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Borrowing More Money: A Short-Term Solution to a Very Long-Term Problem


Eric Fry

As we begin a new week, the morning papers are full of headlines about an alleged rape committed by a high-profile politician. There are also a few stories about IMF Chief, Dominique Strauss-Kahn, assaulting a hotel maid. According to reports, Strauss-Khan dragged her kicking and screaming into his hotel bedroom.

But let’s return to that rape story…

It seems that at least one very prominent politician wishes to continue violating the US taxpayer by raising the nation’s debt ceiling, without also proposing a viable means of reducing the nation’s debt. (At least those are the shocking allegations by his accusers). It is not our place to name names. We are neither judge nor jury, just bystanders with a keyboard and a website. So we will allow the accused and the accusers to speak for themselves.

Over the weekend, US Treasury Secretary, Tim Geithner, warned, “A default [by the US government] would inflict catastrophic, far-reaching damage on our nation’s economy, significantly reducing growth and increasing unemployment.”

Geithner’s solution: Borrow more money.

President Obama engaged in similar fear-mongering on CBS’s Face the Nation. Said the President: “[If investors] around the world thought the full faith and credit of the US was not being backed up, if they thought we might renege on our IOUs, it could unravel the entire financial system. We could have a worse recession than we’ve already had.”

Obama’s solution: Borrow more money.

Both Geithner and Obama are urging Congress to raise the nation’s $14.29 trillion debt ceiling. Neither Geithner nor Obama is addressing the dubious logic of borrowing money to bolster credit-worthiness.

The US will reach its debt limit sometime today. But Geithner says he can juggle some things around at the Treasury to keep the cash flowing until early August. The government can continue borrowing until mid-summer, Bloomberg News explains, “by taking steps that include declaring a ‘debt-issuance suspension period’ under the statute governing the Civil Service Retirement and Disability Fund.”

To be sure, desperate times call for desperate measures. But we are not certain that desperate insolvency calls for desperate borrowing…and half-hearted attempts at fiscal restraint.

Geithner and Obama may have their macroeconomic snow globes turned upside down. Christmas trees don’t hang from the sky, scattering snowflakes across the clouds below. And neither do trillion-dollar deficits buttress the “full faith and credit of the United States.”

“Even a short-term default could cause irrevocable damage to the American economy,” Geithner warns. Maybe so, but long-term fiscal recklessness is the blight that is already causing irrevocable damage to the US economy…and the US dollar. Default is merely an effect, not a cause.

“To raise the debt ceiling without dealing with the underlying problem is totally irresponsible,” scoffs House Speaker, John Boehner.

Senate Minority Leader, Mitch McConnell, concurs: “We need to do something significant. We need to impress the markets, impress foreign countries that we’re going to get our act together, and astonish the American people that the adults are in charge in Washington and are actually going to deal with this issue.”

Your editors here at The Daily Reckoning have no particular grudge against Obama and Geithner, nor any particular affinity for Boehner and McConnell. (Neither the Democrats nor the Republicans hold a monopoly on bad ideas).

But we do have a certain contempt for idiotic notions that purport to work, simply because they have not yet failed. And we also have a certain fondness for discarding idiotic notions before they cause irrevocable harm.

One of the foremost idiotic notions of the moment is called quantitative easing (QE). That’s the process by which the Federal Reserve prints dollars to buy bonds from the federal government. Ben Bernanke, the architect and leading advocate of QE, says printing dollars will stimulate economic growth. A companion idiotic notion is that the government can stimulate economic growth by spending money it does not have.

Operating in concert, these idiotic notions simultaneously debase the dollar and increase national indebtedness. Which brings us to the leading idiotic misconception of the moment – that “spending cuts” are synonymous with “debt reduction.”

President Obama says he wants to “trim” $4 trillion from the federal budget over the next 12 years. To most Americans, that sounds like debt reduction. But it’s not. It is only a cut in planned spending, the effect of which would make the planned budget deficits slightly less obscene.

In other words, Obama’s “money-saving” budget proposals would cost America trillions of dollars – trillions that the government does not possess, that taxation alone could not raise and that foreign creditors would be increasingly unlikely to provide.

According to analysis by the Congressional Budget Office (CBO), the president’s budget would produce average annual deficits of nearly $1 trillion over the next 10 years. Total indebtedness would soar by a massive $10 trillion over that timeframe, as total annual spending would surge 57 percent – from $3.7 trillion this year to $5.8 trillion in 2021. In reality, these deficit numbers would probably be much higher still.

The CBO’s terrifying projections include an array of hopeful assumptions, the most significant of which are that interest rates remain near generational lows and that tax revenues climb at a robust pace. The president is counting on tax revenues to double over the next ten years.

Your editors are not engaging in this “fun with math” exercise simply to tweak President Obama’s nose, we are doing so to highlight the extreme danger that now faces the US bond market and, by extension, the US dollar.

Bond yields won’t soar into double-digits immediately, nor will the dollar slide to zero overnight. Even decay takes its sweet time. In fact, we predicted a dollar rally in the April 28, 2011 edition of The Daily Reckoning, “Staying on the Right Side of the Inflation Trade”.

“At some point, perhaps very soon,” we remarked, “the ‘overbought’ gold and silver markets will conspire with the ‘oversold’ Dollar Index to embark on ferocious counter-trend moves. We should be prepared for such an eventuality, but not perplexed by it… If/as/when the dollar rallies, don’t forget to hit the bid. The greenback remains a sick puppy…and inflation is its life threatening disease.”

A few days later, in the May 2, 2011 edition of The Daily Reckoning (“The Long Legs of the Silver Rally”), we offered a companion prediction that the silver market would crack.

“Over the next few weeks,” we wrote, “the precious metals are likely to become a bit less precious for a while… A major correction in the silver market is very likely, very soon.”

Both predictions/guesses have come to pass. The Dollar Index is up more than 3% since the end of April, while the silver price has plummeted more than $10 an ounce. These counter-trend moves mean only that the dollar is a better sell and silver is a better buy.

As reported in our May 2 column, “Your editor does not raise this caution to suggest that silver be sold. Rather, he raises it to suggest that silver be bought…at lower prices… The silver rally still ‘has legs,’ even if those legs might wobble occasionally.”

For as long as the leaders of this nation portray “money they don’t borrow” as “money saved,” the dollar will remain a long-term “sell,” while gold and silver will remain long-term “buys.”

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