Two More Nails in the Dollar's Coffin

The Republican "Victory" and the Fed's QE2

So on Wednesday, not only did the Republicans win control of the House of Representatives, but the Federal Reserve finally took the plunge with Quantitative Easing 2—

—in other words, on the very same day, the U.S. dollar got the ol’ one-two punch—right to the groin:

First the spend-and-cut-taxes Republicans won the Congress—and then, the Fed opened the money spigot with QE2.

Light at the end of the tunnel?

Talk about a bad hair day! The issue is no longer if the dollar will be killed—it’s now a matter of when.

Full disclosure: Though I am a fiscal and social conservative, I have always sneered at the Republican Party’s fiscal policies.

The Republicans have always espoused “smaller government” and “fiscal prudence”—but in the last 40 years, it was the Democrat’s president, Bill Clinton, who actually made government smaller. Shrub, Bush, Ford, Nixon, even the dubiously sainted Ronald Reagan all made government bigger: Bigger in absolute terms, bigger as a percentage of GDP—bigger government has been the real mantra of the Republican Party.

As for “fiscal prudence”—nominally, the Republican Party is in favor of balanced budgets. But ever since Richard Nixon said, “I am a Keynesian”, there hasn’t been a single Republican president who has managed to balance the budget. Cutting taxes without cutting spending is not a viable definition of “fiscal prudence”—but that’s what Republicans have been selling as viable macro-economic policy for close to 40 years.

The reason is simple. Long ago, the Republicans and the Democrats came to a tacit understanding: The Republicans let the Democrats spend all they want on various Big Government programs, while the Democrats let the Republicans cut all the taxes they want and spend all the money they want on defense. That way, both parties look good with their voters.

The cost of this Faustian bargain? The Deficit.

Dick Cheney summed up the Republicans’ attitude: Deficits don’t matter. Those three simple words are the Republican Party’s real mantra—their real motto. Deficits don’t matter—which is why Republican administrations have never delivered a balanced budget since Dwight Eisenhower, over fifty years ago.

That the Deficit doesn’t matter to Democrats is understandable: They are a party that by definition is fiscally irresponsible. Keynesian Klowns run that particular circus.

But the Republicans were supposed to be the party of fiscal restraint and discipline. After the profligacy of the George W. Bush administration, does anyone really believe that anymore?

The United States now has a debt of roughly 100% of GDP—the deficit is now running at about 10% of GDP annually. This is worse than Greece.

Yet aside from raising shrill bleetings when it suits them—id est, whenever there’s a Democrat in the White House—never a peep is heard from the Republicans about the Deficit when they are in power, either in the White House or up on Capitol Hill.

So now that the Republican Party has won Congress, this is what they will want—and get:

• Tax cuts for the wealthy will become permanent.

• A great big chunk of regulations governing corporate behavior—and corporate excess—will be rescinded, most especially in the banking and financial sectors. That whole “financial reform” bill? Neutered like Spot, its teeth pulled for good measure.

• There will be no cuts in the bloated defense budget, much less any cuts in the budgets for the pointless, needless wars in Iraq and Afghanistan.

Meanwhile, the Democrats will want more Keynesian stimulus—and ironically, they will likely get it.

Precisely because the Republican Party won’t want to be perceived as hindering the economic recovery—and because the current Republican Party is at heart Keynesian to its very marrow—the Republicans will support the Democrats with:

• More money for another round of stimulus. Yes, you heard right.

• More money for jobs programs and extended unemployment benefits. Ditto.

• More money for Social Security. Talk of reforming Social Security is just that—talk. A cheap way to buy the illusion of fiscal responsibility and prudence.

• More money for Medicare. Need those seniors’ votes—especially with 60 million Boomers about to become seniors.

• More money for the individual states, many of which are bankrupt in all but name.

In exchange for their votes on these spending programs, the Democrats will let the G.O.P. kill environmental bills and regulations, and probably gut the so-called “health-care reform” bill that was passed in the last session.

Why will the Republican-controlled Congress allow the passage of even more Democrat spending bills? Because the measures are popular and populist, no matter how fiscally irresponsible.

See, the Republicans aren’t stupid—they know that they won the mid-term by default. It wasn’t a Republican “victory”—it was a throw-the-bums-out election. If it had really been an election signalling a true ideological shift—like the ‘94 midterm—then the Tea Party candidates would have swept all their elections. They didn’t—but the Dems got trounced anyway. So in other words, it’s not that the Republicans won—the Democrats lost.

So the Republicans aren’t going to do anything that will antagonize the voters.

On the contrary: If the American people want more deficit spending, in the mistaken Keynesian belief that deficit spending can pull the economy out of this black hole? Then by golly, that’s what the new Republican-controlled Congress is going to give them!

More spending!

That is of course not what the American economy—and the American people—need.

What the American people need is for the political leadership to say, “We need to cut spending here, here, and here—we need to wind down these pointless wars that are sucking us dry—and we need to raise taxes on these wealthy folks and big corporations here, here and here.”

In other words, America needs a political party to stand up and speak to the people like the grown-ups that they are—like David Cameron in the UK is doing: The Conservative Prime Minister is slashing government spending and raising taxes, in a hell-bent-for-leather drive to cut the Labour Party deficit his government inherited.

Are the British people happy about these measures? No. Are they going along with them? Yes. Why? Because they realize it has to be done.

The American people aren’t getting this grown-up treatment from their political leadership. They might have thrown out the Democratic bums out—but they got new bums in their place: The Republicans.

Just you watch: The Deficit is going to get a whole lot worse, because of the Republican Congress.

Now, this alone would be bad enough—

Once through the Money Hole,

the travellers ventured into another

dimension of the Fed-Dollar continuum.

—but the Fed’s actions are making it all even worse.

With Wednesday’s announcement of QE2, the Federal Reserve has implemented the absolutely worst choice it could possibly make, in terms of monetary policy.

Before Wednesday’s announcement, there were three paths the Fed could have taken:

One, more stealth monetization: Printing money—sorry, “expanding its balance sheet”—and buying more toxic assets from the Too Big To Fail banks. The TBTF banks would then turn around and use this cash to buy up Treasury bonds, and thereby complete the stealth monetization process I described here. (I was actually betting on this outcome.)

The rationale for buying more MBS was that, because of the Mortgage Mess that I discussed here, the Mortgage Backed Securities market is tumbling even as we speak. The MBS’s Credit Default Swaps—the same bit of financial kryptonite that damn near wasted the entire financial sector in 2008—are climbing like Edmund Hillary on speed. A big swath of money to prop up MBS’s would soothe the financial markets, which are beginning to stress something awful because of Foreclosuregate.

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Novelist, Filmmaker, Economic Commentator