"...The purpose of issuing bonds into the market is to provide a putative check and balance on Treasury overspending. That is, at some point the continued issuance causes the bond market to revolt and refuse to buy, driving rates much higher. That in turn causes the interest expense to go to the moon.
This threat [of Treasury buyers refusing to buy, causing interest rates to rise] is the primary check and balance on an out-of-control Federal Government.
...you can print all the money you want. However, you cannot control it's value except through relative scarcity!
The Bond Market, rather than being a monetary tool as these people claim, is in fact a fiscal discipline enforcement device.
This is what The Fed with its QE and now QE2 has destroyed.
When Ben Bernanke said "we will not monetize the debt" what he was saying is that he would not permit that fiscal discipline device to be removed from the scales of financial balance. He lied - he not only removed it with QE1, he has now ratified that this discipline function will remain removed via QE2.
The problem with removal of this device of restraint is that fiscal discipline is in fact the only way one avoids imposing taxes on the public. Taxes come either in the form of a literal tax that must be paid or they are financed by causing an increase in the price of things denominated in a currency as a result of debasement.
Taxes inhibit business profits by diverting income from the business and to government. Therefore, in the general sense, the lower the tax rate the more business prospers. Of course taxes cannot be zero, because the government must have funding to perform its essential functions...
QE is effectively naked emission of currency into the economy by government spending. It thus always results in shifting the price equilibrium on commodities in that currency...higher. ...input costs are effectively a tax on production... This in turn means that while cost pressures go upward, wages go downward.
Thus QE cannot spur employment. It in fact does the opposite by imposing an effective tax on business operations and consumers, which tends to drive down after-tax compensation of employees.
Ben Bernanke claims that QE is intended to "spur investment" by increasing the "wealth effect." But any such effect is in fact transitory, as one cannot support higher stock valuations while margins are being pressured. You need margin expansion to be able to support higher valuations over time, and that means you need either lower input costs, higher employee after-tax earnings or both.
...QE is an implicit tax on the population. Input costs go up. This is an effective tax increase on everyone in the country. A dollar increase in the price of gasoline is an effective $140 billion dollars a year in additional tax... Basic staples are already up about 10% annualized, despite Bernanke's claim of "no inflation."...
This in turn means lower disposable income for consumers. That in turn hits discretionary spending. And that, in turn, means companies don't need to hire people to provide discretionary goods and services...
This, in turn, means more demand for social programs. More unemployment. More Medicaid. More food stamps. More government spending of all sorts. But there is no tax revenue increase coming in to pay for these increased demands (it's all going to the commodity producers) so the government once again turns to the bond market and issues debt to fund this increased spending demand.
Left alone, the bond market will react to this "never-ending" deficit spending cycle by increasing rates in an attempt to cut it off. This in turn provokes The Fed into even more QE to "spur employment and increase asset prices."
See the problem? The more QE you do, the more jobs you destroy because you continue to trash margins through the imposition of an effective tax on the entire economic system.
Eventually The Fed ends up being, for all intents and purposes, the entire government bond market.
At that point the issuance of credit money is no longer backed by anything at all - it is simply emitted raw, and for every dollar emitted in this fashion you have both a 100% transmission into prices and a premium applied on your threat to do more of it.
That's Weimar Germany folks - it is exactly what happened there...
...Government will, in its last gasps of trying to prevent itself from being unable to pay the military, Congress, and of course Ben, find ways to literally confiscate everything in a futile attempt to increase the asset base upon which it issues its increasingly-worthless currency.
...when your tax increase results in more unemployment and you respond by further increasing taxes, you are simply tightening the noose around your own neck.
The implied tax that has been imposed on the economy thus far since QE1 was put in place is a stunning $250 billion annually due to oil's price increase alone... QE2 will add another $1/gallon (roughly) to gasoline which is another $140 billion, for a total of almost $400 billion each and every year.
And that's just in oil prices - then you have to add in all the other input cost-push problems, from corn to wheat to oats to cotton to wood pulp. The total effective tax increase from QE2 is in fact the entire $600 billion QE package, plus whatever the market anticipates Ben will do as a follow-on!
What is being done here, if it is not stopped by Congress and/or the people, will destroy the economy. There is no ability to withdraw... without causing all of the previously-hidden costs to immediately assert themselves in the economy.
This is not speculative - it is factual.
We cannot get wage inflation due to the lack of pricing power by labor in a market with 17% of the people either out of work or underemployed and another 7 million who are not counted as they are not part of the labor participation rate, which has declined by 5% in the last two years. The true unemployment rate is thus closer to 25%.
Without the ability to pressure wages higher there is no means available to set in motion Bernanke's "virtuous cycle" he is looking for as there is no pricing power for labor today.
We won't get a "high inflation" spiral. We will instead get a downward-spiraling economic disaster where employment and productive investment is successively destroyed by these artificially-imposed tax increases that amount to hundreds of billions of dollars over the next six months - north of a trillion in just one year, or some seventeen times the amount Congress is "debating" with the "tax cuts for the rich."
This is the true tax issue that will destroy our economic future - and nobody's talking about it."
Karl
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