Short and Sweet Blog

As I write this the Debt Ceiling talks are on life support. The president has become involved in order to revive the talks. Although the nominal focus of the talks is upon raising the borrowing limit, the nuts and bolts actually concern budgetary reform.

A few days ago Republican talk participants withdrew. The withdrawal was apparently caused by the insistence of Democratic members on raising taxes. The president met with congressional leaders from both sides. At his press conference Wednesday he chastised the Republicans for being unwilling to raise taxes on some, including jet owners, in order to pay for things like student loans and other high priority federal government programs.

Just before the 2008 Democratic landslide election it was Fox News’ resident liberal, Juan Williams, who said, and I paraphrase, if the Democrats win this election in the numbers it appears that they will (and they did) there is one thing that won’t matter — the deficit. How prescient was Williams? The question is, though, do the deficit and the federal debt really matter?

To answer this question you must first understand what a dollar is. We all know that a dollar is a unit of value. It is the unit which we use to facilitate our economy. How does this work in practice? It is only paper after all. It works because on every dollar bill there is the legend, “This note is legal tender for all debts, public and private.” In that phrase is the value. By federal law you use the dollar as the means of paying your debts. But what if the transaction doesn’t involve dollars at all, though, what is the role of the dollar then? How is the dollar involved?

Let me give you an example, what if you and I agree to trade my Kawasaki dirt bike for your 1994 Ford Thunderbird. After the transaction, under IRS rules, the the party which received the vehicle with the greater market value in dollars must report that as a gain on his Form 1040 and pay income taxes denominated in dollars on the gain. But let’s suppose that one of us backs out of the exchange, what happens then? The one wishing to perform takes the other one to court. In the typical court proceeding the judge will not order the physical exchange to occur but will issue an order that the party refusing to perform must pay the performing party the difference in market value between the two vehicles plus, in many instances, attorneys fees, all of which are reckoned in dollars. Hence, even in situations not involving dollars per se, the dollar is ever present.

What then backs our dollars? Where do they come from? Is it just a big secret or a fiction we all agree on or does it really have something to do with the real world?

Our dollars, at least the greater part of them which are in banks, are backed by the full faith and credit of the USA through a federal agency called the FDIC. FDIC provides deposit insurance to bank depositors. This insurance says that if the bank goes bust that the vast majority of dollar deposits will be made good by the federal government. If the bank doesn’t have the money then the FDIC will stand good for their debt to you which is represented by your deposit in the bank (up to $250,000 per depositor).

Where does the FDIC get it’s money? It gets the money first from premium payments by banks and when reserves from those premium revenues fall short the FDIC can draw on the borrowing power of the USA and if the borrowing power of the USA falls short the Federal Reserve Bank will simply print the money (although the Fed will receive a federal bond in the amount of the cash created like it did during QE and QE2) and the FDIC will in turn give it to the disappointed depositors. Problem solved?

As our president is finding out, however, the ability to print bonds and dollars does not mean that you have unlimited wealth. You cannot print them at will and in any amounts you wish without consequence. The government may have access to dollars (through an increase in the national debt limit which is simply the ability to print more bonds) but the actual value is not in the ability to print bonds and inject the dollars into the system. That process is clearly limited only by the availability of paper and ink. The real value of the dollar relies in a very real sense on the resolve and dependableness of the USA to make the hard choice of choosing to pay it’s creditors first out of it’s income and consume only what is left. A reputation for dependability in seeing that creditors are paid is what gives the dollar it’s value.

In seeking to raise the debt limit the government is not showing the world we are as dependable as we have always been. We are not seeking to pay our creditors out of our income. We seek to borrow some more in order to pay our creditors back. In seeking to raise the debt limit today the government is really just putting off the day when the dependability of the USA will really be tested. And ideally for this government, that ultimate test will happen only after the current crop of debt-increasing politicians has left office. Now, after a bit, we get to the real point of this post.

How is it possible that passing a resolution to create more federal debt, basically just printing more greenbacks, indicates that the US is a dependable nation? It simply doesn’t. It shows nothing but a devil may care attitude towards being dependable and hence towards the value of the dollar itself.

Well then, how is it that the US can show that it is a dependable nation? How do we demonstrate that the value of the dollar should be relied upon now and in the future because it is backed by our full faith and credit? We must do something which is hard. We must show that we can endure the pain of taking responsbility for the debt. We must make what the president calls the “hard choices.”

Showing dependability cannot be achieved to any great extent by extending the depreciation schedules for jet plane owners, or by “making the tax code more progressive” or by taking itemized deductions away from all those who make $250,000 or more. Raising taxes, while possibly being helpful in reducing the debt, will actually be counterproductive to the idea that the majority of people in this country have the resolve to do something hard. It will demonstrate that a majority are not interested in giving but are interested only in taking!!!!

That the top 10 per cent of income earners in the US already pay around 70% of all US personal income taxes is well known. What is not so well known is that a trememdous part of the US government’s budget is made up of “transfer payments.” Transfer payments are payments which are made without the government getting anything valuable (except a vote I guess) in return. Federal transfer payments make up these percentages of the total federal budget: 20% in social security payments; 21 % in medicare, medicaid and CHIP payments; and, 14% in safety net programs.

If we do not show a willingness to fundamentally change ourselves by rejecting the idea that the federal budget should predominately be a vehicle for transfer payments, we will simply not show that we are willing to accept hard choices. We will give evidence that we are a people who want someone else to pay our bills and are not, therefore, very dependable at all except in our wants. We will show that we are willing to raise the taxes of a few in order to pay the bills of the many. Perhaps raising taxes, an outcome apparently desired by the president, will help balance the books in the short run however it will do nothing about the long run problem of a country which is interested in living at the expense of someone else. Unless we show that we, as a people, reject the belief that our federal government is mainly a vehicle for transfer payments, we will prove that our full faith and credit is just not worth very much and the dollar will eventually be valued accordingly.

A cynic might say, ‘what other decision would one expect from a form of government which has no effective protection for the property right of the minority in their own income?’ This nation has been exceptional so far and I fervently hope that it will remain so by debunking this voice of the cynic. In fact our country must debunk the cynic or risk allowing the entire idea of self-government to perish along with the value of the dollar.

Happy July 4.