This column will outline the worst case scenario that might confront Bad Ben at some time in late 2011, just one year away from the 2012 presidential election. Worst case scenarios are important because they warn us of the most serious consequences that bad economic policies present before they have been fully implemented.
Let us assume that President Obama successfully steers the 2011 budget through an increasingly resistant Congress. Let us further assume that he is successful in securing small scale health ‘reforms’ that add to the overall budget deficit. Let us assume that the 2010 elections return a reduced Senate majority for the Democrats, inclusive of two independent supporters (Specter has gone), of only 52 to 48, with a new Senate Majority Leader (Reid has gone). Let us assume that Nancy Pelosi’s Democrat majority in the House survives by a whisker, with her electorally disastrous leadership under critical threat from within her caucus. President Obama by then has aged 10 years in just two disastrous years in office. By 2012, if my prediction comes true, his hair will be completely white.
Let us assume that, by late 2011, whatever the changes imposed on the financial sector, the banks have restored their financial ratios and, in a slowly recovering economy, are prepared to move decisively into big-time lending. The demand for loanable funds is there, and the money supply – oh the money supply – is very definitely there. Big Labor is on the wage-war path, and Big Business is only too willing to deal. In short, inflationary expectations are on the rise, and are exacerbated by a relentless weakening of the US dollar.
What will Bad Ben do? Well, we can be sure that he will not engage in open-market operations, selling off his toxic assets at yard sale prices in a doomed attempt to mop up the money supply; an attempt that assuredly would bring down the private housing market once again, and that would also collapse the commercial mortgage market. We can also assume that he will not bankrupt the Fed by selling off all his Treasury notes. No, sitting at the poker table on a diminishing pile of borrowed chips, a visibly sweating Fed Chairman will predictably attempt to buy off those who threaten his survival: he will boost interest payments to banks on the reserves they hold in their vaults.
Bad Ben will try to suppress the income velocity of circulation of the excessive quantity of money with which the Fed has flooded the economy. Because inflationary expectations are on the rise, the Fed must now tread a treacherous path. If interest rates for banks to hold on to their reserves are too high, there goes economic recovery, and with it all propects for an Obama second-term. If they are too low, inflationary expectations will soar and with them the nominal interest rates that Bad Ben must pay out to the banks. Remember that for Bad Ben to fund such protection outlays, the Fed will have to resort to the printing press, since it dare not sell back its toxic assets or its Treasury notes. This is a first-step to hyper-inflation as my earlier column on that topic clearly explained.
My expectation is that hyper-inflation will be avoided – since that would result in landslide defeats for all incumbent politicians when they faced re-election, and assuredly would force the resignation of all appointed members of the Fed. Instead, the United States economy, once again will confront the specter of stagflation, characterized by high and upward trending inflation, stubbornly high rates of unemployment and a well below trend rate of economic growth. Such troubled times will persist until a sufficient spirit for change emerges within the US electorate and a new Ronald Reagan or Margaret Thatcher emerges to lead the nation back to laissez-faire capitalism.
And no, Sarah Palin will not cut the mustard. She is a populist, not a stateswoman. Sarah Palin is no Ronald Reagan. Most certainly, she is no Margaret Thatcher.