Opinion of the court, delivered by Nicole Adams, signed by David Lamb:
Three decades ago, Alfred Kahn, then an economic advisor to President Carter, warned Americans that double-digit inflation and a stagnant economy might give rise to “the worst banana in forty-five years.” Although Mr Kahn’s word choice was humorous—Mr Carter had instructed him to avoid the word “depression”—his message was entirely sincere; inflation can be a sign of waning faith in the domestic economy and a trigger to further erosion of faith in the economy and its currency.
The recent stock market rally of the past four months—only now beginning to falter—and results from the Federal Reserve’s bank “stress tests” in May have persuaded Treasury Secretary Geithner and Reserve Chairman Bernanke that America has avoided the worst banana since the Great Depression. Before passing such judgments, Mr Geithner ought to examine President Obama’s 2010 budget.
The budget resolutions currently in both houses of Congress are unlikely to reduce the $1.17 trillion deficit that Mr Obama’s plan forecasts. If that federal deficit—the second largest nominal deficit ever—remains, it will be all but impossible to finance.
When the House and Senate settle differences in their budget resolutions and approve an identical plan, the budget will come into effect for the fiscal year that starts on the first of October and the Treasury will be responsible for bridging the gap between federal revenue and federal spending. During normal times, faith in the U.S. government and an international need for secure investment allow the Treasury to finance the national debt through Treasury securities and government bonds with low interest rates. This, however, will prove difficult if China isn’t a returning customer.
Over the past two decades, the Chinese government has reliably invested its annual surpluses in U.S. Treasury Bills. By doing so China secures its wealth and, more importantly, helps the U.S. government to continue running the deficits that allow Americans to afford Chinese imports; if the federal government were unable to easily finance deficits, it would need to raise taxes enough to remove them, thereby decreasing every taxpayers’ disposable income—much of which is spent on products manufactured in China.
If nothing else, this recession has shown China how much it needs American demand: since the U.S. recession began, China’s exports have dropped more than 18%. And combined with its own domestic recession, this drop has produced China’s largest fiscal deficit in sixty years.
So China’s government needs to buy Treasury Bills so that the federal government can stimulate demand for Chinese exports, but China’s government can’t buy Treasury Bills because it’s as bankrupt as the federal government.
What’s Mandarin for “pickle?”
America has been in this situation before—where Congress ran massive deficits without sufficient demand for government bonds. The time was 1978 and the result a 12% inflation rate.
Instead of raising bond yields to rates at which they would be purchased, the Federal Reserve decided to purchase long-term Treasury Bills. This method of funding, called monetizing the debt, is a form of quantitative easy, or what the layperson calls “printing money.” Although quantitative easing works to finance deficits in the short-term it also creates inflation, which functions as tax on everyone holding the U.S. Dollar. Since less affluent people tend to hold more of their wealth in the form of cash savings—instead of in a home, a car, or the stock market—the tax is regressive.
Mr Geithner should ensure that this doesn’t happen again. He should testify before Congress, advising its members to minimize deficits in their budget resolutions and explaining to them why “free lunch,” at least in fiscal policy, is so elusive. In a global outlook where the Treasury’s best customer—China now owns 24% of the national debt—has a deficit, Congress needs to decrease spending or create sufficient revenue to close its budget shortfall. Otherwise Congress will unknowingly levy a tax on the poor.
That’s a recipe for one very bad banana.
William Leich, Dissenting:
The inflation rate from May of 2008 to May of this year was -1.28%. Given the assumption of the majority opinon—that inflation acts as a regressive tax on the poor—the past twelve months should have been one of the best years to be poor since the Great Depression.
They weren’t.
That said, Mr Obama is doing what he can to trigger a recovery and transport more Americans from poverty. Yes, one of the stimulus measures Messrs Obama and Bernanke are using is quantitative easing, and, yes, it will probably yield higher inflation, but this will probably also benefit the economy.
The deflation that the American economy has experienced over the past eight months has stifled any opportunity of growth. Falling prices have given Americans incentives to delay purchases, thereby contributing to the recent increases in the personal savings rate. Such savings, which have displaced aggregate demand, have created a self-fulfilling prophecy, where Americans delay purchases expecting deflation, and by delaying purchases create more deflation. If Mr Obama doesn’t stop that vicious cycle it will ravage the economy.
