No Automatic Spending Cuts

In our December 20th blog we suggested that any last minute deal to resolve the Fiscal Cliff was unlikely to produce a meaningful change in the size or scope of the federal government.  To quote our earlier blog:

“So, let’s get back to the fiscal cliff. Why do we hope a deal isn’t reached? Simply because of the automatic spending cuts that are scheduled to occur if there is no deal! We’d like to see government spending decline as a percentage of GDP. In fact for the long-term health of the U.S. economy we think a federal spending decline is imperative. Any other sort of deal that is struck between the President and Congress is likely to involve a few symbolic gestures such as a higher tax rate on ‘rich’ people, while diverting attention away from the one real concern, which is the size of the overall bite the federal government is stealing from the GDP pie.”

Sad Face

Contrary to our hope, in the past two days a deal was struck.  And, unfortunately, our prediction of what the deal might look like was spot on.  (We should not boast about our forecasting prowess, as anyone who has been watching Congress could see it coming.)  The details of the deal involve a few tax hikes targeted at the wealthy.  Namely, the tax rate on those individuals making over $400,000 is increased from 35 percent to 39.6 percent, and the capital gains tax rate is increased from 15 percent to 20 percent. Also the payroll tax rate will go up by 2 percent (on everyone, not just on “rich” people).

OK, so that is the outcome on the tax side of the picture.  But what about those automatic spending cuts which were scheduled to occur?  Well, the decision was to postpone those.  Rather than letting the automatic cuts happen, Congress will wait 60 days and then get to work on the spending side of the equation (yeah, right).

Bottom line:  The federal government is going to continue to run enormous budget deficits, financed by monetization of the debt by the Federal Reserve.  As long as the government can postpone any spending cuts through the printing of new fiat money, any real progress on lowering the national debt is unlikely.  Printing new fiat currency is the way out (at this point perhaps the only way out) for an enormous, past-the “tipping-point,” rapidly growing government sector. Only by switching to a “money” whose value depends on something real (i.e. physical capital) could this process be reversed (read Capital as Money).  Meanwhile we can make another no-brainer forecast, given that converting debt to currency is the last refuge for the financing of out-of control government expenditure, the prudent might batten down the hatches in expectation of rising inflation during the next few years.

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