The Circle of Socialism: The Real Story of “Quantitative Easing” and the Federal Reserve

America’s got a massive deficit and debt problem. On that, most folks can agree. How it happened, however, is something many aren’t so certain to say.

The process of running up a $16 trillion Federal deficit may seem complex and convoluted, but it’s really no more complicated than the average American family swimming in a sea of credit card debt. The same principles are at play, and the same mistakes are being made.

Government, like most households, finances its spending in one of two ways: income (in the form of taxes for government / salaries and wages for households) or through the use of debt (Treasury securities for the government / credit cards, student loans, car loans, etc. for households).

The responsible government and/or household strives to make the ends meet by using the income coming in, all the while striving to stay away from the use of debt. Deficits come when debt is treated like income and as like it never needs to be repaid.

Despite their similarities, however, there are several major financial differences between our Federal government and the average household. The biggest of these differences is the ability of the Federal Reserve to print the money to pay back the government’s debt obligations. Where households actually have to earn the cash they need to pay back their debt obligations, the government just fires-up the printing press. This means that, ultimately, we all pay for fiscal irresponsibility in Washington in the form of devalued dollars, which lead to higher prices on everything from corn flakes to clothes and a lower standard of living.

Here’s how DC’s debt cycle works:

1. First, Congress blows over a trillion dollars more every year than the Federal government takes in through tax revenue.
2. Then, the US Treasury Department issues bonds to securitize the debt (remember, the bond is the credit card of the government), then the Treasury sells these bonds to investors to raise the capital needed to pay for this out-of-control spending by the Congress and President.
3. Now, the question becomes: who buys the bonds? Since the Treasury has issued trillions of dollars in new bonds since Barack Obama became president, private investors are less interested than ever before.
4. This is where the Federal Reserve comes into play: they print money out of thin air to buy bonds no one else wants to touch.

Since the stimulus packages and big government bailouts began back in 2008, the Federal Reserve has been the single largest purchaser of bonds issued by the Treasury. This is a telltale sign that investors in this country, as well as abroad, have very little appetite to continue bailing out an out-of-control government in Washington.

It’s also important to point out that the Federal Reserve doesn’t take in tax revenue, so they have to come up with the money to buy Treasury bonds by just creating it out of thin air. They just make (quite literally in this case) the money they need to buy the bonds no one else will buy.

So, the cycle of socialism is the following:

1. Congress blows the money.
2. The Treasury issues bonds to raise money to cover spending by Congress.
3. The Federal Reserve prints the money needed to buy the bonds from the Treasury.

If it sounds nice and tidy, trust me, it’s not.

There have been other governments in modern history that have tried this same sort of scheme, with predictable results. The German Weimar Republic gave it a whirl, destroyed their economy and ended up with Adolf Hitler. The Greeks gave it a go, only to find themselves going down the road to economic oblivion. Just two examples of what not to do that policymakers in Washington seem unwilling to heed.

Hyperinflation is the inherent result of printing money from thin air, and this is a de facto tax on the American people.

Think about it, if the government prints money to pay their own bills, that destroys the value of money already in circulation. We call that process of monetary debasement, inflation. That means that the dollars in each of our pockets are becoming more and more worthless as the printing presses keep printing. This goes back to the fact that everything from corn flakes to clothes more expensive for American consumers.

So, the circle of socialism, wherein an over-promising, big spending Federal government attempts to cover for their financial mismanagement through the printing of cash (something far less popular than outright tax increases) which actually has the same effect as a tax hike. The lasting effect is less purchasing power for American families, which translates into hampered economic demand and sluggish economic growth.

I’m in no way advocating tax hikes, but I am suggesting that we start focusing on spending cuts. If we don’t, inflation will make us feel like we’ve had a tax hike…and I think we’re taxed enough already.