Posted by Karl Denninger
“Achieving long-term fiscal sustainability will be difficult, but the costs of failing to do so could be very high,” Bernanke said in remarks prepared for a speech today to a White House commission on the budget deficit. “Increasing levels of government debt relative to the size of the economy can lead to higher interest rates, which inhibit capital formation and productivity growth — and might even put the current economic recovery at risk.”
We need to review a few graphs again.
Let’s start with this one:
This is the true deficit, measured simply by the amount of Treasury debt (including intergovernmental games) outstanding.
Of note is that it has never decreased materially since 2001.
Why is this important? Because every dollar that the government borrows and spends is one dollar that pulls forward demand from tomorrow and spends it today.
This game continues, as it did in the housing market, right up until you can’t get any more credit to do it with.
But more importantly as you put forward this sort of distortion in the market the economy becomes habituated to that deficit spending and incorporates it into GDP!
This then turns that deficit spending into a mandate on an ongoing basis lest you have a recession – or worse.
Now let’s look at how big that distortion has become, as a percentage of GDP:
This is where your problem begins. While government deficits have varied over time, during the 2000 decade they became both embedded in the economy and at a high and continuing level of about 4-5% of GDP.
That is, the so-called “recovery” in 2003-2007 was false; it did not consist of organic demand from the marketplace, but rather it consisted of government’s fraudulently inflated demand.
Contrast this with the 1990s when private demand rose fast enough that the government was able to slowly withdraw stimulus via deficit spending, to the point that it actually approached zero! That’s REAL economic growth.
But now we’ve gone even further, and in the last two calendar years have put up nearly 10% and nearly 12% of GDP distortions, respectively. Let me remind everyone that in the world of economics a 10% economic contraction is the formal definition of economic Depression; ergo, we have been in one for the last two years and are today!
The Obama administration estimates budget deficits will total $5.1 trillion over five years and hit a record $1.6 trillion in the year ending Sept. 30. The $1.4 trillion deficit in 2009 was equal to 9.9 percent of gross domestic product, the largest share since the end of the World War II.
Bernanke spoke to the National Commission on Fiscal Responsibility and Reform, established by President Barack Obama to identify policies to reduce the deficit to a sustainable level. The commission’s mandate is to propose a plan to balance the budget, except for interest payments on debt, by 2015.
That cannot happen without the economy undergoing the very adjustment in matching of output and final private demand that the government has spent ten years trying to avoid.
This is the ugly truth that Bernanke doesn’t want to speak of, but he knows it to be true. But neither he, nor the government budget folks, are willing to come out and tell the people the truth – since 2003 we have managed to compound a 58% distortion to our $14 trillion GDP!
To say that the adjustment occasioned by withdrawal of that support would be catastrophic would be the understatement of the year. We never got anywhere near this level of distortion in the 1920s and 30s – the distortion reached about 25%, top to bottom. The adjustment produced what we call The Great Depression.
Let me be clear: We have a $14 trillion economy that has accumulated a fifty eight percent net deficit, or more than double the distortions that had to be absorbed in the 1930s.
It is obvious that sudden withdrawal of that support would lead to an instantaneous and catastrophic economic collapse.
If you’re wondering why I have spent three years arguing strenuously against the policies that our government adopted to try to “stem” the crisis, you now should understand – we are now absolutely dependent on the ability to maintain this level of distortion and will be able to withdraw it only slowly, if at all.
Any event that causes us to have to withdraw it suddenly WILL RESULT in the loss of our economy and republic.
This is not speculation – it is hard mathematical fact.
The risk taken on by those who promulgated and adopted these policies is criminally negligent. Of course since the actors who did so work for the Federal Government criminal negligence isn’t punishable as it’s not a felony to do this as a government employee, even though such acts in the private sector certainly are punishable.
This is the precise set of actions that has led Greece to find itself in the box it is now in. Portugal is headed down the same road, as is Spain, Ireland and Italy. All five are at risk of economic collapse.
We are inexorably headed for the same result if we do not accept the economic adjustment that is necessary to bring both private demand and GDP into balance.
There are means available to massively stimulate private demand but none of them include federal deficit spending. I have covered some of these in the past, including my particular favorite, adoption of The Fair Tax. Sadly such real reform is radically and diametrically opposed by the interests in Washington DC as doing so removes the tax system as a means of social engineering, control, and corporate lobbying.
Ben Bernanke has reason to be “concerned”, as he notes.
In truth, ladies and gentlemen, he is not “concerned” – he is terrified. He, like I, is well-aware of the above graphs and facts, and since he knows how to use a calculator (or even a paper and pencil) he also knows the extent of the economic distortion that has been built up over nearly a decade of borrow and spend politics.
Our opportunity to solve this problem will expire, and as Greece has discovered that expiration is likely to come with little or no warning, and once it arrives there will be no real options available to us that avoid a disorderly economic collapse.