(08-05-2011 09:25 PM)Machiavelli Wrote: My crystal ball says we get more QE and monetizing of debt. Definite pain in our future. My worry is the govt. has been providing the hiring slack in the jobs area until the private sector could recover. The scary part is where do we go from here?
It definitely has been trying to make up for the lack of jobs/spending in the private sector which is why you have seen trillion dollar plus deficits going on three years now. Cutting government debt now will cause an event worse than the Great Depression which is why politicians won't do it. The problem is that our economic issues themselves are debt based (like in the Great Depression) and you can't see a recovery in that environment unless you deal with the debt our radically change the world itself. In World War II, the entire industrial world outside the US was basically smashed. A truly revolutionary invention could theoretically work too, but it would have to be something like basically free energy. Absent dealing with the debt or a radical change in the world, we keep getting worse.
I was trying to work through out all of this in my head yesterday and this is basically what I see happening.
1. Our politicians play kick the can for as long as possible. They will promise trillions in cuts/increases, but it's always long term and mostly back-loaded promises that can be reversed later. The Federal Reserve will help with the delay by starting qualitative easing 3 and continuing to accept trash as collateral from the insolvent banks. This delays things (for how much longer is anyone's guess), but makes the fundamental problems worse and increases prices on necessities (food, gas, etc; non-necessities prices will go down as fewer can afford to buy them).
2. Interest rates can't be contained everywhere forever. More debt means more risk that investors aren't going to be paid which means they want higher interest. Fear in other areas, government manipulation (from the Fed in the US), and being the world's reserve currency will continue to help keep rates down here for a little while though.
The same can't be said everywhere though. Greece has needed 2 promised/perceived bailouts to get this far, but with interest beyond 30% last I checked, they won't make it without default long term. Italy, Spain, Ireland, and Portugal aren't much better. One of these countries is going to fall and it will produce a domino effect (Greece might be able to be contained, but a 2nd one never will be).
3. Once one of the semi-major nations is forced to start defaulting, it's going to set off a huge domino effect. Trust in government debt will continue to drop and banks in Europe will fail and that will then filter through to over here.
Interest rates will go into a death spiral mode very quickly at some point (once you get to that point, history shows its quick). Interest rates will rise because of fear and the increasing need for debt. This will make borrowing more expensive and the government will have to borrow more to pay for the added interest (especially when you consider how much of the debt they have is only short term stuff that is constantly being renewed). That increase in government debt will further raise interest rates which will further raise borrowing, etc. In little time you go from a relative stable interest rate to completely out of control.
4. At this point the government has two choices. The first large scale printing which would completely destroy the dollar and lead to hyperinflation. I doubt they do this because I bet the banks will hold onto enough influence to stop it.
The other alternative is large scale default. Since the government is going to have funding problems at this point, this will mean an immediate need for Congress to balance the budget (with no lending available they won't have a choice). Doing so at this point will be the worst possible way to do it and the biggest shock on the economy. Given that the economy itself will have been hurt from these events, that there is likely to be massive civil unrest, and that all of this disappearing government spending is going to filter into a number of other activities, Congress would probably have to drop more than 50% of spending which could well mean Social Security and Medicare just go poof all at once.
While #4 is happening, I think most credit in the country freezes for a time which is bad since everything relies on it (trucks to grocery stores very much included).
In short:
1. We kick the can. We monetize the debt to an extent and spend money we don't have until we are forced to stop.
2. Some European country blows. This filters to other European countries and already unstable banks and then over here.
3. Interest rates spiral out of control and funding deficit spending become impossible.
4. Congress/President chooses default over hyperinflation. Mass chaos for a time. Greatly diminished standard of living afterward.
