This is a cross post from the Righteous Investor.
Americans keep repeating the meme that Federal deficit spending is borrowing from the next generation. This is not entirely true. Deficit spending creates more debt, and debt creates a larger money supply, and a larger money supply is the quintessential definition of inflation. Inflation soon results in increased prices for everything.
Henry Hazlett wrote in his important primer, Economics in one lesson (pdf), p. 19-20 (emphasis mine):
Everything we get, outside of the free gifts of nature, must in some way be paid for. The world is full of socalled economists who in turn are full of schemes for getting something for nothing. They tell us that the government can spend and spend without taxing at all; that it can continue to pile up debt without ever paying it off, because “we owe it to ourselves/’ We shall return to such extraordinary doctrines at a later point. Here I am afraid that we shall have to be dogmatic, and point out that such pleasant dreams in the past have always been shattered by national insolvency or a runaway inflation. Here we shall have to say simply that all government expenditures must eventually be paid out of the proceeds of taxation; that to put off the evil day merely increases the problem, and that inflation itself is merely a form, and a particularly vicious form, of taxation.
The premise of Hazlett’s one lesson in economics is that one must always look to the unseen, indirect side effects of economic policy–the law of unintended consequences. With regard to deficit spending, the immediate benefit that policy makers hope for is a stimulus that primes the pump of the economy and stimulates growth. Furthermore, politicians themselves wish to postpone making painful decisions such as government cutbacks, at least until the next election, so that they may maintain voter support. Thus, in the United States, deficit spending is spiraling completely out of control and the end result is the debauching of the currency. We can see the resultant dollar inflation in the Federal Reserves adjusted money base:
But if inflation is a tax–who is it taxing? It is a tax on all who are holding the dollar or receive payments in dollars. Who is affected by this? Wage earners, savers, retirees, and private companies. These are the domestic losers in the Federal deficit, whose money is subject to effective taxation caused by the dilution of the currency. But there are also some very important foreign holders of US dollars that I wish to point out.
Since World War II, the dollar has become the world’s reserve currency. Most central banks, some foreign corporations, and even many foreign individuals hold physical US currency, electronic US currency, and United States treasury debt. Nearly all transactions for commodities on international markets settle in dollars. The Chinese alone hold about a trillion in United States treasury debt. The deficit spending of the United States is an effective tax on all these foreign holders of the dollar.
So when the trolls around the internet point out that everyone should pay their share, we can remind them that the budget deficits of the United States are a form of taxation on the world. Since Barack Obama has come to power, the federal deficits have been in the range of 40 cents or more on every dollar. This means that Americans, as a class of people, are not paying their “fair share” by 40 cents on every dollar, but they are expecting others, including foreign holders of US currency to pay their “fair share” for them. The not-so-easy solution to this taxation via inflation is the complete and utter rejection of the US dollar as the world’s reserve currency. I believe that this rejection of the dollar will probably take place soon, perhaps within the next five years. Sooner or later it will happen. But the world will not stand to be taxed by the whiners in the United States who think that the way to solve the problems of the budget is to go after the bank accounts of expats.
Neither of the two political parties, Republican or Democrat, has the will to change this problem, and as long as they can lay their deficit spending on the backs of the entire world, they will do so. It is time that our central banks, our people, and our corporations, reject wholesale the dollar and require that the Americans be honest about their effective extra-territorial taxation.
As an investor, I’m doing my part. I have a significant short position in my dollar accounts.