Wednesday, July 13, 2011
- Being Wrong Vs. Acting Crazy
In 1979, the US Treasury failed to redeem 122M in Treasury bills. At the time, they blamed technical errors with a word processor and a delay in approving an increase in the debt ceiling. But as soon as those issues were addressed the money was repaid along with a penalty, and world continued to spin.
The world didn't end in 1979. Borrowing became horribly expensive for the government and the price of hard assets skyrocketed. We had to invent a new term for the failure of keynesianism - the hence overused term 'stagflation'. But in the fullness of time we elected an administration that actually understood something about how the economy works, and all the issues were resolved.
If we have a technical default, we will survive it. Even if Obama decides to keep the money flowing to his union handlers instead of paying the debt, turning our technical default into an actual default, we will still survive it. Countries have defaulted before. And although standards of living fall, and maybe government are overturned... life goes on.
So the good news is, even if everything he does turns out to be the exact wrong thing to do, Barak Obama does not have to worry about destroying the United states in that way. It won't happen. We'll continue to see the completion of Jimmy Carter's second term, with anemic economic growth, skyrocketing prices of hard assets, a lowering of the standard of living, and a general economic malaise. But the world will not end that way.
But if Obama decides to issue debt in defiance of the 14th amendment, then all bets are off.
Most Americans don't seem to realize that inflation and hyperinflation are two very different things. Inflation is a mistake. Mistakes happen, and when they do, they can usually be corrected by the person who made them (or at worst - the person who replaces him). In almost all cases, inflation is a relatively mild and short lived phenomenon. And when it's recognized by policymakers, it can be dealt with very effectively by increasing interest rates.
But hyper-inflation is not caused that way. Hyper-inflation is caused when the markets lose confidence in the ability of a political body to act rationally. When political decision makers let politics trump every decision, be it rational or not, then hyper-inflation is often the result. Printing money is easy, and virtually costless to the people who do it. And when politicians let it become a solution to problems that should be solved in other ways, a run on the currency is often the result.
It's literally the difference between being wrong, and acting crazy. If Obama issues new debt without getting the debt ceiling raised, then it will be an announcement to the markets that the US is no longer respecting the rule of law. It will be an economically irrational act, driven by politics. And if that's so, then what's next? Downgrade or no downgrade, the result will be a run on US Treasuries and radical rise in interest rates. If that happens, the Fed will likely step in as a buyer of last resort and the run will move from US Treasuries to the US Dollar.
At best the result will be a dramatic drop off in economic activity and a fall in the prices for all risky assets. America can be impoverished in an instant.
Obama cannot destroy America by being wrong. Neither can Tim Geithner, or Ben Bernanke. No one can. Jimmy Carter was wrong about everything, and he didn't manage it. But if Obama abandons the rule of law, it will shake the markets at their foundations. At that point, America really will have become a banana republic and it will be Barak Obama who finally made it into one.