the state of affairs — the world central bank cartel, after all, is in a position to dictate such terms — the onus is therefore on fiscal reformers to show why spending should be cut anyway, and that sound money should be restored. The fiscal reformer’s case is very much a prescriptive one to make, whereas those in favor of unlimited, perpetual deficit-spending and never repaying the national debt need only argue for the status quo.

Why act?

The first reason for action is because it is necessary — before it is too late. The greatest threats to the current system are black swan, worst-case scenarios. For example, 1) the increasing possibility of widespread rejection of the dollar as the world’s reserve currency because our debt load is too great; 2) that oil and other commodities will no longer be settled and priced in dollars, causing rampant inflation domestically; or 3) China and other foreign creditors actively dump their U.S. treasuries holdings in an attempt to crash the market for U.S. debt and dollar-denominated assets.

Any one of those events occurring would likely cause the other two to take place, and therefore pose considerable downside risks. The death of the dollar as the world’s reserve currency would significantly increase the costs of servicing U.S. debt privately, and lead to much higher prices (i.e. hyperinflation) here in the U.S.
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