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Old 10-18-2011, 03:14 PM   #61
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Are we all in agreement that - whether it is via keystrokes to the various banks and primary dealers or via physical printing press - the Federal Reserve just creates money out of thin air?
i believe so. so far as I'm concerned.
By what mechanism can the US government run out of US dollars it creates out of thin air?
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Old 10-18-2011, 03:15 PM   #62
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techincally it can't.


but just because everytime I wipe my *** my thumb breaks through and I get **** on it, doesn't mean I should stop wiping my ***, but maybe do it differently.
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Old 10-18-2011, 03:38 PM   #63
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techincally it can't.
And an entity that is bankrupt is "unable to pay outstanding debts." If the USA can create dollars out of thin air, it will never be unable to pay outstanding debts (so long as they are only denominated in dollars).

That is the foundation that must be established, understood and accepted.

The USA can only be bankrupt if it chooses to stop paying its debts. Anyone that says otherwise (i.e. we are going bankrupt, we are running out of money, etc) either still thinks we are in the 1960s or is in some way being disingenuous.

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In the operational reality of today's monetary system, the USA is not funded by taxes or bond auctions. The bond auction is a monetary policy tool (allows Fed to target interest rates) and not a funding tool. Taxation affects deficits and drains money supply - it does not fund government spending.
Pls. explain.
I have explained this already and posted links to research papers (not blog articles or op-eds or opinion pieces) that dig in to the operational reality of the funding of government spending. I hope those will be more persuasive than just me asserting it.

The brief version is that the US government spends first. It does not borrow and then spend like a consumer getting a loan for a car. It does not tax on April 15, 2011 to pay for the spending from April 16, 2011 through April 15, 2012. The government does not send a proposed budget to the Chinese, the Japanese, CalPERS, et al before it spends.

The Treasury does not check its inventory of dollar bills or gold bullion before it spends. It does not tax before it spends. It does not hold a 10-year or 2-year Treasury security auction before it spends.

Congressional spending creates new money and taxation removes money.

Bond auctions are a monetary tool (aka used by the Federal Reserve for interest rate targeting). They are a vestigial remain of the previous monetary system and required by law, but they are not technically necessary for Government spending. The Federal Reserve knows the required reserves to be held by banks. The Fed and the Treasury are in constant communication regarding the level of required reserves. Those reserves right now pay 0.25%. The Fed can set some target interest rate for the bonds and the banks swap their 0.25% yielding reserves for something paying 1%, 2%, 3% etc by adding duration.

Again, think about bond auction subscription ratios. There is no bonus prize for a subscription ratio over 1:1 but they regularly come in at two or three times oversubscribed. Why? Because the Fed and Treasury know ahead of time the minimum that they can sell and set the auction accordingly.

Bond auctions are NOT a fiscal tool (aka used by the Treasury to pay for spending).

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The threat is inflation.
I've been saying this all along.
And we are in agreement there. We are even in agreement that currency rejection (aka hyperinflation) is an extremely unlikely outcome.

Where we disagree is that you keep making comments that imply that the USA can run out of money or be insolvent despite apparently understanding that this cannot be true (barring a voluntary decision to not pay up).

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How many % of GDP does the gov't consume today, and how sustainable is it?
How much longer do you think the current system can be sustained?
Do you think there's a breaking point where the whole system threatens to collapse?
I would like to discuss this in a separate post as the answer is pretty complicated, but requires some understanding of the basics of the MMS.

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You cannot accurately compare Greece (a currency USER) to the USA (a currency ISSUER) in that way. The USA (and Japan, Australia, Canada, the UK) does not operate the same as a household, a business, the state of Iowa or the USA of 1950. The USA does not borrow or fund first and then spend.
Why can't you compare the two, or even say Anguilla for example, in the way that fiscal ruin is inevitable when government spending grows faster than the productive part of the economy and by contrast countries like Canada or Ireland, who decreased spending as a share of gdp, are doing better?

regardless if they can pad their own banks with 1 and 0s...
My comment was in reference to bond market actions between a currency issuer and a currency user. You can compare anything you want to - apples to bobcats - but your conclusions are probably not going to be very instructive.

