Congress Should Be Dancing to the Tune of the Taxpayer Two-Step

Monday, 17 Jun 2013 07:46 AM

By Denis Kleinfeld

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Spending by Congress is nothing more than a coordinated bi-partisan political dance routine.

No matter who is president and which party controls Congress, spending by the government goes up. In the end, regardless of the posturing and demonizing of the other party, both Democrats and Republicans increase the amount the government spends. A demonstration of the art of political performance over principles.

Libertarians, the few that get elected, are the exception. For Libertarians, limiting taxation and government is a matter of principle over politics — something that the entrenched bi-partisan political establishment fears, abhors and tries to destroy at every opportunity.

Milton Friedman, the famous economists from the University of Chicago, was clear in his opinion when it came to who benefits from increasing taxes and spending by politicians. He said: "When the federal government spends more money each year than it collects in tax revenues, it has three choices: It can raise taxes, print money or borrow money. While all three of these actions benefit politicians, all three options are bad for average Americans."

Those in Congress understand that they can bamboozle the voters with campaign promises involving taxes and spending, which, like children being told fairy tales, makes the voters think they will be getting all the candy canes and gingerbread they want, while this time around the tax system will be reformed and made simple.

The actuality that capital kept by the private financial markets and not confiscated by government will generate a more productive economy that generates more tax revenue is not a part of the political calculus of Congress.

Reducing taxation, and thereby losing the political power it generates, is extremely threatening to the status quo of the bi-partisan political establishment dance team.

It is also clear that there is little chance that the bi-partisan Congress has any desire to do anything other than what they have always done. That is, spend in excess of tax revenue on whatever programs it takes to get re-elected.

It seems that Congress has pushed the tax limit right now as far as they can without most of the economy either going offshore or into the shadows.

What is left for Congress to cover their excessive spending habits relies on printing money and selling debt. This is a coordinated dance called the "Rip Off the Taxpayers Three-Step."

Step one: the Treasury uses its printing presses in the basement to print up Treasury notes.

Step two: the Federal Reserve uses its printing presses in the basement to print up brand new batches of dollars.

Step three: the Treasury and Fed procedurally exchange the little pieces of printed paper.

They print the money and the debt on different colors of paper so they will know which is which.

Thus, it is possible to magically create economic liquidity by calling this Fed/Treasury illusion quantitative easing.

But what would happen if the borrowers other than the Fed became a little more interested in the reality of financial risk management instead of believing in the fairy tale of full faith and credit?

One of three things would happen. Interest rates would go up, borrowing would go down, or both.

Congress cannot be expected to cut spending. It never has and (after seeing how fast a trillion dollar farm bill got passed without any member of Congress actually having read it) it is more than reasonable to doubt any Congress ever will on their own.

Limiting the rate of increase of spending only becomes possible if Congress can avoid being blamed by the taxpayers of using the excuse that the banks and other evil big money guys are at fault. Taxpayers have already been fed this line of baloney and they seem to tolerate swallowing it very well.

It seems taxpayers are coming to the realization that they cannot trust government. The financial market's volatility reflects this. Institutional and individual buyers of government debt are getting concerned that government debt might be more financially risky than they thought.

Interest rates on government debt are going up. Lenders want more of a risk premium.

The taxpayers are off the hook for making the payments. If the debt needs to be a lower figure for political re-election purposes, then the Fed likely will be the first to take a hit. This is not as bad as it seems.

The Fed is just, well, us. On paper, to the extent the Fed loses, the Treasury gains by having less debt outstanding.

What about the rest of the federal debt being bought by institutional or individual buyers?

The rest of the creditors, or at least their risk managers, are waking up to the fact that they're buying unsecured debt from a borrower whose credit rating is definitely not what it once was.

Not being paid is a financial risk every time a loan is made. If potential lenders don't like the risk of an untrustworthy government whose political leadership is addicted to mismanaging government's finance, they can either raise the interest rate further to cover the risk premium or not make the loan. Instead of the process being greased as it is now, there will be considerable friction instead.

The political problems created by excessive spending are solvable.

What it takes is having the taxpayers dance to a new tune, "The Taxpayer Two-Step."

Step one: the buyers of government debt act as the limiting force to restrain excessive borrowing without creating political risks to Congress. Heck, it wasn't Fannie Mae or Freddie Mac that caused the real estate crash. It was the greedy Wall Street bankers all by themselves. It is a tried-and-true blame shifter.

Step two: by lowering taxes to retain capital in the private capital markets, the productive economy uses that capital to expand, generating earnings per share and resulting in tax revenue going up.

The "Taxpayer Two-Step" may even become so popular that it will be played at the opening of every session of Congress.

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