But first, it will bankrupt the poor. That’s because deflation, not inflation, functions as a regressive tax.
In proportion to their income, poorer Americans tend to carry more debt; richer ones tend to carry less. Therefore when deflation spikes, the people who have the least capacity to repay their debts are forced to do so in dearer dollars. When they can’t, they declare Chapter 7 bankruptcy.
No right-minded economist would argue that high rates of bankruptcy aid economic recovery. What a right-minded economist will argue is that they erode the trust of lenders, which can, in turn, prompt a credit crisis. Therefore from an economic standpoint, the cost of high inflation is a small one compared to the costs of deflation.
Whether or not China decides to buy Treasuries the next time they are auctioned, the Treasury will be able to finance the 2010 budget deficit, either through European demand for Treasuries or quantitative easing. Indeed, if Mr Geithner chooses the latter path, Mr Bernanke and the Federal Reserve ought to have their hands on the dial, ready to raise the federal funds rate at the first sign of runaway inflation.
Until then, they should worry about deflation and recession, and Congress should pass Mr Obama’s budget—$1.17 trillion deficit and all. A little inflation could go a long way.
Opinion of the court, delivered by Nicole Adams, signed by David Lamb:
Three decades ago, Alfred Kahn, then an economic advisor to President Carter, warned Americans that double-digit inflation and a stagnant economy might give rise to “the worst banana in forty-five years.” Although Mr Kahn’s word choice was humorous—Mr Carter had instructed him to avoid the word “depression”—his message was entirely sincere; inflation can be a sign of waning faith in the domestic economy and a trigger to further erosion of faith in the economy and its currency.
The recent two-month stock market rally—only now beginning to falter—and results from the Federal Reserve’s bank “stress tests” in May have persuaded Treasury Secretary Geithner and Reserve Chairman Bernanke that America has avoided the worst banana since the Great Depression. Before passing such judgments, Mr Geithner ought to examine President Obama’s 2010 budget.
The budget resolutions currently in both houses of Congress are unlikely to reduce the $1.17 trillion deficit that Mr Obama’s plan forecasts. If that federal deficit—the second largest nominal deficit ever—remains, it will be all but impossible to finance.
When the House and Senate settle differences in their budget resolutions and approve an identical plan, the budget will come into effect for the fiscal year that starts on the first of October and the Treasury will be responsible for bridging the gap between federal revenue and federal spending. During normal times, faith in the U.S. government and an international need for secure investment allow the Treasury to finance the national debt through Treasury securities and government bonds with low interest rates. This, however, will prove difficult if China isn’t a returning customer.
Over the past two decades, the Chinese government has reliably invested its annual surpluses in U.S. Treasury Bills. By doing so China secures its wealth and, more importantly, helps the U.S. government to continue running the deficits that allow Americans to afford Chinese imports; if the federal government were unable to easily finance deficits, it would need to raise taxes enough to remove them, thereby decreasing every taxpayers’ disposable income—much of which is spent on products manufactured in China.
If nothing else, this recession has shown China how much it needs American demand: since the U.S. recession began, China’s exports have dropped more than 18%. And combined with its own domestic recession, this drop has produced China’s largest fiscal deficit in sixty years.
So China’s government needs to buy Treasury Bills so that the federal government can stimulate demand for Chinese exports, but China’s government can’t buy Treasury Bills because it’s as bankrupt as the federal government.
What’s Mandarin for “pickle?”
America has been in this situation before—where Congress ran massive deficits without sufficient demand for government bonds. The time was 1978 and the result a 12% inflation rate.
Instead of raising bond yields to rates at which they would be purchased, the Federal Reserve decided to purchase long-term Treasury Bills. This method of funding, called monetizing the debt, is a form of quantitative easy, or what the layperson calls “printing money.” Although quantitative easing works to finance deficits in the short-term it also creates inflation, which functions as tax on everyone holding the U.S. Dollar. Since less affluent people tend to hold more of their wealth in the form of cash savings—instead of in a home, a car, or the stock market—the tax is regressive.