Greece can be forced in to bankruptcy because it can run out of money, just like (for example) Louisiana could face bankruptcy. They do not have the ability to create the currency their debt is denominated in. In the case of Greece, that's the euro - created by the European Central Bank. In the case of Louisiana, that's the US dollar - created by the Federal Reserve.
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Old 10-18-2011, 03:49 PM   #64
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I recommend these PDFs:
I come from an "Austrian" background and have read most of those (although it has been a while for some of them. It is all well and good to tout the benefits of a commodity-linked or pegged currency and/or to decry the evils of a fiat monetary system. In general, the reason I "left" that school of economic thought (but not all of its elements) is because it largely fails to understand the operational reality of the current monetary system. There is too much focus on value judgment (how things should or shouldn't be) and not enough on how things are: aka "the operational reality."

Just look at The Mystery of Banking. It is almost entirely focused on the historical nature of a gold-standard or gold-pegged world with virtually no insight in to how things actually work with the Federal Reserve, the Treasury and the member banks and primary dealers.

As I recall, The Gold Wars has virtually nothing to do with our current monetary system.

I will make you a deal: if you will read the first working paper I posted ("Understanding the Modern Monetary System" by Roche), I will read or re-read the other PDFs you posted. When you have complaints, criticisms or questions of the material presented, I will try to respond. I will then point out what I think is correct and what is lacking in your links.


However, if you have adopted the Austrian school as a religion and are completely unopen to alternate or updated models, please tell me now. I am trying to look at this like an engineer - not a theologian.
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Old 10-18-2011, 03:59 PM   #65
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Originally Posted by Scrappy Jack View Post
In general, the reason I "left" that school of economic thought (but not all of its elements) is because it largely fails to understand the operational reality of the current monetary system. There is too much focus on value judgment (how things should or shouldn't be) and not enough on how things are: aka "the operational reality."
The Austrian school doesn't understand the operational reality of the current monetary system?

http://mises.org/daily/4869
http://academy.mises.org/courses/anatomy-of-the-fed/
http://mises.org/daily/4897
http://mises.org/daily/4499
http://mises.org/daily/3662
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Old 10-18-2011, 05:59 PM   #66
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The Austrian school doesn't understand the operational reality of the current monetary system?
Blech. I started a response and closed the window by accident.

There are a TON of VERY intelligent people at the Mises group, but I do believe that most either do not understand the transmission mechanisms or are willing to distort reality for ideological purposes. There are more and more Austrians moving to embrace a greater understanding of the MMS.

For example: http://mises.org/daily/4869

1) In the hypothetical illustration he uses to explain a scenario in which the Fed becomes insolvent, he assumes an 800 basis point spread between the 1-year and 10-year Treasuries. That is ten times the average spread between the 2-year and 10-year under the MMS (data I had handy). For a 1-year, it should be slightly greater.

Either he is assuming that the "bond vigalantes" or market forces can exert way more impact on longer-term bond yields than has ever happened before (anything is possible, I guess) or he is exagerating for some other reason.

2) I will have to look at it in more detail (my reading list is really growing!) but that accounting measure looks incomplete. I am also not sure that the Federal Reserve uses mark-to-market accounting (which the author must be presuming given the write-down in asset prices of the Fed's yield products).
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Old 10-18-2011, 09:42 PM   #67
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http://www.consultingbyrpm.com/blog/...he-mmters.html

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For those of you intrepid (foolish?) enough to wade through the comments on this blog, you will note that–contrary to perhaps your initial perception–the Modern Monetary Theory (MMT) proponents do not actually say that the issuer of a fiat currency can’t become insolvent. Rather, they qualify it in the following way: To qualify for the vaunted invulnerability status, we need a central bank having “all liabilities denominated in a free floating, non convertible currency which they are a monopoly issuer of.” So that’s why Iceland, Greece, and Spain are all in trouble, even though the gold standard ended in 1971.

I have an observation and then a question.

OBSERVATION: If this is the MMT position, fair enough, but then to be consistent they should stop saying, “You Austrians have to drop your gold standard thinking. That ended in 1971.” No, it is still very much relevant, as the collapse in Iceland and the current trouble in Europe demonstrate. I could understand you making such a claim during the US debt ceiling debate, because there you were arguing that the politicians were foolishly imposing artificial constraints on the US gov’t/Fed apparatus. But there is nothing artificial about the crisis that hit Iceland, or that is currently hitting Greece. So if the MMTers agree with Krugman (he’s not an MMTer, by the way) when he says that we are seeing the problems of a “nouveau gold standard regime” in Europe right now, then they at least should have the decency to stop ridiculing Austrians (and others) for clinging to “gold standard analysis.” They themselves are admitting it is still necessary to understand–dare I say it?–modern monetary institutions.

