Monday, October 25, 2010

Destructive Deficit Spending

The global financial crisis is going to end. The only question is when, not how. The how is certain. With ugly stratospheric budget deficits. Investors will need to be persuaded to hold Himalayan high mountains of debt for decades. The history of financial crisis show that public debt typically doubles, even adjusting for inflation, in the three years following a crisis. America and many rich and poor nations are well on their way to meeting these projections.

Throwing money at the problem and propping up greedy banks that created the speculation is, as Jim Walker of Asianomics says, like trying to put out a fire by pouring gasoline on it. The result will be an even bigger, more searing fire.

The multi-trillion U.S. deficit financing is crowding many emerging economies and their companies out of the international capital markets that only creates more resentment towards America.

The reality is that in order to build America and restore it to its former glory the current financing models have to be torn up and replaced with fiscal prudence. A depression will undoubtedly follow with mass unemployment and wealth destruction. But it can be short and sweet as opposed to the prolonged agony America and the world have gone through the last three years ─ and also lay the foundation for a new era of healthy sustained growth.

A drive to devalue the dollar could spin out of control by eroding confidence in the currency, leading global investors to cash out of assets denominated in the dollar before their losses worsen. The potential for a mass dumping of the dollar, especially by the Chinese, is a very realistic scenario.

No nation has ever devalued its way to prosperity. The Japanese tried and failed in the late 1990s. A weaker dollar, or the mirror image of a stronger Chinese yuan would be no exception to that time-honored premise.

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