Truth or Consequences: An experiment in monetary policy and fiscal insanity

Governments may only continue so long this road of fiscal spending for so long until it suddenly stops working.  Read Niall Ferguson's "Decline and Fall - When the American Empire Goes, It Is Likely to Go Quickly"  (it will cost you a dollar to read the article, but there's a good summary here.  You can only pay your McMansion mortgage and party expenses on a credit card for so long before someone says: "enough already".  That moment may manifest itself in many ways, and usually happens, to the one being told, quite suddenly.  There simply will not be enough money to pay for it all.    Obviously the biggest commitments of money are medicare and social security, but what of all the federal and state employees? We have two ways out, truth or consequences.

If the government were to be honest (truth scenario) it would chop entitlements (likely on a gradient scale based on income, so Bill Gates wouldn't get any of his social security).  This would affect many people, and since the US is still a pretty rich country it's likely no one would starve, but many people would have to downsize their lifestyle.  That's not enough however.  The military would see dramatic cuts, further slashing veterans benefits and revenue for defense contractors (they'd cut employees).  Federal jobs would be slashed, cutting entire departments out of government.  These actions would unleash an unprecedented wave of government sector workers out on to the street, many of which who's skills are not fit for the current market demands.  They'd need to learn to do something else.  It would be a substantial bit of pain until a large enough number of these people begin to create traction in the productive market (the former state worker that invents a new, more efficient photo voltaic cell, builds a factory and hires a bunch of people).  This is the better long-run scenario for most of the people.

The next option has less upfront pain, but makes up for it in volume later.  This is the inflationary scenario.  There has been volumes of books written on the hyperinflation of Austria, Germany, Argentina et al.  Victor Sperandeo, an author and one of George Soros's top traders wrote an article here demonstrating that if a government runs 40% deficits for 4 years in a row in the last several hundred years of history, each time it ended in hyperinflation.  You can read more about hyperinflation over at Gonzalo Lira's blog to the left, or go pick up a copy of "When Money Dies" by Adam Fergusson.  In most of these cases, the government employees did much worse than the worker on the street that had his or her salary dependent on the market.  In the most extreme case of Germany however, inflation killed the middle class.  Doctors, Lawyers, and other upper middle class workers were reduced to ditch diggers, or subsistence farmers if they were lucky.  Many people starved on their wages that couldn't keep up.  Stray dogs and cats disappeared from the streets. 


Some ignorantly say "we will just tax more" to muddle along. Unfortunately we have historical evidence and an economic law, Hauser's Law, that shows us the maximum amount of tax revenue at 19.5% of GDP even during times of 98% and 28% top marginal tax rates.  Now GDP isn't exactly a great metric to use, it's got lots of problems, but it's close enough for this example.  Given our current GDP of 14.26T, we have a maximum revenue stream of 2.78T give or (more likely) take a couple hundred billion.  We spent 6.04T in 2010. 

We're in for some rough sledding either way.  Let us hope the people of the West will listen to the truth before the music stops.