Monty Pelerin's World

Economics, Finance and Politics Through The Prism of Classical Liberalism

Government Choices

Government Choices

This is a visualization of what the Fed is doing:

The chart is from a Martin Weiss article dealing with Bernanke and Fed irresponsibility.

The current path is unsustainable and must be stopped. There are only three options according to Thomas Hoenig, President of the Federal Reserve Bank of Kansas City. Weiss describes the Hoenig’s three options,

Path #1 — Monetize. The government runs massive deficits and borrows without restraint. At the same time, the Federal Reserve monetizes the debt — finances it by running the nation’s printing presses. This is the path of least resistance for politicians … and of greatest danger to the nation.

Yet, unfortunately, as evidenced by the explosion in the monetary base illustrated above, it’s also the speedway down which the Fed is now racing.

Path #2 — Policy stalemate. As in path #1, the government runs massive deficits and borrows without restraint. But the Federal Reserve refuses to finance it. Instead, the Fed lets the natural supply and demand for debt drive interest rates higher.

Soon, the government finds it is too expensive — or nearly impossible — to borrow. And ultimately, Washington has no choice but to slash spending despite any near-term consequences.

This is what’s happening to many governments around the world right now — not only in Greece, but also in California, Arizona, New Jersey, Massachusetts, plus scores of other state and local governments across the USA. In the final analysis, Washington cannot avoid a similar day of reckoning.

Path #3 — Fiscal discipline. The government takes strong pro-active steps to reduce the deficit. This is, of course, extremely tough politically in the absence of a massive fiscal and financial crisis. But unless pursued promptly and aggressively, the government winds up forced to do it anyhow — albeit with more urgency and greater trauma for the country and its people.

I have speculated in “Obama’s Ides of March” that Bernanke will choose Path #1. To do otherwise would be to shut the government down. I do not believe they can borrow the amounts required at anywhere near reasonable interest rates. Path #2 drives interest rates up so high that any chance of an economic recovery is quashed.

Path #3 is the only solution. It will be the last one tried and done so when our situation is much worse.