QUESTION: The European Central Bank itself currently has dollar-denominated liabilities, on account of its swap lines (and probably a bunch of other stuff too). I can’t get an exact number, but I am sure the Fed in its humongous balance sheet somewhere owes somebody on planet Earth a debt denominated in a currency other than dollars. So, what is the cutoff for MMT to become applicable? (In other words, the Fed presumably counts right now under the umbrella of MMT, so you must think that it’s OK to have a piddling amount of liabilities denominated in foreign currencies.) Does MMT currently apply to just the Fed, or to the ECB too? If the former, should you maybe stop calling it “Modern Monetary Theory” and instead call it “Future Monetary Theory,” for a time when its results are applicable to more than one central bank on earth?
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Old 10-19-2011, 07:46 AM   #68
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I should preface this by further clarifying that I am NOT an expert, by any means, on the operational realities of the modern monetary system in the USA. Re-reading some of my posts, they do seem a bit "lecturing" which is not my intent.

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Originally Posted by mgeoffriau View Post
Quote:
Originally Posted by Cunsulting by RPM
OBSERVATION: If this is the MMT position, fair enough, but then to be consistent they should stop saying, “You Austrians have to drop your gold standard thinking. That ended in 1971.” [...] But there is nothing artificial about the crisis that hit Iceland, or that is currently hitting Greece.
This may sound like semantics and I do not speak for anyone other than myself, but most of the scholars and money managers I have seen that are lumped in to the "MMTer" group (I hate that term, BTW) don't seem to be saying "forget everything you know about the history of the gold standard." They seem to be saying - which that author seems to agree with - stop applying gold standard analysis to scenarios in which it does not apply (e.g. the debt ceiling, misunderstanding the difference between the USA and Greece, etc).

Like I have said, I see no reason you can't approach MMS analysis from an Austrian perspective.

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Quote:
Originally Posted by Cunsulting by RPM
So, what is the cutoff for MMT to become applicable? (In other words, the Fed presumably counts right now under the umbrella of MMT, so you must think that it’s OK to have a piddling amount of liabilities denominated in foreign currencies.) Does MMT currently apply to just the Fed, or to the ECB too?
This is an excellent set of questions that I do not know the answer to but will try and get some opinions on.
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Old 10-19-2011, 10:12 AM   #69
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So, it just so happens that one of the authors and top researchers on the MMS (Scott Fullwiler, one of the authors referenced above) responded to Mr. Murphy. Regarding the Observation, he basically said what I posted above (incorrect application of analysis).

Regarding the Question, Mr. Fullwiler writes that, if the Federal Reserver or the US Treasury "does in fact have debts denominated in foreign currencies" than the standard of the MMS would not apply to those specific debts. This is one reason to be against the Federal Reserve lending US dollars to the European Central Bank in large amounts. If the ECB defaulted, "the euros used to collateralize the loan would lose value and the net effect would be that the federal govt would be the one taking the loss" even though it was not legislatively approved.

Many "MMTers" are very much "anti-Federal Reserve."

Mr. Roche adds that "the Fedís currency swaps amount to a grand total of 0.003% of GDP according to the latest Fed statement" so - while they oppose the Fed's currency swaps - at this point they should not prove at all debilitating.

I do not know at what stage they do become a major concern and that was not really addressed.
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Old 10-19-2011, 10:25 AM   #70
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this thread is too much, this is why i stick to hyperboles.
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Old 10-19-2011, 11:06 AM   #71
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this thread is too much, this is why i stick to hyperboles.
The basics are counter-intuitive at first, but not all that hard to understand if you spend a little time with it. That first link, the paper by Cullen Roche, is the best (and least academic) intro I have found.

I generally dislike analogies (they are always imperfect), but here is a car-oriented one you might like (and others will hate ):

Think about the basic automobile. A new car today isn't massively different, at the core, from one made in the 1950s. Four wheels, internal combustion, transmission, steering wheel, etc. The specifics of those elements has changed, but the basics of spark, fuel and air are there.

