The Fault Lines Emerge

For a few fleeting, horrifying moments this past week the fault lines that underlie the global economic crisis erupted into plain view. With deft effort leaders in Washington, Europe and Asia papered over the fissures and fears largely subsided. But the shock of plain truths which resulted in violent currency movements are the latest reminder that the 21st century economic order will bear little resemblance to the world we now know.

The tremors began in Beijing, where an essay from the governor of the People's Bank of China seemed to favor the creation of an International Monetary Fund currency to replace the US dollar as the world's reserve. In Europe, the rotating president of the European Union, outgoing Czech Prime Minister Mirek Topolanek, characterized America's plan to combat the widening global recession as the "road to hell." At same time, a British Member of the European Parliament, Daniel Hannan, made world headlines with his stinging rebuke of the inflationary and debt-focused policies of the current UK government.

As a result of these clearly voiced frustrations, the US dollar suffered a drubbing. However, US Treasury Secretary Timothy Geithner and his ministerial counterparts in Berlin, Paris and London did their best to convince everyone that the world is pulling together as one to combat the economic crisis. The charm offensive was effective in restoring calm.

Given the size and scope of the remedies that the Barack Obama administration is cajoling the world to adopt, it is likely that the unease will grow until many countries emerge in open revolt to America's plans.

President Obama and the majority of the US leadership on both sides of the aisle are confident that the right mix of monetary and fiscal policy can restart the spending party that defined America for a generation. And as the bleary-eyed revelers wisely reach for a cup of black coffee or stumble into a rehab center, Obama is pouring grain alcohol into the punch bowl, hoping to lure the walking zombies back onto the dance floor. Europe and Asia fully understand that Obama will ask them to lend the booze.

Washington is telling Americans that their problems result from a lack of consumer spending. Therefore, the solution is for government spending to pick up the slack. However, if Americans are too broke to spend, then how can the government spend for them? The only money they have is taken through taxation. To postpone immediate tax hikes (adding interest for good measure), Washington plans to borrow more from abroad. However, if the foreign creditors refuse to pony up, much of the money will simply be printed instead.

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Printing money is merely taxation in another form. Rather than robbing citizens of their money, government robs their money of its purchasing power. Many people assume that if government provides the funds the US can spend its way back to prosperity. However, it's not money the US lacks but production. If the government simply prints money and doles it out, America will not be able to buy more stuff; they will simply pay higher prices. The only way to buy more is to produce more. It is production that creates purchasing power, not the printing press!

The world's current predicament resulted in part from US efforts to maintain consumer spending at unsustainable levels, primarily by the reckless extension of consumer credit. Pushing up consumer credit to levels not supported by market realities required government subsidies and guarantees. In addition, Wall Street pitched in with securitization and credit default swaps, which created a false sense of confidence among the US's creditors that high-risk consumer loans could actually be repaid. However, now that all those gimmicks have blown up, the entire farce has been exposed. There is simply no way to sustain an economy based on consumer credit.

The administration argues that more debt will restore growth which will then allow the repayment of borrowed money. First, the US government has never repaid, and will never repay anything. Second, the assumption that additional borrowing and spending will restore growth is flawed. In fact, more consumer debt and government spending will undermine the economy and restrain growth.

To solve the problems the world must first come to terms with their source. That is what the voices from abroad are telling the US. The US borrowed and spent itself to the brink of bankruptcy, and now the country must save and produce themselves back to prosperity.

Of course, this simple solution is rejected by Keynesian economists who insist that the US and the world must keep spending. The "paradox of thrift," as they call it, holds that if we stop spending the recession will worsen. While this is true, it is hardly a paradox. As they say in the fitness game, "no pain, no gain." No one said this was going to be easy, but the only way to rebuild a viable economy is to let the phony one collapse. If we follow the Keynesians, the fault lines will continue to widen until our wealth, our lifestyle, our very ability to prosper is swallowed up. The calls from abroad will only get louder until the US faces this ugly truth.

Peter D. Schiff (schiff@europac.net) is president of Euro Pacific Capital, Inc of Darien, Connecticut, USA. He publishes the free, on-line investment newsletter http://www.europac.net/newsletter/newsletter.asp