In 2008, the global economy nearly died. In response, governments around the world – lead by our own – embarked on a level of stimulus unparalleled in modern history. Five years later, the global economy continues to seek its deathbed. Meanwhile, the stimulus continues. The US might have left TARP and cash for clunkers in its rearview mirror, but we still have QE Infinity and ZIRP pumping hundreds of billions of dollars into our economic life support every month. For its part, Europe has broken out bigger guns nearly every month in efforts to forestall a cascading sovereign debt crisis. And yet nearly all of her economies are now in significant contraction – including the “safe haven” Germany.
In response, a sizeable chorus of economists call for more stimulus – claiming that green shoots are forming and, in spite of the magnitude of what’s been done so far, it just hasn’t yet been enough. Unfortunately, this approach won’t work. Economic stimulus is quite analogous to bio-chemical stimulus. Just as a shot of amphetamine can boost an athletes performance (for a short time) so, too, can economic stimulus boost the performance of an economy. But only for a short time. Hit the stimulants too often and your economy (like your body) becomes an addict. Requiring more and more stimulant for less and less effect. All while the body corrupts from within.
Debt limits are real. While the limits on sovereign nations are different than those on private debtors, there are limits. Whether the debt to GDP line is 100% or 150% or (like Japan) north of 200%, at some point, creditors get wise to the fact that sometimes governments don’t pay back their debts and start charging a little more interest. This is where the first trap hits. As Greece, then Spain then Italy all discovered in turn, when you are deeply in debt, even small increases in interest rates can break the bank.
Of course, Greece, Spain and Italy are ‘trapped’ by the fact that they do not control their own printing presses. The United States is not Greece. If private market creditors start to grumble about the quality of American debt, Uncle Sam can always turn to the Federal Reserve to be a customer “of last resort” and the Fed can create some new money to buy. In fact, we’ve actually done a lot of this over the past five years. In 2008, the Federal Reserve held $0.5 Trillion of Federal Government debt. In 2012, it now holds $1.9 Trillion. This process of buying debt with freshly created money is called “monetization” and while it can forestall a debt crisis, it is no cure. In fact, its really just an upping of the ante.
The Federal Reserve can create new money because our currency is a “fiat” currency. This means that it is backed by nothing but the “full faith and credit” of the United States government. In ordinary times, the full faith and credit of the United States government is pretty substantial backing. But monetization puts this faith to the test. After all, every new dollar created by the Fed is a tax on every dollar that is currently in existence. So, whether you like it or not, when the Fed is monetizing the debt, it not magic that is paying for it. Its you. You and everyone else who is holding dollars. In essence, what monetization does is take a debt crisis and turn it into a currency crisis. And, since the US dollar has been the global reserve currency since World War II, monetization by the United States creates a global currency crisis.
This does not come without consequences. Take a look at this following chart:
This shows the relationship between the Federal Rerserve’s Quantitative Easing stimulus efforts and global commodity prices. Want to understand why Egyptians were rioting in the streets in the Spring of 2011? Quantitative easing in the US equals starvation in the rest of the world. Yes, we can monetize the debt. But at what cost? And how much will the world take before it realizes the the US has broken faith and lost credit?
The simple fact is that money is important. Money is the signal that allows a decentralized economy to work. Its the sign that tells us what things to make and who is good at making them. It directs what jobs we seek, what education we undertake to get those jobs and where we move to work in them. When we dilute the currency and push it into the economy from the top, we undermine this crucial signal. The result is enormously maladaptive and dysfunctional. People still try to follow the money – but where it leads no longer has any basis in what the economy (and the society) actually need. Like a junkie looking for junk – when what he really needs is a hot meal and a safe place to sleep.
This, of course, is precisely what has happened to our economy. We have been under some form of stimulus not only since 2008, but for decades. Dot com bubbles. Real Estate bubbles. All carefully engineered to stimulate the economy and “stave off” a “withdrawal”.
On the way, we’ve racked up a pretty good tab. Since the most recent crisis began, our sovereign (federal, state and local) debt to GDP ratio has jumped from a relatively benign 80% to 123%. This kind of debt burden is difficult to sustain. By comparison, Greece was at 129% when they began their melt-down in earnest. And, let’s not forget, we’ve already started the process of monetization in earnest. Coming out of World War II, the United States had the largest economy in the world and the world’s reserve currency. We inherited an amazingly privileged position. We can probably continue to spend that inheritence for years, perhaps even a decade to support our stimulus addiction. But its not going to help anything. All the while, our debts will rise, our economy will decay and our global position will fade. In the end, we will hit the wall – and leave our children to clean up the mess.