Kittens, Bar Rafaeli and football. Oh yeah, the dollar collapse that will destroy our economy too, I guess...

Since I started writing this blog thing I've gotten some positive response from people who tell me how much they enjoy it.  So I want to take the time and say thanks to both of you that read my ramblings.  The other people who have brought it up to me have expressed concerns, most notably that politics/economics is much too complicated and boring to waste their time reading about, especially during football season.  Well, I want everyone to know that I've heard your criticism and I am going to take some steps to make these posts more enjoyable to a larger audience.  I'm not a good enough writer to make these topics interesting and fun, but I do know how to link to pictures and other websites.  So as you're reading this just know that there will be some extremely uncomplicated and entertaining links scattered about.

I know reading that paragraph was probably difficult, so here, take some time to enjoy this picture of Israeli supermodel Bar Rafaeli

Now, onto the topic at hand.

I wrote last time about how the trade deficit coupled with the fact that our dollar is the reserve currency of the world has lead to a huge number of dollars that we printed, sent overseas and because they're not coming back we see no inflation.  I'm going to try to expand on this inflation idea but focus more on our domestic policy this time.  I think that this is the most important issue facing our country right now and it's not going to be very long before we start seeing a currency in shambles.  I'll try to explain why I feel this is a very real possibility.

Right after I show you this clever Calvin & Hobbes cartoon strip!

 Since the recession started, the Fed has increased the money supply by $2 trillion and lowered the interest rates to 0%, which is what they call "Quantitative Easing".  The Fed recently hinted that they were going to do another round of Quantitative Easing.  In an effort to prop up an economy that is trying to crumble, the Fed is printing money and giving it to banks at historically low interest rates.  This is being done in an attempt to give banks incentives to lend to businesses and consumers.  The reason we're not seeing the inflation that should come with an extra $2 trillion is that the banks aren't lending the vast majority of that money.  The dollars are just sitting in the banks, and since they're not reaching the economy we don't see the inflation.

WOW!  Have you guys seen the 2010 Lamborghini?!

Now these dollars aren't going to sit in the banks forever.  At some point we'll start to inflate another bubble and it'll send false signals through the economy and banks will feel like it's safe to lend again.  Or maybe the Fed will take interest rates from the current 0% into negative territory to further incentivise banks to get the money into the economy.  Once enough of those dollars enters the economy, we'll start to see real signs of inflation.  This is where the Fed will have to time their actions almost perfectly in order to keep inflation from getting out of hand.  What can they do to keep inflation under control?  Well, they have to suck back those dollars that they pumped into the economy.  This is done by raising interest rates.  Banks don't lend as much when rates are high, the money starts flowing back to the Fed and they remove the money from the economy.  The tricky part is that the Fed has to time this out perfectly.  Raise rates too soon and you lose any positive effect of pumping those dollars to banks.  Raise rates too late and you'll be chasing inflation and it'll get out of control.

This is essentially what we did in the 1970's.  Back then we had inflation at about 12% and a weak economy.  In order to fix the mess, the Fed had to raise interest rates to 20% for an extended period of time to get inflation under control.  That was a difficult move because it kept people from borrowing money which in turn stalled economic activity.  But back then we were the world's largest creditor nation.  Today we're the worlds largest debtor nation.  This brings with it a whole host of problems, the most notable one is the damage that is done once interest rates start to rise.

Remember this hilarious scene from the hit movie Armageddon?  HAHA, that Affleck is so lovable and goofy.

Ok, so let's say for the sake of argument that the banks start lending and the dollars start to hit the economy and inflation starts to go up more than the Fed is comfortable with.  Fed chairman Ben Bernanke said that he would combat the inflation with higher interest rates, as is historically done.  The problem with that is that we have a lot of debt.  And a lot of that debt is financed with short term treasury bills because the interest rate is so low.  When the Fed raises interest rates, and those loans are reset, the government's payments on the interest of those loans is going to go through the roof.  We just did the same thing when people bought homes with adjustable rate mortgages.  When the rates went up, people suddenly couldn't afford their house.  Right now we pay about $200 billion every year on interest alone.  That's because the interest we pay is at 0.3%  If we see interest rates go up to even a modest 4 or 5%, we're going to be paying an astronomical amount of money just on interest, not to mention the principle.  What if the Fed has to raise interest rates to 10 or 15% to combat inflation?  Remember, with all the Quantitative Easing that the Fed did, they DOUBLED our money supply.  In the 1970's they added less than 15% to the money supply and got 12% inflation and 20% interest rates.  If you passed 3rd grade math you can see what a mess this is.

Hey, have you seen this adorable clip of cats running in a wheel?  How cute!

