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Talk about cutting off your nose to spite your face! It looks like the Republicans are going to get their pound(s) of flesh from the debt ceiling discussions. And the economically ignorant Democrats are going along for the ride. President Obama’s fundamental lack of understanding with regards to the current economic predicament in the USA (the balance sheet recession) is going to result in spending cuts in order to avoid the mythical insolvency of the USA. According to the Associated Press, the President is in talks to make a “significant” reduction in the size of the deficit:

“The White House has proposed raising about $600 billion in new tax revenue, including ending subsidies to oil and gas companies, an idea that failed in the Senate.

The administration also would tax private equity or hedge fund managers at higher income tax rates instead of lower capital gains rates, change the depreciation formula on corporate jets and limit itemized deductions for wealthy taxpayers. It also has called for repealing a tax benefit for an inventory accounting practice used by many manufacturers.

But Republicans are demanding huge cuts in government spending and insisting there be no tax increases.

Ahead of his meeting with Obama, McConnell said Democrats’ calls for tax increases do not amount to a “serious” position.

“It is my hope that the president will take those off the table today so that we can have a serious discussion about our country’s economic future,” McConnell wrote in an editorial that appeared Monday on CNN.com.”

Of course, this is all stemming from the myth that the USA is about to “run out of money”. The US government sets a political limit on the amount of government issued debt which is called the “debt ceiling” (see here for a more in-depth discussion). This is entirely political. There is NOTHING operationally that constrains the USA’s debt issuance. The USA issues its own currency and has no foreign denominated debt. There is simply no such thing as the USA “running out of money”. In this regard, they are never solvency constrained and the only thing stopping the US government from spending money is the willingness of politicians to vote on these changes. This is nothing like a household, business, US state or European nation – all of whom are revenue constrained. The real bogey with regards to government spending is inflation and the effects of this spending via mal-investment, spending in excess of productive capacity and the resulting lower standard of living. There is simply no such thing as a traditional US government “default” – as in, not having enough money to meet your obligations.

The USA could suffer a form of insolvency in the name of hyperinflation, but there is almost nothing about the current state of the US economy that is consistent with past cases of hyperinflation. More importantly though, there are no signs that markets are even remotely concerned about a US insolvency (even if you were silly enough to believe it could happen). Both USA credit default swaps and US government bond rates are among the lowest in the entire world. And the myth of a potential surge in interest rates is sheer nonsense as the Federal Reserve controls the yield curve via the monetary policy that serves ZERO funding purpose and only helps to drain reserves while targeting the Fed Funds rate.

In short, these politicians have absolutely zero clue how the US monetary system actually functions. They have failed to properly diagnose our problems (a balance sheet recession) and are now implementing policy that will prove destructive. All in the name of a bankruptcy that can only happen if they decide to let it happen! So buckle up America. In their fight for power the politicians are about to “help” us avoid a technical bankruptcy while bankrupting us economically.

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