financial aid and rants and raves

What's it like getting burned in effigy?

I re-read some of the prior posts, and realized I only talked around why I feel there won't be a policy change to end our situation; I never actually defended my position. Why won't (can't?) we stop QE-I've-lost-count, and also raise interest rates a few percent to encourage saving? Well, it was done before, and with painful results. We're in a similar situation now, but with much worse numbers in our ledger.

 Before getting into the meat of the discussion, I should explain what exporting inflation means. The ability to export inflation is the primary benefit of being the reserve currency, and this has allowed our debt to balloon to a point unreachable by all but a few nations (Japan). But how does the USA export inflation? Other nations export their products to the USA; we're the world's largest consumer of, well, probably everything. Nations that import to the USA are myriad, but China and Japan are the most commonly cited examples. The notion of exporting inflation works best with China, so we'll use it as an example. We print money, or have 0.5% interest rates, or something similar. This money is then distributed to the local economy in the form of tax rebates, Social Security payments, a public (make) work project, my salary, etc. Americans use this mana from heaven to buy gadgets from China, and the Chinese company goes to the Chinese Central Bank, dollars in tow, to get Yuan in trade for the greenbacks. Whether the bank has to print currency, or has cash on hand, the dollars will go in the vault, and the Yuan gets paid to the employees, vendors, bribes to local officials, etc. Now there's too many Yuan chasing a limited supply of goods and services, and thus inflation is created. If I gave everyone in a small town $1,000,000, but told them they could only buy products in that small town, everything would get really expensive really quick. It would also encourage local production and employment, which is why the Chinese government plays this game, lest the natives get restless and start demanding freedom of speech, fair trials, etc. It's better to keep them working.


Under the Bretton Woods agreement, America had a nominal gold standard and the world reserve currency. We were in charge, but the gold link kept us from abusing our authority. In 1971, Nixon removed this restraint, and the economy went haywire. We hit not with mere inflation (which was probably expected) , but stagflation, where the cost of everything went up, and the economy either wasn't growing, or in recession. Prior to 1965, economic contraction/stagnation and inflation were seen as mutually exclusive. Inflation is supposed to make people, governments, and companies spend money. Just as a falling stock market encourages people to sell shares, the falling purchasing power of a currency is supposed to encourage consumption. If you waited to buy something, it would be more expensive, even much more expensive later. Those of us who remember this facet of the 70's also remember that the decade, for most people, fucking sucked. The stagflation of the 70's was cured, at least according to conventional wisdom, by Paul Volcker's raising interest rates; the Prime rate hit approx. 21.5% in 1981. This stopped inflation, along with any false hope of economic growth.

Effectively, Volcker made a choice. Inflation, for all it's negative consequences, is seen generally as better than a recession, in small enough doses. In the stagflation era, we had rising prices, but without the assumed growth in economic activity. Volcker could kill one bad effect or the other, but not both. He chose to kill inflation, and cause a nasty contraction as well. To use another metaphor, we weren't getting high of the stimulant; we were barely approaching normal even while using. If you'd be normal without the drug, why not just quit cold-turkey? Because it causes withdrawal, and that comes with a great deal of pain. Volcker chose the pain, with only the hope of recovery guiding him. Naturally, he was hated, and he was burned in effigy in his first year. Now he's respected, even lauded, for doing what others didn't have the courage to do. I've read in a few places that his actions didn't actually cure inflation, but the theories are too arcane for a layman like myself to understand.

One can argue that America could have another Paul Volcker come along and curb-stomp us out of this mess, but so far we're appointing people doing just the opposite, and I have no faith in this possibility regardless. In my prior post, I discussed the effects interest rates had on the purchasing power of mortgages. Let's take that and apply it to the national debt. At the end of 1998, we had a national debt of 5.6 trillion, with debt payments of  353,511,471,722.87. Figures are from http://www.treasurydirect.gov/NP/debt/search?startMonth=12&startDay=31&startYear=1998&endMonth=12&endDay=31&endYear=1998

and that means an interest rate of about 6.5%. Today out debt stands at 17 trillion. Our year to date debt payments are a little over 415 billion, with a yearly total of around 498 billion. Our debt has tripled, but our payments are only 1.5 times higher. What happens when interest rates hit 6.5% like 1998? 1 trillion, 100 billion in interest.

These figures is why I believe we'll never have another Volcker. Never mind being burned in effigy; this person would be burned alive. There's no self-directed way out of this save either MASSIVE money creation or outright default. Either action leads to the rest of the world taking away our role as economic stewards. What happens then?



 

learning how to lie. We have something call faculty development days, and we have unusual lectures, classes, etc., to encourage our personal growth. The cynic would say it's a way to keep the teachers busy in the gap between finals and graduation, but I actually enjoy the presentations.

One of the more interesting ones was a lecture from one our Criminal Justice teachers on the nature of lying and how to spot it. Now, I'm something of a bullshit artist, so I wanted to see if could lie to the professors sitting next to me. The set-up was simple: what is your favorite vacation? My answer was to fly to Miami Beach and hang out on the sand all week. Now, is this a lie or the truth? Well, one person who knows me quite well said it was the truth, as did someone I know only in passing. The person who knew me changed her mind only after much deliberation.
The answer I gave was a lie. Anyone who really knows me also knows I hate FLYING to Florida, though I find myself doing it a lot more often with my present vehicle. I consider the drive down part of the vacation, with only my thoughts, and maybe a good audiobook, for company. I consider flying to Florida the easy way out. Also, I like having a car down there to take trips to FIU and Key West, and don't want to pay the additional money for a rental.  I also hate beaches (unless they're nude), though I love the ocean. Two small details rendered the statement a lie. The key in convincing even those who know me that my answer was truthful is that it's close enough to the truth to withstand scrutiny. Also, I'm full of shit.