Those who are trying to apply only gold standard analysis to all economies would be like an old muscle car tuner - someone who may be an extremely smart guy and the best damn wrench turner you ever met - being unfamiliar with OBD2 or CANBUS systems. They might be able to get a carb'd big block running amazing, but trying to apply the same tuning techniques to a BMW 335i are not going to work.

On the other hand, the Modern Monetary System (MMS) group is like the guys trying to figure out how to "chip" the 335i ECU by deciphering the actual code (the operational reality). "Okay, here is the code. This element does this, that element does that." That's the descriptive part.

The prescriptive part (what we should do) can be all over the map. That's the best part of the MMS analysis. It's politically agnostic. You can use the understanding to make "left" proposals (direct government spending in a consumer-led recession) or "right" proposals (eliminate payroll taxes during a consumer-led recession).
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Old 10-19-2011, 11:18 AM   #72
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The only thing I care about is saying things like good fiscal policy happening when the private sector grows faster than the public.

Going to your analogy, you can chip the 335i all you want, but if there's no octane in the gas tank, youre not going very fast.
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Old 10-19-2011, 12:47 PM   #73
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...In the hypothetical illustration he uses to explain a scenario in which the Fed becomes insolvent,
My argument was never "when the Federal Reserve becomes insolvent", it is "When the FEDERAL GOV'T becomes insolvent".

The Federal Reserve will never want to inflate enough to risk hyper-inflation, regardless of how bad the Fed Gov deficits and debt become. The FED will tell Congress "we cannot inflate more. You Congressworms need to truly cut spending". (Helicopter Ben has already said this, weakly, a few times)

The only time hyperinflation may be a risk, is if Congress decides to nationalize the FED. Then the politicians may inflate to the moon.

The scenario by which the Fed Gov goes insolvent is this:

- politicians are incapable of cutting spending, and increase it <- the past few months has proven this incapacity
- deficit widens and debt increases exponentially
- foreign purchasers of Treasury debt start to realize they're loaning money to a deadbeat (this lowers the Fed Gov's credit rating)
- Treasury debt interest rates rise
- the % of the Fed Gov budget that goes to paying interest on the debt, increases, further increasing the deficit
- the FED buys more Treasury debt which makes inflation increase
- repeat, until we get mass (not hyper) inflation, at which point the FED stops inflating
- the deficit widens, nobody will lend to the Fed Gov but at very high interest rates, and the Fed Gov is teetering on insolvency. It either needs to make drastic spending cuts, or partially default, or both

The only way out, is for the Fed Gov to cut spending by 30%, across the board, *before* interest rates rocket.

The critical point is the exponential increase in the deficit due to an increase in the interest the Fed Gov pays on debt, coupled with the refusal of the FED to inflate further.
We are now at the point where the deficit is increasing, the credit rating has been lowered a notch, but not yet where the interest rates increase.
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Old 10-19-2011, 02:14 PM   #74
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so: We don't put leeches on people to heal them anymore, but we still think we can put a leech on the economy to heal it?


muahahah.
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Old 10-19-2011, 03:00 PM   #75
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The critical point is the exponential increase in the deficit due to an increase in the interest the Fed Gov pays on debt, coupled with the refusal of the FED to inflate further.
We are now at the point where the deficit is increasing, the credit rating has been lowered a notch, but not yet where the interest rates increase.
Help me make sure I am understanding your perspective, Jason.

Through what mechanism will US Treasury yields rise? It sounds to me like you are saying that, at some point in the future, market forces will drive Treasury yields higher.

Is that a fair representation of your stance?
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Old 10-19-2011, 04:54 PM   #76
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Yes, market forces. Same mechanism that made Greek T bondn yields get >20%.
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Old 10-19-2011, 05:33 PM   #77
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Yes, market forces. Same mechanism that made Greek T bondn yields get >20%.
A) Greek bond yields spiked because market participants realized that Greece cannot repay Greece's debt in euros. Greece cannot create new euros.

B) The USA owes its debts in dollars. The USA can always (barring a voluntary refusal to do so) repay its debt in dollars.

C) Below is the correlation of Treasury yields versus the Fed Funds Rate (FFR) for the past 40 years:
  • FFR vs 2-year Treasury Yield = 97%
  • FFR vs 10-year Treasury Yield = 88%

What that means is that "market forces" only have about a 12% influence on 10-year UST yields. In other words, the market will not drive bond yields significantly higher, the Federal Reserve will.

