Wednesday, August 1, 2012

The Depressing Implication of the Fiscal Cliff

If Congress takes no action between now and January 1, 2013, the United States gets hit with the double whammy of tax increases and spending cuts. Marginal tax rates reset to pre-2003 while the automatic spending cuts from the budget deal in 2011 gives the Federal discretionary budget a haircut across the board.

Economists, politicians, and businessmen have all warned of the impending "fiscal cliff" come January. Everybody agrees it will send the economy in a tailspin and throw the economy back into a deep recession. But at the same time, this gives us a clue as to what the endgame is for the country.

If we can't abide by a combination of tax increases and spending cuts that would reduce the Federal deficit by 500 billion in the first year, what does that mean for the country? Because we're running 1.2+ trillion dollar deficits far into the future, and the vast majority of the new bonds issued by the Treasury are being bought by the Federal Reserve.

Treasury Inflation Protected Securities currently have a negative yield for all notes under 9 years of maturity. That is absolutely insane. What that means is people who want even the slightest real return on their money have to stow away their cash for a decade or have their money being eaten away by inflation. So the likely course of action seems pretty clear: inflate away the debt. The public won't tolerate tax increases or any meaningful reduction in spending. That leaves the government with only one course of option: monetization of the debt.

There is no easy way out of the mess that we're in. We either have to take our licks now or in the future Since a deal has already been struck (as of today) in Congress to punt on the budget, it seems like the the government has opted for a future licking.

It has become impossible for our politicians to look past the next election. And that is a damning indictment on the people who elect them.

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