- The Washington Times - Thursday, February 26, 2009


Without warning, the lines between the Bernard Madoff Ponzi scheme business model and the American government are starting to blur.

According to the Congressional Budget Office (CBO), the U.S. government will incur a budget deficit in excess of $1.1 trillion in 2009 - recent estimates put that number at $1.5 trillion. Obviously, the federal government is spending $1.5 trillion in 2009 that it does not have.

In February, the total federal public debt was $10.8 trillion. That is the sum of all federal deficits (occasionally reduced by rare budget surpluses) since Alexander Hamilton restructured the Revolutionary War debt in the late 18th century. Now fast-forward to 2009, when the federal deficit will increase the national debt by 14 percent.

This federal debt is financed in the capital markets by investors in Treasury bills, notes and bonds. These days, more than 44 percent of the U.S. national debt is held by foreign investors.

Up to this point, the federal government has had little trouble selling this debt to investors. However, at some point, investors, especially foreign investors, may decide that they have had enough of U.S. government debt in their portfolios. At that point, the interest rates on U.S. government debt will go sky high.

Secretary of State Hillary Rodham Clinton is realizing that the U.S. is dangerously close to reaching the point where China will completely cut off its future investments in the U.S. Recently, she was in China urging officials to continue investing in U.S. government securities - the Chinese own about $700 billion of U.S. government debt.

If the U.S. government cannot economically finance its budget deficits in the capital markets, it must reduce or eliminate its deficit. Businesses, state governments and individuals have two conceptual alternatives to decrease annual losses or budget deficits: First, cut spending, and second, increase revenues or taxes. However, it has a third alternative that is not legally available to other debtors: It can print money.

The recently enacted $787 billion stimulus package contributing to the $1.5 trillion deficit is politically rationalized by Keynesian economic theory, which asserts that additional government spending will result in the employment of unemployed workers who will spend wages on consumer items. It also suggests that a reduction in taxes will leave additional spendable income in the hands of taxpayers who will spend the money on consumer goods. The additional consumer spending will have a multiplying effect and stimulate a depressed economy.

The stimulus package includes spending increases of $485 billion. The spending increase is spread among a wide variety of housing, welfare, energy, education and transportation programs. Also included in this spending is about $54 billion in state aid.

According to economists and the CBO, it’s unlikely that more than 15 percent to 20 percent of the funds allocated by this spending package will be spent in 2009 to stimulate the economy. If the economy recovers by 2010, the remainder of the government spending will be stimulating an economy that does not need stimulation and will crowd out private spending and promote inflation. This is just the beginning of proposed federal spending increases.

President Obama recently proposed a $275 billion housing-bailout package. In addition, he has promised additional unspecified spending in health care, energy and education. This spending increase will be partially offset by a “peace dividend” generated by winding down the war effort in Iraq. It is not yet clear how the projected increased war effort in Afghanistan will reduce the peace dividend. Therefore, based on appropriations already approved and promises of additional spending by the president, the government will not be cutting spending in the foreseeable future.

The stimulus package also includes tax reductions of $302 billion. The tax reductions include tax credits to lower- and middle-income taxpayers, middle-class tax relief from the alternative minimum tax (AMT) and various business tax cuts. These tax revenues will not be taken from these favored taxpayers, who may spend much of the money in 2009 and hopefully help lift the economy out of the recession. Mr. Obama also wisely ruled out tax increases on upper-income taxpayers and businesses while the country is in a recession. Clearly, the government is not planning to increase taxes until the Bush administration tax cuts expire at the end of 2010.

Not surprisingly, this means that the government will have massive budget deficits for the foreseeable future. If it has trouble selling bonds to investors at reasonable interest rates, what are its alternatives?

Economists and politicians will tell you that the Fed will increase the money supply to reduce interest rates and make more money available for investment in government bonds. The rest of us call it printing money. But whether you call it accommodating monetary policy or printing money, it results in inflation.

In the mid-1970s through the early 1980s, the U.S. suffered painful bouts of double-digit inflation. This is an experience that we do not want to repeat. If you had cash, fixed salaries or a pension, or fixed-income securities, you had 10 percent less in purchasing power at the end of a year, with 10 percent inflation.

Businesses and consumers could not predict future pricing so there was a tendency to hoard assets. The principal beneficiaries of inflation are debtors with fixed interest rates. Debtors, who borrowed $100 cash with purchasing power of $100 at the beginning of the year, get to repay their creditors one year later $100 cash with purchasing power of only $90. That is a $10 benefit in purchasing power to the debtor.

Who is the world´s largest debtor? If you guessed Uncle Sam, you are correct, and to the tune of $10.8 trillion and counting. Inflation is a huge hidden tax on all who hold cash, fixed-rate financial assets and unindexed wages and pensions. It also causes price distortions, which adversely impact the allocation of resources.

In the 1970s, politicians did not have the political resolve to fight inflation because they thought it was the lesser of two evils. It was thought that fighting inflation would cause unemployment. Under the present circumstances, it would be shocking if Mr. Obama and the Democrat-led Congress made a decision to fight inflation at the cost of rising unemployment. A little advice: Buy now before the price goes up.

So what is the difference between Mr. Madoff and the government? When Mr. Madoff can no longer raise enough money to pay off his investors, his Ponzi scheme is exposed and he is subject to federal indictment. When the government can no longer raise money, it prints money. By printing money, it causes inflation, which debases the dollar and indirectly taxes Americans and holders of U.S. government debt.

If a financial institution covered its losses by printing money and debasing the currency of its depositors, its executives would go to prison. It is ironic that the federal government can do the same thing under the rationalization of Keynesian economics and claim that it is acting responsibly.

• Logan D. Delany Jr. is president of Delany Capital Management Corp.

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