When I look over my shoulder, what do you think I see? Some other cat looking over his shoulder at me. And he’s strange, sure he’s strange. You’ve got to pick up every stitch, you’ve got to pick up every stitch. Beatniks are out to make it rich; oh no, must be the season of the witch. I was luck enough to see Donovan last week at one of three concerts he performed in the US to commemorate his induction in the rock and roll hall of fame. While the song – like most Donovan songs – is somehow about drugs, it reminds me of Frank Baum’s Wizard of Oz. And with Halloween fast approaching, a discussion of the four witches from the story (unlike the three that are in the movie) seems appropriate.
The Wizard of Oz is more than just a children’s story, it is an allegorical tale of populists (read progressives) desire to stoke inflation, for inflation is one of the great income redistributing tools. Through inflation, and its ability to reduce the value of future currency, debtors gain at the expense of creditors. Put this is the context of 1890 and the vast majority of the population (farmers) gain at the expense of the rich (bankers). Similarly today, low interest rates benefit mortgage holders at the expense of lenders.
In his classic novel, Baum identified four witches all of which had allegorical ties either to a person or to an interest in the debate over inflation. In his story, the Wicked Witch of the East represented the eastern bankers or in modern terms sound money, while the Wicked Witch of the West represented the land barons and mortgage holders from which most farmers had to acquire their land. On the other hand, Glinda the Good Witch of the South represented what was know at the time as free silver, or higher inflation, while the Good Witch of the North represented the munchkins or voters who were being held in servitude by the Witch of the East.
These same four witches (even the wicked witch of the east) are still alive and well in the current debate about the Federal deficit. In fact, each of the witches is preventing one of the four ways that the deficit problem can be solved.
Inflation: The first way to solve the deficit problem is to go back to the debate that was taking place in the late 1890s when the Wizard of Oz was written. That is to simply inflate it away. This is the solution that the current Administration is undertaking through its control of the Federal Reserve. Simply put, like Glinda, Chairman Bernanke is printing money at a rapid pace. This will lead to a spike in inflation when the economy eventually picks up. As the Wizard knew, inflation reduces debt in real terms at the expense of lenders, so this would be something that the Witch of the West (read China or other holders of government debt) would be fighting.
Tax Increases: The second way to reduce the deficit is to actually pay it down, and rather than borrowing 40 percent of every dollar spent or transferred, to actually raise revenues to match expenses. This is done through tax increases. Now sure, President Obama is calling for some rather small tax increases on certain parts of the population – specifically the residents of Oz – but in reality, neither party wants to raise taxes. Why, because the Good Witch of the North (or the public) is not willing to pay the 40 percent taxes needed to support the current level of spending.
Spending Cuts: So why not take on the deficit at its core and reduce government spending. Mitt Romney says that he is going to do that – he’s going to cut subsidies to Public Television. If this is not skirting the spending issue than nothing is. Nearly all government spending consists of transfer payments through Social Security, Medicare, Medicaid, Farm Assistance, Welfare Programs and Veterans Benefits. Even totally eliminating all other spending (save for defense), will not eliminate the current Federal Budget deficit. Anyway, the Good Witch of the South (the 47 percent those who receive the benefits or other government largess) are all using their magic to prevent any meaningful cuts.
Strategic Default: Finally, there is a fourth way to attack the deficit. Go the way of Argentina and simply default. The federal debt is nothing more than an obligation to bondholders, no different than a mortgage, so just like millions of Americans who defaulted on their mortgages when the equity on their homes disappeared, the Federal government can simply stop paying interest on its trillions of dollars in obligations. Sure the government has assets – land, oil, timber, the White House – but it also has a really big army so it is unlikely that lenders, be they grandmas with savings bonds, pensioners holding Treasury Bills, or those darned Chinese can attach those assets. Like Argentina, Brazil, Greece and Mexico before it, Uncle Sam can simply declare the obligations to be invalid.
Obviously the money markets – the Wicked Witch of the East – would be horrified of this, but hey, she was struck down by a house anyway.