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Bad debt

Friday, August 22, 2008, 12:50 PM
 

Will the U.S. Treasury repudiate its obligations
to its creditors, be they citizens or investors around the world? Most
observers would answer "no" without hesitation. But Congress, with the
complicity of the White House and the Fed, has arguably embarked on a
stealth repudiation.

In his famous treatise, "The Wealth of
Nations," Adam Smith noted there had never been a "single instance" of
sovereign debts having been repaid once "accumulated to a certain
degree." We may have reached Smith's threshold.

We are at a
Smithian moment, in which the temptation for the Fed to spend its last
dime of credibility may prove irresistible. Investors are already being
taxed by inflation and can rationally expect that tax rate (the
inflation rate) to be raised going forward. Wages are not keeping up.
Main Street is being taxed to fund Wall Street excess. Anyone who
works, saves and invests is exposed to confiscation of his capital and
earnings through inflation. If the Fed maintained its independence of
action and said no to the inflationary finance of Congress's
profligacy, we wouldn't have reached this point. But the Fed has
forsaken that independence amid an absence of leadership.

I posted
this because it is striking to see printed in the Wall Street Journal.
The author is from the Cato Institute, a libertarian think tank, so the
sentiments are not surprising; only that they were printed so
prominently.

I happen to agree with the assessment that the
most likely outcome for this whole mess will be an outright repudiation
of U.S. debt obligations. I remain agnostic as to whether this will
happen through a process of inflation, as the author suggests (and as
is certainly underway), or deflation – although I am hedged 70-30 in
favor of inflation. So I guess I am a tilted agnostic.

At any
rate, such sentiments being openly printed is not good for Sino-US
relationships at this delicate moment when the U.S. is on the verge of
nationalizing Fannie and Freddie.

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