Risk versus Reward… Have the Rules Changed?

The adage of “risk versus reward” just vanished because the Federal Reserve has guaranteed to backstop losses to depositors from several banks that were taken over by the FDIC this past weekend. 

While this seems good on the surface, in the short run the fallout to the markets and economic policies remains to be seen over the coming weeks, months, and years. However, in this author’s opinion, the value of the dollar versus other currencies due to the unprecedented liquidity provided by the Federal Reserve may have long term deleterious effects for all of us. 

Everyone gets a Trophy.

The guarantee of losses to banks depositors by the Federal Reserve will likely have a significant impact on the financial markets and economic policies. In the short term, the markets may react positively to the news as banks may become more willing to lend, which could stimulate economic growth.

However, in the long term, this policy could have several negative consequences. First, it could create a moral hazard problem by incentivizing banks to take excessive risks without fear of consequences, leading to a potential increase in bad loans and financial instability. This was part of the problem that caused the Great Recession in 2008.

Secondly, the uncontrolled liquidity provided by the Federal Reserve could lead to even more inflation, as an increase in the money supply without a corresponding increase in economic output would result in more money chasing the same amount of goods and services, driving up prices. Talk today is that the Fed may hold off on their next anticipated increase which was scheduled for March the 22nd.

The value of the dollar may also be affected by this policy. If inflation rises, the dollar could weaken against other currencies, as investors seek to move their investments to countries with lower inflation rates.

Additionally, if the policy leads to a lack of confidence in the financial system, it could cause a flight of capital out of the US, further weakening the dollar.

Overall, while the policy of guaranteeing losses to banks may have short-term benefits, the potential long-term consequences could be significant, and policymakers will need to carefully monitor its impact on the markets and economy.

Why do we balance our checkbook? But the Fed continues to write checks…

Balanced Budgets seem to be a pipe dream recently, and when will the government stop writing checks with no concrete plan of ever paying them back? 

Balanced budgets can be difficult to achieve in practice, particularly in times of economic recession or crisis when government spending tends to increase to support the economy. However, it is important for governments to strive for fiscal responsibility and work towards achieving balanced budgets over the long term.

The government’s ability to write checks with no prospect of paying them back is dependent on its ability to borrow money. In the short term, borrowing can be a useful tool to finance important investments or address emergency situations. However, excessive borrowing can lead to unsustainable levels of debt and put a strain on our children, grandchildren, and future generations who will have to pay off the debt.

To address this issue, governments can take several steps, such as implementing spending caps, reducing wasteful spending, increasing revenues through tax reform (i.e., raising your taxes), and prioritizing investments that will generate long-term economic growth.

It’s important to note that the decision to borrow money ultimately lies with the government and is subject to political considerations. Therefore, changing the current pattern of borrowing and spending will require a shift in political priorities and a willingness to make difficult choices to achieve fiscal responsibility.  Due to the fact that there still seems to be political gridlock in Washington DC, it could be a long time before we see a return to normalcy, like we had in 2001, when there was actually a surplus.

Learn from History, Germany and 100-year cycle. 

In the 1920s, Germany experienced a severe economic crisis caused by the heavy war reparations imposed by the Treaty of Versailles after World War I, as well as a lack of confidence in its currency, the German mark. To finance its debt, the German government resorted to printing large amounts of paper money, which led to hyperinflation and a rapid devaluation of the mark.

The hyperinflationary spiral resulted in the total collapse of the German economy and social unrest, as workers and pensioners saw their savings and salaries become worthless. In 1923, the German government issued a new currency, the Rentenmark, backed by land and industrial assets, and backstopped by the Bank of England with a 500 Million Mark Gold Bond which stabilized the economy and restored a temporary confidence in the new currency. But political storm clouds were brewing and very few people knew what was next.

In the 1930s, Germany’s economic policies shifted under the Nazi regime, which focused on rearmament and public works programs to stimulate the economy. This resulted in a decrease in unemployment and an increase in economic output, but it was achieved at the expense of a massive increase in government debt and inflation.