I have personally calulated these numbers using data supplied by the Federal Reserve. I would be happy to show you the links to download the data from the St. Louis Fed so you can run them yourself if you don't believe me. [Edit: Found a graphical representation for Braineack's benefit. ]

What will cause the Federal Reserve to raise interest rates? Higher, sustained core inflation. There is about an 80% correlation to CPI-AUAI-exFE RoC over the same time period.

D) Greece is a currency user. You should be looking at another currency issuer that has experienced a balance sheet recession if you want a parallel in the way US Treasury yields will perform. Japan is the (albeit imperfect) parallel for the USA, not Greece.
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Old 10-20-2011, 11:32 AM   #78
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Don't just take my word for it in terms of how the US Treasury bond market operates. Take it from the Federal Reserve.

Quote:
Originally Posted by NY Fed
Staff on the Desk start each workday by gathering information about the market's activities from a number of sources. The Fed's traders discuss with the primary dealers how the day might unfold in the securities market and how the dealers' task of financing their securities positions is progressing. Desk staff also talk with the large banks about their reserve needs and the banks' plans for meeting them and with fed funds brokers about activities in that market.

Reserve forecasters at the New York Fed and at the Board of Governors in Washington, D.C., compile data on bank reserves for the previous day and make projections of factors that could affect reserves for future days. The staff also receives information from the Treasury about its balance at the Federal Reserve and assists the Treasury in managing this balance and Treasury accounts at commercial banks.

Following the discussion with the Treasury, forecasts of reserves are completed. Then, after reviewing all of the information gathered from the various sources, Desk staff develop a plan of action for the day.

That plan is reviewed with interested parties around the system during a conference call held each morning. Conditions in financial markets, including domestic securities and money markets and foreign exchange markets also are reviewed at this time.
In other words, the Federal Reserve knows the level of required reserves and the level of excess reserves in the banking system. The Fed, the US Treasury and the primary dealers are all in communication prior to the auction. Using this information, the auctions are designed to be oversubscribed (in other words, not fail).

After all, look at the obligations of a primary dealer:
Quote:
Originally Posted by NY Fed
Primary dealers are also required to participate in all auctions of U.S. government debt and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.

The US Treasury bond market is a monetary tool used to set interest rates and drain reserves, not a fiscal tool used to fund government spending. It is not a free market, natural supply-and-demand environment. The US and Japanese sovereign bond markets are not the same as the Greek sovereign bond markets.

"The market" will not meaningfully drive up interest rates on US Treasuries. The Federal Reserve will drive up interest rates.

Last edited by Scrappy Jack; 10-20-2011 at 11:35 AM. Reason: Added a link for the primary dealer source
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Old 10-20-2011, 11:47 AM   #79
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Originally Posted by mgeoffriau View Post
The Austrian school doesn't understand the operational reality of the current monetary system?

http://mises.org/daily/3662
There ya go: a Mises author who makes the distinction between debt denominated in foreign currencies (or gold) and one whose debt is denominated in the free float exchanged currency of which it is the sovereign monopoly issuer.
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Old 10-20-2011, 12:14 PM   #80
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Scrappy,

Why do you think the system in its current state is indefinitely sustainable?

What changed recently is we now have a deep lingering recession with no sign of ending and the gov't is increasing its spending.

The deficit is beginning to increase exponentially. Why would it be in foreign governments' interests to keep buying Treasury debt? Why should they continue to treat the USD as the reserve currency of the world?

What will prevent mass inflation (10-15% p.a.), if and when the commercial banks begin to lend again ... and what do you think the size of the deficit will be at that point? What do you think gov't expenditure might be as a % of GDP at that point? How many % of the gov't's budget will have to go towards paying debt interest alone?

Ultimately the gov't is eating productivity, destroying economic efficiency, and is slowing economic growth. The path it's on now is towards ever greater wealth destruction and inflation.

Medicare and SS are on a trajectory wherein there will be only 2 workers for every retiree (in the 1960s it was 5 workers). Is that sustainable? Or will the gov't have to default on its Medicare/SS promises? (remember the gov't spent the Med/SS contributions of soon-to-be retirees)

The FED will stop "bailing out" the Fed Gov when we have mass inflation. What will happen to the Fed Gov's finances then?
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