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Don’t touch my wallet!

Sigma Investment Counselors

June 18, 2010
This discussion relates to our blog posting of May 26, 2010 about the unraveling social contract in Europe. Since that time, “austerity” has become the policy prescription of choice by the governing classes to fix the budgetary ills of Europe generally and Greece specifically. Elected officials, for the most part, do not like to impose austerity measures on their constituents because they are unpleasant and cause angst (particularly to those voters that are most impacted by the measures). If no alternatives exist, then austerity becomes the only choice. But, is there an alternative? Perhaps the government could borrow funds to facilitate social spending and then conduct monetary policy in such a way as to cause inflation. This would allow the borrowed funds to be paid back with devalued currency (called “monetizing the debt”). This seems a fairly deceptive course of action and a clear violation to the lender providing the capital. It also would seem unlikely to take place in a transparent political environment such as the United States, correct? Perhaps not. We have been mulling this for several weeks. Our concern relates to the testimony from the February 24, 2010 US House Financial Services Committee hearing when Representative Brad Sherman, California Democrat, suggested that the Fed might want to do just that (monetize the debt) since it was endorsed by the International Monetary Fund.http://www.washingtontimes.com/news/2010/feb/25/bernanke-delivers-warning-on-us-debt/

Fortunately, Fed Chair Bernanke was quoted as saying “We’re not going to monetize the debt.” He noted that Congress would need to become more disciplined with regard to deficit spending instead. Now, flash forward to the discussions currently taking place on the financial regulation bill being debated in Congress. Consider those aspects that relate to Fed independence. Recently the bill was stripped of the provision limiting Fed independence. But, could it reappear? Could a similar provision resurface as part of another bill? Would a future Fed chair have less reticence about monetizing? Connecting the dots suggests that this has to be monitored closely or the Fed could be forced by Congress to indeed, monetize the debt.

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