The National Debt and Its Consequences: Part II

Debt is at the heart of today's chaotic financial world. The Federal Reserve has simply given the banks over $1 trillion in the mother of all easy money policies. In addition, the federal deficit has grown to over $1.5 trillion a year and pushed the level of the national debt close to that of the gross domestic product (GDP), $15 trillion.

However you measure these unmeasurables, Tea Party members and liberal Democrats alike are agonizing over this unprecedented debt. What is going to happen? Well, I can't predict but I can't describe the three most probable scenarios.

The first and worst outcome is the catastrophe that fear-mongers are pushing. In effect, 1914 could happen again, with democracy playing the part of monarchy. Because globalization has made the world even more integrated, the disintegration will be even more costly than it was then. We got to see the trailer for this coming attraction when in 2009 our Great Recession quickly spread worldwide.

The cataclysm could be triggered by all kinds of acts or accidents. Imagine: Israel loses its nerve and bombs Iran, Pakistan goes Islamist and bombs India, the EU breaks up or Russia tries to reabsorb the Ukraine. The interdependencies of globalization would spread the resulting disintegration with a near breakdown of civilization. As in Germany and Japan post-WWII, all debts and assets would be wiped out. End of story.

Possible but most unlikely. It would take idiotic mistakes of biblical proportion. The United States would not wait almost three years to become involved, as it did in 1914, nor would our enormous military establishment allow worldwide military chaos. Despite the daydreams of survivalist militias and those emptying the gun shops, this is not going to happen. The Four Horsemen are not going to ride just yet.

The second scenario is the most popular and, in some version, the most likely. The people controlling our money supply could manage to get it right and we coast serenely into a jobless recovery. More realistically, they will err on the side of caution, one way or the other, and choose between hyper-inflation and depression.

Monetarists and Keynesians both agree that “too much money chasing too few goods” is the cause of inflation. The financial industry and those with money fear that the $2 trillion that the Fed and the US Treasury pushed into the economy will be “too much money.” If the monetary authorities get it just right and take the money out at exactly the right moment or, preferably, a little ahead of time, we have a soft landing and everything is fine, except for lingering unemployment. Taking the money out too little or too late means hyper-inflation, like Germany in the mid-1920s. Taking out too much money or too soon brings back depression as Pres. Roosevelt did in 1937.

What many people fear is a deliberate use of inflation to cheapen the dollar and undermine the value of the debt. Inflation is good in that it makes it possible to pay off the debt with depreciated dollars. Conventional history says that this is the way that we finally “paid off” the World War II debt.

Or the opposite could happen. The authorities could so fear inflation that they deliberately pull out the money too soon and accept the economic downturn as the inevitable and necessary way to pay off the debt.

The bankers who control our money supply have to be cautious but it depends on their priorities: do they want to be cautious to protect the value of the money and the people who loan it or do they want to be cautious to protect the jobs and the money of people who borrow it.

Since Chairman Bernanke and Secretary Geithner have already explicitly stated that their priority goal is to fight inflation, this scenario is the most likely and makes continued recession almost inevitable.

Yet, there is a way out and it is the way we really did it after World War II. The world sits on the edge of a technological revolutions in biotech, nanotech, robotics, artificial intelligence and areas yet undreamed of. The rapid implementation of these technologies could so cut costs and engender economic growth that the resulting profits could reward all the necessary investment and still pay off the debt. This is the promise of a vibrant capitalism.

The Progressive Era at the beginning of the 20th century and the economic growth period in the 1950s and 60s were not periods of small government or low taxes. During both periods, the government regularly stepped in to thwart entrenched special interests who were invested in the status quo.

So we have a choice in handling our debt: let the bankers decide between unemployment and inflation or let our government guarantee an open and competitive economy for real wealth creation.