Belmont Club

No Way Out

The story is told that Franz Liszt, the famous pianist, was playing a difficult piece as a child. In the course of his exercises, the child prodigy found all his little fingers engaged but saw on the sheet a note yet to be played. “When this happened, he’d thrust his head down and play the missing note with his nose!” It is too bad that Liszt never became a politician. For he might have found a way to do things both on the one hand and the other and still had his snoot in reserve.

The world needs his like now.

Hot Air links to reports that S&P will downgrade the US debt rating to AA+ or AA. Sources tell Jake Tapper that the administration will ascribe it to a refusal by Republicans to raise taxes:

A government official tells ABC News that the federal government is expecting and preparing for bond rating agency Standard & Poor’s to downgrade the rating of US debt from its current AAA value.

Officials reasons given will be the political confusion surrounding the process of raising the debt ceiling, and lack of confidence that the political system will be able to agree to more deficit reduction. A source says Republicans saying that they refuse to accept any tax increases as part of a larger deal will be part of the reason cited.

At the same time, Clive Crook in the Atlantic argues that stalling US growth and the European sovereign debt crisis means the time has come to unleash QE3.

Weeks ago I said I thought the case for QE3 was strong. At that point, there seemed little chance of it: inflation hawks on the FOMC were asserting themselves. The bad growth numbers for the first half surely ought to be changing their minds. QE3 looks like necessary insurance against a second dip and possible deflation. Now, unlike then, you can accept most of the inflation hawks’ way of thinking and still be in favour of QE3.

This sets up a dilemma. If the deficit is to be reduced while deflation is to be avoided, a political Franz Liszt must find a way to stimulate the economy beyond the oomph raised taxes can pay. For even if taxes are raised to cover the present deficit, it is only paying for past sins. What is needed is a source of income to commit new ones. We must spend as never before to keep the economy from shrinking. The International Business Times writes that with fiscal stimulus now placed out of reach, all hopes now lie with the Fed.

The U.S. debt deal will lead to a smaller federal government, which means less stimulus for an already low-growth U.S. economy, and that, as many Americans might sense, tosses the ball back in to the U.S. Federal Reserve’s court, perhaps with a third phase of its quantitative easing program, QE3. … U.S. Federal Reserve Chairman Ben Bernanke, in testimony in July before Congress, underscored that additional, unconventional monetary action is possible, if economic conditions deteriorate further. …

What would tip the scales in favor of QE3? Additional deterioration in the U.S. labor market. Unemployment has been at a dangerously elevated rate, currently 9.2 percent, for more than a year. If job growth, already anemic, does not pick up, rise to 150,000 to 200,000 new jobs created per month, Bernanke may feel QE3 is the prudent tack to take: in essence, the handwriting will be on the wall.

The rise in unemployment, which despite the most recent “reductions” which are due in part to statistical redefinitions, is already sounding the administration’s collision klaxon means the time for more stimuli has long come. The trouble is with those terrorists who are keeping the government from spending money.”The critics, U.S. Rep. Ron Paul, R-Texas, among them, will start howling about Q3, if it’s deployed.”

Paul Ryan, who Joe Klein says should “be sued for political malpractice” was one of those who believed quantitative easing would “risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment”.

A group of prominent Republican-leaning economists, coordinating with Republican lawmakers and political strategists, is launching a campaign this week calling on Fed Chairman Ben Bernanke to drop his plan to buy $600 billion in additional U.S. Treasury bonds.

“The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment,” they say in an open letter to be published as ads this week in The Wall Street Journal and the New York Times.

The economists have been consulting Republican lawmakers, including incoming House Budget Committee Chairman Paul Ryan of Wisconsin, and began discussions with potential GOP presidential candidates over the weekend, according to a person involved.

The increasingly loud criticism of the Fed comes as some economic officials outside the U.S. are criticizing the central bank’s move to effectively print money, which has the side effect of pushing down the dollar on world currency markets. President Barack Obama last week defended the Fed. The move to buy more bonds, known as quantitative easing, “was designed to grow the economy,” not cheapen the dollar, he said.

Whatever you think of Ryan, he must surely be right in believing that actions which cheapen the dollar  present a creeping default to creditors by paying them in less valuable money. How can this help the creditworthiness of a country? And yet what is to be done about the deflationary wolf at the door?

For Barack Obama to have a ghost of a chance of reelection in 2012 he must both curb unemployment and avoid a runaway credit rating downgrade. Without or without new taxes.  Can that be done? That is what the political Liszts are trying to figure out.

It is likely that no feasible tax increase can generate the necessary money to avoid deflation. And it is possible that nothing will prevent deflation from coming anyway. If that is the case, Paul Ryan’s advice boils down to facing the music now.  To go ugly early. Yet to accept that counsel would mean that Barack Obama’s presidency is doomed. That is at all events not what they want to hear. It may be true in any case and perhaps the best the spin doctors can manage is a Parthian shot: blame Paul Ryan even as the flagstaff on the stern plunges into the dark depths of history’s ocean.

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