Congressional spending and Federal Reserve policy have teamed up to lock the U.S. economy into a downward cycle that may lead to catastrophic failure if left unchecked. Both Congress and the Federal Reserve have taken reckless abandon in their recent attempts to insert the federal government as a solution to the country´s economic woes. Rapid response and common sense solutions are required to counteract these irresponsible practices.

With the increase in federal spending, and the latest passage of a debt ceiling increase by Congress and subsequent signing into law by the White House, interest in investing in U.S. Government securities, like treasury bills, has begun to decline. The increase in deficit spending has created a growing loss of confidence in the government´s ability to repay its loans and threats from credit rating agencies of a potential downgrading of the US’s credit rating. As interest in the bond market decreases, interest rates on bonds automatically increase creating a higher cost to the U.S. government to sell its debt.

The Federal Reserve’s loose monetary policy to finance deficits and suppress interest rates indirectly contributes to what is known as the “carry trade” against the U.S. dollar. By borrowing dollars on the assumption that the dollar will decline and then using them to buy commodities, investors reap higher profits when paying back the initially borrowed dollars. With the continued decline in value of the dollar, the incentive to use the carry trade is increased which leads to a growth in speculation that the dollar will continue to be devalued.

Separately, the Federal Reserve is essentially subsidizing financial institutions by setting the benchmark interest rate at 0%. This initially spurred an increase in financial institution investment in treasury bills to shore up their balance sheets – a practice that served as probably the most under the radar bailout packages in federal government history. The ability of financial institutions to take Federal Reserve dollars at 0% interest and invest them in federal treasury notes with a set interest rate, essentially meant that the federal government was simply handing the financial institutions an allowance (or bailout). The Federal Reserve paying interest on bank reserves is not a solution. Not only is borrowing nearly free money from the Fed to then loan funds back to the Fed at a higher rate immoral, this will force up interest rates on treasuries which, ironically, present policy is trying to prevent.

In the case of a 30 year bond, this was 4.7% as of 1/6/09. Whether by design or by accident, this will serve as a creative federal subsidy until, due to a climbing deficit and reduced faith in the government´s credit, these institutions find it too risky to invest in treasury bills and look elsewhere, or the Fed is forced to raise interest rates due to concerns about creating an artificial bubble for the financial industry, or in housing.  Either that, or the Federal Reserve will displace the market and become the exclusive buyer of treasuries.

The irresponsible lending practices of the Federal Reserve and the reckless spending levels of Congress will inflict greater damage than the country would have felt had the housing and financial institutions been allowed to find equilibrium on their own in the first place. The involvement of the federal government hasn´t saved the U.S. economy; it has simply prolonged and likely worsened the pain of the eventual economic reset. A structurally sound financial system shouldn’t need bailouts or rescues. Swift and steady action is required to help brace the country for a potentially worse decline.

Federal spending must be checked and reversed, including a plan to permanently eliminate the deficit and restore faith in the U.S. government´s credit, thus re-establishing confidence in the bond market. The Federal Reserve must also seek to raise interest rates to prevent inflation and offset any potential asset bubble bursting created as a result of the recent 0% interest rate. Entitlement spending must be decreased and non-essential programs phased out in order to help lessen the strain on the federal budget. All of these actions are necessary now to help soften, and potentially prevent, a predicted economic decline within the next 10-20 years.

Danny Tarkanian
Republican Candidate for the United States Senate
Tark2010.org

Here is a very good recent article that dovetails with this issue: Watchdog: Bailouts created more risk in system

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While Professor Glaeser regards this book as being “well written and far more serious” than others which share similar views, he disputes a number of points such as this idea that “there is anything secret about this history of American protectionism.” Professor Glaeser notes for instance, that the “Tariff of Abominations and the Smoot-Hawley Tariff are often taught in high school history classes.

Professor Chang insists that historically, high tariffs were largely responsible for the economic success of both the United States and Britain. Professor Glaeser disagrees, citing “insufficient evidence” based on his own findings and the work of other researchers. Meanwhile, Dartmouth economist Douglas Irwin has provided documentation that also disputes Professor Chang’s argument. For example, in response to the question,“Were high import tariffs somehow related to the strong U.S. economic growth during the late nineteenth century?”, Professor Irwin states his answer in a paper entitled “Historical Aspects of U.S. Trade Policy,” published in the non-partisan National Bureau of Economic Research (NBER), in which he cites a number of factors such as “population expansion and capital accumulation as playing a greater role in late nineteenth-century economic growth than improved productivity.” In fact, he observes that tariffs may have had a “detrimental affect by raising the prices for imported capital goods and discouraging capital accumulation.” Surprisingly, Professor Irwin has found that the “greatest productivity growth was in non-trade sectors (such as utilities and services) not directly affected by tariffs.”

Professor Irwin is barely mentioned in “Bad Samaritans” perhaps because he had expressed similar observations in his critique of Kicking Away the Ladder: Development Strategy in Historical Perspective, which was a previous work authored by Professor Chang.

Professor Glaeser similarly pointed out that “Bad Samaritans” could have been more effective if it had “delved deeper into understanding the broader historical impact of trade protectionism in the United States and Britain in relation to other economic factors.”

Having read the book, I believe that Professor Chang’s focus on high tariffs as being key to economic growth above most everything else is a fundamental flaw in his position along with the argument that “American and British free trade advocates are guilty of hypocrisy” because historically, their countries have not always practiced what they have preached.

Perhaps Professor Glaeser said it best when he mentioned that there is “alternative view that economists shouldn’t be required to endorse the worst policies of their own countries.”