The German government’s policies during the 1920s and 1930s had severe economic and social consequences. Hyperinflation in the 1920s wiped out the savings of many Germans and destabilized the economy. In the 1930s, while economic output increased, the government’s massive borrowing and inflationary policies ultimately led to a collapse of the economy and played a role in the outbreak of World War II.

History is bound to repeat itself again, so the lessons learned from Germany’s experiences in the 1920s and 1930s highlight the importance of responsible fiscal and monetary policies, as well as the risks of unchecked inflation and government debt.

The Sky is Not Falling… yet.

There are several potential solutions to address the risks associated with inflation and government debt. These include but are not limited to:

Fiscal discipline: Governments can implement responsible fiscal policies that prioritize long-term economic stability over short-term political gains. This can involve reducing wasteful spending, increasing revenues through tax reform, and implementing spending caps.

Sound monetary policy: Central banks can implement sound monetary policies that aim to support price stability and avoid excessive inflation. This can involve adjusting interest rates and the money supply to balance inflationary and deflationary pressures.

Structural reforms: Governments can implement structural reforms that address underlying economic issues, such as labor market inefficiencies, barriers to competition, and inadequate infrastructure. This can help increase productivity and economic growth, reducing the need for excessive borrowing and inflationary policies.

International cooperation: International organizations, such as the International Monetary Fund (IMF), can work with governments to promote responsible fiscal and monetary policies and provide support during economic crises.

Long-term planning: Governments can prioritize long-term planning and investments that generate sustainable economic growth and reduce the need for excessive borrowing. This can involve investments in education, research and development, and infrastructure.

Overall, a combination of responsible fiscal and monetary policies, structural reforms, and international cooperation can help address the risks associated with inflation and government debt, and hopefully promote long-term economic stability.

It’s All about the Politics

Charles Dudley Warner once said, “Politics makes strange bedfellows” and in todays fractured political system politicians may be hesitant to vote for fiscal prudence for a variety of reasons.

First, implementing fiscal prudence may involve difficult and unpopular choices, such as cutting spending, raising taxes, or implementing structural reforms. Politicians may be concerned about losing public support or facing political backlash from interest groups that would be negatively affected by these policies.

Second, political priorities may prioritize short-term gains over long-term stability. Politicians may be more focused on winning elections and delivering immediate benefits to their constituents, rather than implementing policies that promote long-term economic growth and stability.

Third, partisan politics and gridlock may hinder progress on fiscal prudence. In some cases, opposing parties may block efforts to implement responsible fiscal policies for political gain, rather than working together to find common ground.

Fourth, the complexity of the budget process may make it difficult for many politicians to fully understand the consequences of their decisions. This can lead to short-sighted decisions that have negative long-term consequences.

Ultimately, promoting fiscal prudence will require a shift in political priorities, a willingness to make difficult choices, and a commitment to long-term planning and responsible policymaking. It will also require public education and engagement to help politicians understand the importance of fiscal responsibility and the potential consequences of inaction.

Outcome for the average American 

The outcome for the average American of the government’s fiscal and monetary policies can vary depending on a range of factors, including the level of inflation, interest rates, and economic growth.

If government policies result in high inflation, the average American may experience a decrease in the purchasing power of their income, making it more difficult to afford goods and services. This can particularly affect low-income households and those on fixed incomes.

If government policies result in high levels of debt, it may lead to higher interest rates on government borrowing, which can have a ripple effect on the broader economy. Higher interest rates can make it more expensive for businesses to borrow money to invest and grow, which can slow economic growth and lead to job losses.

However, if government policies are implemented responsibly and promote long-term economic stability, the average American may benefit from increased economic growth and job opportunities. Responsible fiscal and monetary policies can help maintain low inflation, stable interest rates, and a strong economy, which can improve the quality of life for all Americans.

Overall, the impact of government fiscal and monetary policies on the average American can be significant and far-reaching. It is important for policymakers to prioritize responsible policies that promote long-term economic stability and support the well-being of all Americans.