The bottom line is that there are really only 2 options for the government to take when it comes to the debt we owe to foreign nations.  We can either default on the loans and not pay them back, or we can inflate our way out of it.  Let's take a look at each option, shall we?

...After this awesome picture of fireworks.

Let's say our fearless leaders (whoever they are when this mess unfolds) default on the debt.  They tell China and Japan "Sorry guys, we're not paying this.  We cannot afford it at all and we're gonna screw you over".  Now this would actually be the better long term option.  It's extremely difficult to do in a political sense though.  First, nobody likes to tell their lenders that they aren't paying back their loans.  Second, it makes the nation look week and good luck trying to get those countries to cooperate with us on anything.  Third, and most importantly for America, it means we lose our premium credit rating and are forced to pay MUCH higher interest on any money we borrow.  Since we're planning on running deficits measured in trillions of dollars for at least the next decade, and since so many Americans love the perks of deficit spending, it would be political suicide to default on the loans and be forced to balance the budget overnight.  That's the worst part about this course of action (from a political standpoint anyway), it happens very quickly and whoever makes that tough decision will not be able to pass the blame on to someone else.

So the easier course of action is to inflate the currency, because it happens relatively slow and allows politicians to pass the blame.  It's also, of course, the worst option since it essentially brings us to the same destination in a far more destructive way.  Instead of raising interest rates to sufficient levels in order to keep inflation under control, we'll simply keep them low to protect our debts and let the value of the money decline.  This also helps us pay our debts because we can borrow $1 trillion now, then make that money not worth as much, and when we pay it back we're paying far less than we borrowed in terms of what those 1 trillion dollars are actually worth.

The problem is that, with inflation, the price of everything we buy goes up.  Pretty soon we're paying more for the necessities like food and clothing and spending less on the products that are keeping our economy viable (I'm using that word very loosely).  70% of our economy is based on consumer spending.  Once we stop consuming because of inflation, the government will try to prop up the consumer with stimulus packages and business bailouts and more deficit spending (printing and borrowing money) all in an attempt to keep us spending money on stuff.  It's exactly what the previous administration did and what the current one is still doing.  Obama likes to remind us that it was the failed policies of Bush that got us into this mess.  He's absolutely right.  The problem is that he's repeating those mistakes and at a much higher level.  Keep Americans buying for as long as possible.  Keep the country drunk on credit and debt and convince us that this phony economy pipe dream is real.  Assure us that we can have it all forever and we can borrow our way to prosperity.  Oh, and pray that when the system eventually crumbles you're out of office and the next guy gets all the blame.  Bush nearly made it.  I don't think Obama will get that close, especially if he picks up a second term.

I'm sorry, I went a long time there without taking a much needed fun break.  I bet that was painful.  Hopefully not as painful as this though

But anyway, once our lenders see our currency depreciate, there is no way they'll want to lend to us anymore without higher interest on the loans.  It will become increasingly difficult to finance our debt.  But again, instead of doing the wise and prudent thing (stop running huge budget deficits because credit dried up) that would lead to political backlash (voters complaining about their government checks/programs going away), our fearless leaders at the time, whoever they might be, will decide to finance our debt by simply printing the money.  You want your social security check?  Sure, we'll just print the dollars.  The retired federal employee wants his nice pension and benefits package?  Sure, we'll just print the dollars.  You're out of work and want the unemployment benefits for another year?  Sure, we'll just print the dollars.

Eventually this set of policies can lead to an extremely high rate of inflation that becomes harder and harder to fix.  But fear not America, because we'll have fearless politicians to fix (make worse) the problem (that they created). When prices start to rise our fearless leaders will find someone else to blame, probably the greedy business owners who are only raising prices to pad their huge bank accounts.  So we'll get price controls on things like food and clothing, but that will only lead to shortages of food and clothing.  We'll get wage controls, but that will only lead to higher unemployment.  Every solution to a problem will create another problem that cowardly politicians will combat with a terrible solution that creates more problems.

This kitty does the YMCA.  Isn't that precious?

And all the while, the countries over in Asia will be going through a transformation of their own.  They currently think that they need America to consume their products.  That's why they keep lending to America long after it became obvious that they wouldn't ever be paid back.  But after Americans stop consuming their goods, they could let the value of their currency gain in value.  Suddenly the people who worked hard to make those goods can afford to consume those goods.  Their standard of living will go up as the standard of living in America goes down.  The world will realize that humans have an unlimited amount of demand for products that make their life better.  Americans don't have a monopoly on that.  When our ability to monetize that demand goes away, there will certainly be humans on this planet who will fill that void.

One more of Bar Rafaeli.  Because seriously, that woman is simply gorgeous.