Why is this relevant? Well, in my prior post, I ended with the final action that will remove America's standing as an empire: losing reserve currency status.

While I believe plenty of nations and other groups are very annoyed with America's recent jousting over the debt ceiling and the government shutdown, but I doubt they want the USA out of the top spot. China, on the other hand, is aiming for the dollar to be removed. This has been occurring piecemeal, with China and other nations settling accounts only in their own currencies. I believe this has also happened between other nations without China, but don't quote me.

The stated reasoning behind China's desire to do this that we are no longer responsible enough or cohesive enough to be trusted with the role. Now, I can't call complete bullshit, since there some degree of truth in the statement, or at least I can support some of China's logic. Still, I believe the reason China is saying all this has nothing to do with America's behavior and everything to do with replacing us as the world's economic power.

This will happen anyway, but without the world reserve currency, China will never have the same level of influence America had at her peak. We will always be able to undercut China by printing money or the like. So whether we're not being good managers of the world's wealth and purchasing power is irrelevant.

Now, China may not be honest about why they're asking for this change, but it is correct? I don't know. For one, I never believed we would default, and this would have been true even if the debt ceiling hadn't been raised.  The interest on our debt would have been the first thing paid. 

Honesty aside, what happens when America no longer possesses the WRC and the USA cannot export inflation? That comes tomorrow.

 Why I quit worrying and learned to love coming collapse. We had another artificial deadline and another artificially created crisis. A coworker asked my opinion about what has been going on in Washington, and I told him I stopped paying attention. This wasn't entirely true; if we didn't have a deal in place to increase the debt ceiling as of today, I would have taken $1000 out of the bank and kept it on hand in case of problems with the bank. I would have been able to buy food and gas, as well help my mom with food and rent. It didn't happen this time, but it will happen in the future.

 As I'm fond of saying, the reduction in government spending and programs (and the resultant reduction in economic activity and the average American's standard of living) will be either policy driven or market driven. Changing policy is a much better option, but the recent exchanges in Washington have convinced me that America's politicians will not reduce spending in time to avoid a market forced end to the nation's borrowing.

That leaves a  market-driven solution. To avoid an accusation of invoking a false dichotomy, I do realize that  the two can be intertwined. The bond market my have a rise in interest rates, and that would raise America's borrowing costs, so D.C. could be forced to lower spending. Both factors could be involved in a negative feedback loop, with changes from one forcing changes on the other. So, when I say the market will cause the change, I really mean that the market will drive the change, with the federal government following the market's dictates, with no chance to switch positions.

Now, and I alluded to one above, I feel that the markets themselves will have two different methods of correction, though these are not different paths, but escalations. 1) Interest rates will rise. One of the ironies of our present day is though the debt has risen, our interest payments have fallen. Back in 1998, I was listening to an NPR story on mortgages, and the reporters were remarking that the interest rate in 1982 was around 14%. This meant the payment on a $200,000 mortgage was 2369 a month, not including PMI or property taxes. In Nov. of 1998, the prime rate was 7.78%, cutting your house payment in half; alternately, that meant if you could afford the $2400 payment, you suddenly could borrow $330,000 for your home.

The rates given above are the Prime rates, so the mortgage rates would have been higher, but the math otherwise works. Now imagine you took out a mortgage in 1982 and refinanced in 1998, cashing out 50,000 dollars in equity. You originally paid 2369 an month, and now you're only paying 2100 a month. You blow through the $50,000 borrowed, and cash out more equity again. Now rates are 0.5%, so you borrow the 250,000 to pay off the second mortgage, and take out an additional $100,000. Your payment is a scant 1050.00 a month! Suddenly, the banks, who considered you a risk-free borrower, start getting a little skeptical. When you blow through you additional 100,000 and come back for more money to both pay off the 3rd mortgage and take more equity to finance your lifestyle (say 50,000), the rates suddenly jump up to 3%. The bank lends you the money, but now your payment is 1686 a month. You make $4000 a month after taxes. It was affordable at 1050, much less so now. In a mad scramble, you reduce spending a little bit, but the bank is unimpressed. Now you're in dire straights, and you didn't cut spending enough to live within your means, or at least close to that level. Yes, your salary is going up a little bit, but no where near enough for the bank to be happy.

One more time to head to the bank, and you find the interest rate in 6.5%! Yikes. Now the payment for the $400,000 you owe and the additional $50,000 you need is a whopping 2,844. Your salary went to $4,100, and you have to scramble to afford food, gas, what have you. All your excess spending is gone; you no longer eat out at the best restaurants in town, and the kids no longer have private school, their own cars, 1000 digital channels and on demand movies, and so forth. As a ripple effect, all the local businesses that depended on your stupidity largess have much lower sales, and waitress you were sending through college has to drop out to pick up more shifts, and the town's sales taxes go down because you aren't acting like a rapper in a strip club anymore.

Without beating the metaphor any longer, you the point. As bad a the above scenario sounds, it's the milder of the two option the rest of the world has when making the USA curtail her borrowing. Moreover, the process would be much swifter than as described above. Also, you have the chance to reduce your spending to rectify the situation, but you then have to explain this to the wife, and kids, and those who depended on your support. I'm not saying ALL the spending was a total waste; you were trying to keep grandma in her home (if only to prevent her from moving in with you...), and you were trying to send the kids to the best schools, etc.

The real damage will be caused by the second option: removing the American dollar as the world reserve currency. I've covered this in the past, but for next time, let's look at whether or not this is likely.