Confused Sheep

You can bet that in the battle between reason and fear, fear will win every time. Democrats are making Republicans look bad on their debt ceiling negotiations by telling Grandma she won’t get her Social Security check. They claim that we must, yes MUST raise taxes to manage the deficit. Americans, skittish of doing without entitlements and scared to distraction about a US default, are falling in line over the last few days. They are beginning to look like confused sheep.

Good arguments can be made to avoid a default now. The outcome would not be pretty. There is a grave danger in losing our top-tier credit rating, but Aug. 2 (the alleged date on which the US can’t pay some of its bills) is the least of our worries. We are on the slaughterhouse conveyor, worried about a minor vibration under our feet.

Let’s review how a government gets its money. It can tax its citizens, borrow it from private sources, or create it out of thin air. All three are in play now, though the third option is not widely understood among the populace. Democrats insist that more taxes are necessary to pay our bills. This in part because they have no intention whatsoever of touching entitlements. More on that in a moment. The second way, borrowing money, only works as well as it does because the US has been the stablest and most reliable debt currency on the planet for decades. In fact, when I was an economics student, Treasuries were considered zero risk. My instructors used to joke about the fact that they can always be paid because the government can print the money to pay them.

Which brings us to the third way government gets its money. No matter how Bernanke tries to dress it up, the Federal Reserve purchases debt (lends the government money) with money that is created from nothing. The actual process is fascinating in the way that a badly written horror movie is fascinating–it defies logic to such a degree that the entertainment lies in its absurdity, not its scariness.

Let me see now if I can make simple the trilemma we face. 1) If we raise taxes too much, we take even more money out of the private sector in an already moribund economy, diminishing any hope of a solid recovery. 2) If we raise the debt limit and borrow more money, we add to an already huge debt load, eventually making it impossible to pay off. (Some say this has already happened.) 3) If we print more money out of thin air, inflation or hyper-inflation sets in, wiping us all out.*

Astute readers are now wondering why we are only looking at the “income” side of the equation. How about not spending so much? Yes, how about that? Well, here is the problem. No significant discussion of reducing out debt can fail to include those programs that nobody wants to touch, Social Security and Medicare being the most noteworthy. That is why Democrats are winning the fight recently.

We are lambs being led to slaughter for one simple reason. We will not admit to ourselves that Aug. 2 is not the problem. We think that the bumpy conveyor belt we are on will get to Disney World as soon as the maintenance guys grease it. (Look guys! The first ride is so much fun that Charlie passed out! Charlie. Charlie? Hey, wait a minute…)

The credit rating we are so in fear of losing will not be sustained for any length of time even if we raise the debt ceiling because we refuse to fix the underlying problem. Government is too big to sustain itself. This is not a philosophical position, by the way. It is an economic fact. At some point, even those who favor much higher tax rates will run out of people to rob. Keynesians who see no problem with printing money will inflate the dollar into oblivion. No one will lend us money, either. Advocates of the entitlement state should be prepared to open their doors to 10,000 Grandmas each. If they still have homes.

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*This option is also complicated by the fact that the debt ceiling jimmies up at least some of the Fed’s tools for injecting money into the economy through debt.

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About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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