Mr Geithner should ensure that this doesn’t happen again. He should testify before Congress, advising its members to minimize deficits in their budget resolutions and explaining to them why “free lunch,” at least in fiscal policy, is so elusive. In a global outlook where the Treasury’s best customer—China now owns 24% of the national debt—has a deficit, Congress needs to decrease spending or create sufficient revenue to close its budget shortfall. Otherwise Congress will unknowingly levy a tax on the poor.
That’s a recipe for one very bad banana.
William Leich, Dissenting:
The inflation rate from May of 2008 to May of this year was -1.28%. Given the assumption of the majority opinon—that inflation acts as a regressive tax on the poor—the past twelve months would have been one of the best years to be poor since the Great Depression.
That said, Mr Obama is doing what he can to trigger a recovery and transport more Americans from poverty. Yes, one of the stimulus measures Messrs Obama and Bernanke are using is quantitative easing, and, yes, it will probably yield higher inflation. But this will have positive effects.
The deflation that the American economy has experienced over the past eight months has stifled any opportunity of growth. Falling prices have given Americans incentives to delay purchases, thereby contributing to the recent increases in the personal savings rate. This drop in aggregate demand has thus become a self-fulfilling prophecy, where Americans delay purchases in the expectation of deflation, and by delaying purchases create more deflation. If Mr Obama doesn’t stop that vicious cycle it will ravage the economy.
But first, it will bankrupt the poor. That’s because deflation, not inflation, functions as a regressive tax.
In proportion to their income, poorer Americans tend to carry more debt; richer ones tend to carry less. Therefore when deflation spikes, the people who have the least capacity to repay their debts are forced to do so in dearer dollars. When they can’t, they declare Chapter 7 bankruptcy.
No right-minded economist would argue that high rates of bankruptcy benefit the economy on the macro level. Rather they erode the trust of lenders, which can, in turn, prompt a credit crisis. Therefore from an economic standpoint, the cost of high inflation is a small one compared to the costs of deflation.
Whether or not China decides to buy Treasuries the next time they are auctioned, the Treasury will be able to finance the 2010 budget deficit, either through European demand for Treasuries or quantitative easing. Indeed, if Mr Geithner chooses the latter path, Mr Bernanke and the Federal Reserve ought to have their hands on the dial, ready to raise the federal funds rate at the first sign of runaway inflation.
Until then, they should worry about deflation and recession, and Congress should pass Mr Obama’s budget—$1.17 trillion deficit and all. A little inflation could go aOpinion of the court, delivered by Nicole Adams, signed by David Lamb:
Three decades ago, Alfred Kahn, then an economic advisor to President Carter, warned Americans that double-digit inflation and a stagnant economy might give rise to “the worst banana in forty-five years.” Although Mr Kahn’s word choice was humorous—Mr Carter had instructed him to avoid the word “depression”—his message was entirely sincere; inflation can be a sign of waning faith in the domestic economy and a trigger to further erosion of faith in the economy and its currency.
The recent two-month stock market rally—only now beginning to falter—and results from the Federal Reserve’s bank “stress tests” in May have persuaded Treasury Secretary Geithner and Reserve Chairman Bernanke that America has avoided the worst banana since the Great Depression. Before passing such judgments, Mr Geithner ought to examine President Obama’s 2010 budget.
The budget resolutions currently in both houses of Congress are unlikely to reduce the $1.17 trillion deficit that Mr Obama’s plan forecasts. If that federal deficit—the second largest nominal deficit ever—remains, it will be all but impossible to finance.
When the House and Senate settle differences in their budget resolutions and approve an identical plan, the budget will come into effect for the fiscal year that starts on the first of October and the Treasury will be responsible for bridging the gap between federal revenue and federal spending. During normal times, faith in the U.S. government and an international need for secure investment allow the Treasury to finance the national debt through Treasury securities and government bonds with low interest rates. This, however, will prove difficult if China isn’t a returning customer.
