Changing the rules of the game

December 15th, 2008

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Next year, the US government needs to borrow US$1.5 trillion to pay for its expenditure. Up till the end of November 2008, $4.16 trillions worth of spending programs were endorsed by the US government to bail out Wall Street and stimulate Main Street. There are rumours that the upcoming President Obama will sign in a trillion dollar economic stimulus package when he takes office next month.

Not too long ago, hundreds of millions of dollars were an unimaginable sum of money. After a while, the concept of million is replaced by the billion. Today, trillion supplanted the billion. How much money is a trillion dollars? Imagine you have a stack of US$1000. For that stack to reach $1 trillion, guess how high it has to go? The answer is: 109 kilometres! By comparison, the earth’s atmosphere is only 120 kilometres.

As we mentioned before in How is the US going to repay its national debt?, the US national debt stood at more than $4 trillion at the beginning of this year. With all these extra spending programs, bailouts, rescues and stimulus, it could easily more than double.

So, where is the US government going to get the money from? Will the Chinese, Japanese and Arabs be kind enough to lend them? Probably not, because the US government still owe these foreigners trillions of dollars of outstanding debt. Will they borrow from the American people? No, the American people are too deep in their own private debt to spare a dime. Will they tax the American people? No, because the US government want them to spend in order to ‘stimulate’ the economy. The only to do so is to shower them with even more money.

That leaves only one option- print money. The traditional way to do so is for the government to issue Treasury bonds to the Federal Reserve, which in turn conjures up the money from thin air to pay for them. But even then, at the rate at which the tide of financial destruction is going, the government cannot print fast enough. After all, there is a legal limit on the amount the Treasury Department can borrow. To break that limit, it has to seek the permission of Congress.

Is there a way to break tradition? In this recent Wall Street Journal article, it reported that the…

… Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

It isn’t known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn’t explicitly permit the Fed to issue notes beyond currency.

Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.

So, they are thinking of new ‘ideas’ to change the rules of the game in the middle of the session? Remember what we wrote in Recipe for hyperinflation:

One thing we have to be clear. Assuming that the ?rules? are strictly adhered to, there will only be one outcome for the current credit crisis: deflation.

Since the current structure of ?rules? will be too restrictive in such a war against deflation, there will be popular momentum towards the bending and rolling back of these ?rules.? If they press on relentlessly till the final end, there can only be one outcome: the US dollar will be joining the long list of failed fiat paper money in the annals of human civilization.

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