The Causes of the Mess We’re In

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ponyRight now, we're in that weird in-between time of financial crises: The Global Financial Crisis of 2008 is behind us, while the next global crisis is not here yet—but it's on its way.

We can feel how it's on its way. Most everyone plugged into the macro-economic zeitgeist can tell you that bad juju is most definitely in the post—just that nobody yet knows (or is sure) what shape the next crisis will take.

Lots of people have been pointing to the various signs of the coming crisis: A U.S. Federal government deficit that's over 12% of GDP, to be repeated in fiscal years 2012, '13, '14 and possibly '15, if not surpassed; abnormal rises in commodity prices; European disintegration; a Federal Reserve that is printing money like there's no tomorrow; the largest bond fund in the world—PIMCO—exiting Treasuries (that's like Baskin & Robbins exiting chocolate); a complete inability of the political leadership class to do anything about the fiscal mess of the United States, at the Federal, State and local levels.

But though everybody points to the signs of the coming crisis, no one can yet make out its true shape. I've posited that it'll be hyperinflationary, while other very clever people have claimed it'll be deflationary.

However, these different interpretations about the coming crisis are interpretations of what's coming up in the future.

As we sit here waiting for the next Apocalypse, let's forget about tomorrow and instead consider the past. Let's ask ourselves the obvious question:

What got us here?

What policies were implemented—decisions made—actions taken—which would set us on such a path to oblivion? Because that is our ultimate destination—oblivion. It's coming to the American economy—and American society—as surely as if it had been FedExed last night. So if we're going to hell, might as well figure out how we got there.

Some people claim it was the very invention of the Federal Reserve back in the early XX century that set us on the path to ruin. Others claim it was the Hamiltonian desire for a central bank. If we play the causal game at these focus lengths, then we might as well go back to Adam and Eve—they're the reason for all our macroeconomic misery!

Patently absurd.

But if we get serious and look at the policies, decisions and actions carried out in our own lifetimes, then I'd have to say that there were two things that set us on the road that we're on:

  • One, the failure of Congress to deliver a balanced budget since 1975, and
  • Two, the subsidy the Federal Reserve gave both the U.S. economy and the Federal government by way of its artificially low interest rates, starting in 1987. 

Starting in 1975, the United States has had an uninterrupted string of yearly deficits—that is, the Federal government has routinely spent more money than it has brought in, barring a few exceptional years in the 1990's.

Deficit spending satisfied the ideologies of both sides of the economic divide:

For the economic Right, cutting taxes satisfied its notion that more money in the hands of the citizenry and corporations guarantees greater economic growth.

For the economic Left, more government spending every year satisfied its notion that more money spent by the government guarantees greater economic growth.

As per my Democratic Bankruptcy Paradox, starting in 1975, both sides of the political divide in the United States failed to resolve the fiscal incoherence of the United States, except in a couple of exceptional years in the 1990's.

The economic Right wanted lower taxes. The economic Left wanted more fiscal spending. Rather than thrash out their differences and come to a compromise, they resorted to the national credit card: Since 1975, the political equation insofar as Federal government money is concerned has not been either/or—it's been both/and.

Both lower taxes and higher Federal government spending—an achievement bought and paid for with fiscal debt. The fiscal incoherence I have posited, and which the American Congress proved in spades.

With each year that the fiscal incoherence was unresolved—that is, with each year that the political factions failed to hammer out their differences and balance the Federal government budget, and instead issued Treasury bonds to cover the difference—the overall debt became greater and greater—

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The Causes of The Mess We're In

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About Gonzalo Lira