This coming May 16, the U.S. Federal government debt ceiling will be breached; that is, the national credit card—currently topped at ,294,000,000,000—will be maxed out. (Yeah, I know: It’s one thing to read “ trillion” and quite another to see the actual number, written out with all those zeroes.)
It's not like lighting farts...
Shortly thereafter, the Federal Reserve’s policy colloquially known as Quantitative Easing-2 (QE-2)—whereby the Fed created 0,000,000,000 of new money, and used it to purchase Treasury bonds—will end.
These two issues seem to be miles apart—notice, seem to be. But they are as intimately related as yin and yang—Mickey and Minnie—Ritz crackers and cheese.
Both policies aim to prop up the sliding U.S. economy, each of them coming at this effort from different directions—one from the demand side, one from the supply side. And the suspension of either policy will result in the exact same thing—government shutdown, and default on the U.S. sovereign debt.
Don’t believe me? Let’s look at them each in turn:
On the one hand, the deficit is the product of fiscal stimulus, whereby the Federal government spends and spends so that the aggregate demand of the U.S. economy does not fall because of the economic slowdown.
The rationale is, as the economy slows because of the recession, and people spend less, the Federal government steps in with more deficit spending, to prop up aggregate demand. Thus, the overall demand in the United States does not fall, as the economy recovers. And when it is finally back on its feet, the private sector in a sense takes over the spending burden that the Federal government has been carrying.
That at least is the rationale.
Quantitative Easing, on the other hand, is the Federal Reserve’s efforts to prop up deteriorating asset prices—that is, inflate prices which have fallen drastically. They do this by overpaying for assets, and thereby giving these assets price support. The first iteration of QE was Fed money-printing to help support the prices of the so-called toxic assets, while QE-2 has been the Fed money-printing to help support the prices of Treasury bonds.
Asset prices are falling because they were overpriced to begin with—overpriced for the better part of two decades, thanks to the Fed’s easy money policies. When the bubble in asset prices finally popped, not only did asset prices fall, they also dragged down the rest of the economy—this is more or less what we’ve been experiencing for the last three-four years.
So basically, the Federal government and the Federal Reserve are burning the candle—ie., the economy—from both ends: The Federal government by way of “stimulus spending”, and the Federal Reserve by way of Quantitative Easing, the one trying to make the economy “grow again” by bouying aggregate demand to the tune of 10% of GDP, the other trying to halt asset price deterioration by printing money.
Did I say “burning” the candle from both ends? Excuse me, I meant to say, they are putting a blowtorch to the economy—and whistling Dixie all the while.
Now, QE-2 is set to end in June, while the debt ceiling will be hit in mid-May. With these two deadlines looming, there have been a lot of people who think that neither will be extended—or at leasthope neither will be extended.
These people are living in dreamland: The debt ceiling will be raised, and QE-2 will be extended. Both policies will continue not because I happen to agree with either one of them—in fact, I don’t. Rather, both policies will be extended because—if they are not—the Day of Reckoning will suddenly arrive:
The Federal government will become bankrupt...