Over the past two decades, the Chinese government has reliably invested its annual surpluses in U.S. Treasury Bills. By doing so China secures its wealth and, more importantly, helps the U.S. government to continue running the deficits that allow Americans to afford Chinese imports; if the federal government were unable to easily finance deficits, it would need to raise taxes enough to remove them, thereby decreasing every taxpayers’ disposable income—much of which is spent on products manufactured in China.
If nothing else, this recession has shown China how much it needs American demand: since the U.S. recession began, China’s exports have dropped more than 18%. And combined with its own domestic recession, this drop has produced China’s largest fiscal deficit in sixty years.
So China’s government needs to buy Treasury Bills so that the federal government can stimulate demand for Chinese exports, but China’s government can’t buy Treasury Bills because it’s as bankrupt as the federal government.
What’s Mandarin for “pickle?”
America has been in this situation before—where Congress ran massive deficits without sufficient demand for government bonds. The time was 1978 and the result a 12% inflation rate.
Instead of raising bond yields to rates at which they would be purchased, the Federal Reserve decided to purchase long-term Treasury Bills. This method of funding, called monetizing the debt, is a form of quantitative easy, or what the layperson calls “printing money.” Although quantitative easing works to finance deficits in the short-term it also creates inflation, which functions as tax on everyone holding the U.S. Dollar. Since less affluent people tend to hold more of their wealth in the form of cash savings—instead of in a home, a car, or the stock market—the tax is regressive.
Mr Geithner should ensure that this doesn’t happen again. He should testify before Congress, advising its members to minimize deficits in their budget resolutions and explaining to them why “free lunch,” at least in fiscal policy, is so elusive. In a global outlook where the Treasury’s best customer—China now owns 24% of the national debt—has a deficit, Congress needs to decrease spending or create sufficient revenue to close its budget shortfall. Otherwise Congress will unknowingly levy a tax on the poor.
That’s a recipe for one very bad banana.
William Leich, Dissenting:
The inflation rate from May of 2008 to May of this year was -1.28%. Given the assumption of the majority opinon—that inflation acts as a regressive tax on the poor—the past twelve months would have been one of the best years to be poor since the Great Depression.
That said, Mr Obama is doing what he can to trigger a recovery and transport more Americans from poverty. Yes, one of the stimulus measures Messrs Obama and Bernanke are using is quantitative easing, and, yes, it will probably yield higher inflation. But this will have positive effects.
The deflation that the American economy has experienced over the past eight months has stifled any opportunity of growth. Falling prices have given Americans incentives to delay purchases, thereby contributing to the recent increases in the personal savings rate. This drop in aggregate demand has thus become a self-fulfilling prophecy, where Americans delay purchases in the expectation of deflation, and by delaying purchases create more deflation. If Mr Obama doesn’t stop that vicious cycle it will ravage the economy.
But first, it will bankrupt the poor. That’s because deflation, not inflation, functions as a regressive tax.
In proportion to their income, poorer Americans tend to carry more debt; richer ones tend to carry less. Therefore when deflation spikes, the people who have the least capacity to repay their debts are forced to do so in dearer dollars. When they can’t, they declare Chapter 7 bankruptcy.
No right-minded economist would argue that high rates of bankruptcy benefit the economy on the macro level. Rather they erode the trust of lenders, which can, in turn, prompt a credit crisis. Therefore from an economic standpoint, the cost of high inflation is a small one compared to the costs of deflation.
Whether or not China decides to buy Treasuries the next time they are auctioned, the Treasury will be able to finance the 2010 budget deficit, either through European demand for Treasuries or quantitative easing. Indeed, if Mr Geithner chooses the latter path, Mr Bernanke and the Federal Reserve ought to have their hands on the dial, ready to raise the federal funds rate at the first sign of runaway inflation.
Until then, they should worry about deflation and recession, and Congress should pass Mr Obama’s budget—$1.17 trillion deficit and all. A little inflation could go a long way.
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Truth is the deficits can’t continue. They will weaken the dollar and leave the country poor. Soon we’ll be begging to China for foreign aid. The economy will recover. That will happen. We just need to make sure we don’t spend too much money trying to make it recover too quickly.