Cliff Notes

 | Dec 21, 2012 | 9:45 AM EST  | Comments
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Here in the Western world, Christmas time is the period of the year when we indulge in our modern mythology. When else can we believe that reindeer can fly, or that a fat man in a red suit can visit every home earth in 24 hours ... or even that he can somehow fit down a chimney flue?

At any age, you can believe in that magic of Christmas!

Similarly, this magical time of year enables our political leadership (on both sides of the aisle) to encourage all of us citizens to believe in the magic of fiscal cliff mythology. We are asked to suspend disbelief and ignore many basic tenets of economics. Here are a few of the myths that our leadership is trying, with the help of the media, to make us believe:

The tax impact will only be on the wealthy -- Neither side dare mention that both favor the expiration of the Obama payroll tax cut put in place two years ago. Withholding for social security and the like is set to rise to 6.2% from 4.2% starting Jan. 1. This tax increase hammers the middle and lower classes, since it only applies to wage income below $110,000. (Keep in mind that an increase to 6.2% from 4.2% s not a 2% increase, it is a 50% increase.) While they argue about whether to raise rates on the wealthy, they are in solid agreement to sock it to you now.

Spending cuts "cut" spending: Many average folk by now are figuring out that the spending cut fight is not about cuts, but rather about reducing the rate of growth. No matter what deal is put into place, federal spending next year will be higher than this year. As the Men's Wearhouse guy used to say, "I gah-rantee it." Furthermore, every scenario from both sides envisions growth of spending. If the cliff is actually implemented, the best spending would do is hold flat year over year. The fundamental argument of how big government should be is really being ignored by all involved, under the ruse of baseline budgeting.

GDP targets: In theory, comparing the size of the deficit and our total debt to our GDP makes sense, since the size of our economy defines what we can afford. In practice, we are comparing a very precise and hard number of what we borrow and owe, which can be calculated to the penny, against an estimate that has little hope of ever being calculated effectively. Economists like to believe they practice a hard science and that they can closely estimate economic variables, but the reality is the opposite. The margin of error on the size of our economy is quite large. Do any of you even know how the numbers are calculated? Via IRS data? Via surveys? No one really knows. Economists use plug factors to balance errors that go into the hundreds of billions of dollars.  The point is, are we safe when the deficit is at 3% of GDP when we do not really know what GDP is?

The Fed is not monetizing debt: Ben "Arthur Burns" Burn-anke absolutely insists that the Fed is not monetizing the Federal debt. He insisted this again, while announcing that the Fed would buy Treasuries at the rate of around $45 billion per month. This amount is roughly half the projected deficit for 2013, after assuming some fiscal cliff relief is passed. For all the fiscal cliff negotiating pain, when all is done we will still be running massive trillion dollar deficits that are only sustainable by printing money. A rose by any other name. The inevitable result is inflation. Even more troubling, the members of our society least able to protect themselves from inflation are the working poor and middle class. All of us wealthy (or aspiring) Real Money readers can recognize inflation and benefit from our asset allocation. Currency debasement balances the budget on the backs of the unsophisticated and to do this while arguing you aren't, and putting on a sham negotiation about keeping middle class taxes low, is the height of exploitative cynicism.

While I would still like to believe in Santa Claus, I cannot even begin to believe that this humongous fiscal cliff conflagration is anything but cynical politics as usual. The amounts they are fighting over simply don't matter. The so-called solution -- debt monetization -- has already been put in place and  even announced. Pundits may argue that you can create trillions in new money every year and not have it be inflationary because they are trapped in reserves at the Fed, but this ignores the fact that the new money flows not to banks but to the federal government, which then spends it. The fact that the stock market is up 15% this year in a punk economy should tell you something. Asset values are being distorted since inflation always shows up first in paper assets.

Whatever strategy you use to protect yourself, just be sure to protect yourself.  The fiscal cliff contretemps is a diversion, don't get distracted by it. Focus on hard objective reality. Trillion dollar deficits require monetization, which always and everywhere leads to currency debasement. You are sure to find the consequences in your stocking next Christmas.

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