Tim Kelly
November 29, 2012

The American people are once again being told of an impending financial catastrophe.

Federal Reserve Chairman Benjamin S. Bernanke has said that America will plunge off a “fiscal cliff” if Congress doesn’t do something by January 1, 2013.

photoIn 1971, President Richard Nixon terminated the dollar’s convertibility to gold internationally.

Former Treasury secretary Robert Rubin has also warned of the dire consequences of Congress not doing something.

And the firm JP Morgan is predicting America will fall “head first into the fiscal meat grinder” if Congress doesn’t do something.

Telling Congress to “do something” isn’t really helpful. After all, wasn’t it Congress doing too much that created this mess?

So what exactly is this “fiscal cliff” we have been hearing so much about lately?

Perhaps some background will be helpful.

Recall that back in the summer of 2011, Congress had run out of money. We were told then that unless something was done, the U.S. government would default on its debts for the first time in history.

Well, that wasn’t true on a couple of levels.

First of all, the U.S. government had indeed defaulted before.

In 1933, when FDR suspended the dollar’s domestic convertibility to gold, that was the U.S. government defaulting on its obligations.

In 1971, when President Richard Nixon terminated the dollar’s convertibility to gold internationally, the U.S. government was once again defaulting.

And some would argue that the U.S. government defaults every time the Fed monetizes Treasury debt. Sure, Washington’s creditors are paid in nominal terms, but they are being fleeced in real terms: the new dollars they receive are worth less than the old dollars they lent out.

Secondly, Congress had other options than outright default in 2011. They could have slashed spending and liquidated some of the U.S. government’s assets. This would have enabled them to stay current with their creditors. But it also would have required deep cuts in the federal budget. Despite the deplorable state of the U.S. government’s finances, there was no political will on Capitol Hill to actually reduce spending.

So Congress reached a last-minute compromise — the Budget Control Act of 2011. This agreement raised the debt limit by $2.1 trillion, which was enough to keep the federal government funded until January 1, 2013. But it also stipulated that, absent another compromise, a series of tax increases and budget cuts will kick in automatically on January 1, 2013.

Now we are being told that unless Congress borrows more money, they will be forced to cut spending and cover their expenses with taxes rather than debt.

This is the dreaded fiscal cliff?

Isn’t that exactly what Congress should have been doing all these many years?

Now, I am no fan of taxes, but I prefer them to inflation or debt, which really are insidious forms of alternative taxation, in that they conceal the true costs of government.

Seen in this light, the fiscal cliff is not the problem. Indeed, it appears to be part of the solution. Congress needs to get its fiscal house in order. This can only happen if Congress slashes spending. And plunging over the so-called fiscal cliff would do exactly that.

Nevertheless, we are being told that unless Congress avoids these spending cuts, the ensuing “austerity” will bankrupt thousands of businesses and throw millions of Americans out of work.

Is that correct? Is the U.S. economy forever dependent on debt-financed government spending?

Well, in its current grotesque form, it is. And that’s the problem.

The U.S. government’s debt-financed “stimulus spending” and the Fed’s “accommodating” monetary policies have distorted the nation’s economy, rendering it fundamentally unsound. The political problem here is that, however destructive these policies are in the long term, they are generally popular in the short term because they do create an illusion of prosperity. This, of course, is useful to spendthrift politicians whose time horizons usually extend no further than the next election.

So whatever form of budget deal Congress works out next month, it will no doubt involve kicking the can further down the road. However, things could very well be different this time. The Fed is now the largest U.S. creditor, finally surpassing China last year.

The central bank’s flagrant debt monetization is now taxing the patience of Washington’s most indulgent foreign creditors. An international run on the dollar is not unthinkable. If this were to happen, the Fed would have to raise interest rates to arrest the panic. The higher rates would make it impossible for the Treasury to stay current with its creditors without Congress imposing massive across-the-board budget cuts.

Such a reckoning would be a rude awakening for the many Americans now dependent on government largess.

Since 2001, there have been twelve increases in the debt ceiling, with $10 trillion being added to the federal debt. President Obama has already borrowed as much in one term as his predecessor did in two terms ($5 trillion).

Washington has never been a repository of fiscal probity, but since the financial crisis of 2008 the city has been on a spending binge that brings into question the sanity of those in charge. For example, just before the crash in 2007, the federal budget deficit was $160 billion. The 2008 budget deficit was $459 billion. And since then, Congress has run annual budget deficits in excess of $1 trillion.

The Bush administration doled out $475 billion to prop up insolvent corporations with TARP, and the Obama administration has spent another $840 billion on the American Recovery and Investment Act. The Fed has also gotten into the bailout act by tripling its balance sheet and initiating periodic rounds of “quantitative easing” (money printing).

What have we to show for all the “stimulus” spending, exploding debt, and inflation of the past four years?

Unemployment remains stubbornly high, with the official rate stuck around 8 percent; furthermore, nearly 30 percent of the jobless have been out of work for more than a year. The real unemployment rate is probably closer to 20 percent. One in seven Americans are receiving food stamps, and 20 percent of all household income now comes from government assistance in one form or another.

So it appears the fiscal and monetary stimulants injected by the Treasury and the Fed are no longer giving the U.S. economy even a short-term fix.

The same thing is happening across the Atlantic, where the European Central Bank has created trillions of euros to bail out the large banks and supposedly lift the EU economy out of recession. The resulting inflationary spasms are only sinking the continent deeper into depression.

There is no light at the end of this Keynesian tunnel, because it is headed straight toward a brick wall. What is needed is a detour.

The only way out of this mess is to change course and allow markets to clear. That means all markets, including the housing market, the stock market, the bond market, and the labor market.

It means we must stop inflating, and we must slash spending to the point where the federal budget is balanced and the principal of the national debt is actually being paid down.

Some have even argued for a repudiation of the national debt. After all, U.S. government bonds are technically unsecured debt. Why should these creditors be shielded from the risk of lending to a deadbeat like Uncle Sam? Moreover, an outright default would unburden future generations from a gigantic debt they didn’t create, while making it much harder for the federal government to borrow money in the future.

Murray Rothbard made exactly this point more than 20 years ago, when the U.S. government’s debt was a relatively modest $3.5 trillion (it’s now $16 trillion). He wrote,

I propose, then, a seemingly drastic but actually far less destructive way of paying off the public debt at a single blow: outright debt repudiation. Consider this question: why should the poor, battered citizens of Russia or Poland or the other ex-Communist countries be bound by the debts contracted by their former Communist masters? In the Communist situation, the injustice is clear: that citizens struggling for freedom and for a free-market economy should be taxed to pay for debts contracted by the monstrous former ruling class. But this injustice only differs by degree from “normal” public debt. For, conversely, why should the Communist government of the Soviet Union have been bound by debts contracted by the Czarist government they hated and overthrew? And why should we, struggling American citizens of today, be bound by debts created by a past ruling elite who contracted these debts at our expense? One of the cogent arguments against paying blacks “reparations” for past slavery is that we, the living, were not slaveholders. Similarly, we the living did not contract for either the past or the present debts incurred by the politicians and bureaucrats in Washington.

All things considered, an outright default would be the most honorable and least disruptive thing to do. But there is little chance the current crop of elected officials and bureaucrats who run things in Washington will follow Rothbard’s advice.

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