James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter at @JamesGRickards.
One of the most high impact outbursts in the history of television occurred on February 19, 2009 when CNBC editor Rick Santelli, standing on the floor of the world's largest derivatives exchange, launched into a spontaneous attack on a White House plan to provide mortgage relief to homeowners. Santelli's remarks were pointed. He accused the White House of "promoting bad behavior" and questioned whether government should "subsidize the losers' mortgages." He ended with a rhetorical flourish by asking, "President Obama, are you listening?" in response to which the crowd near him on the exchange floor erupted into applause and cheers. At the end of the clip, Santelli announced, "We're thinking of having a Chicago Tea Party." His remarks became the subject of a White House press briefing the next day in which Press Secretary Robert Gibbs rebuked Santelli and the derivatives industry generally.
Students of the national Tea Party still debate whether Santelli's attack was the beginning of that movement. There were Tea Party-like protests against government spending going back as far as 2006. Yet, many observers consider Santelli's comments to have had a catalytic effect. Websites, organized protests and media commentary about the "Tea Party" all emerged within 24 hours of Santelli's attack. The outburst transformed the Tea Party from a loose array of local protests into a more cohesive and focused political movement.
And there can be no doubt about the power of the Tea Party. It has turned into a well-organized, well-financed political movement that was instrumental in helping the Republican Party to take control of the House of Representatives in 2010. That Democratic loss was said to have shocked the White House and has conditioned their political strategies ever since.
The rise of the Tea Party points to a particular failure of Obama's economic policies. One of the mysteries of the depression that began in 2007 is why there has not been more debt relief. Large-scale elimination of debt will be needed before a strong economic recovery can begin. The existence of bad debt on bank balance sheets impedes their ability to make new loans. The need to pay down debt impedes the willingness of consumers to spend money or incur new debt for big-ticket purchases of cars and homes. Pervasive unpayable debt is like sand in the gears of the economic machine. Elimination of this debt by some means is an essential first step in escaping the depression.
Yet, how? There are only three ways to eliminate debt that cannot be repaid: default, forgiveness, and inflation. The first two are just different forms of the same thing. With either default or forgiveness, the debtor is relieved of an obligation and the banks suffer the loss. Inflation eliminates debt by making it easier to repay in cheaper dollars. The difference is that the loss falls not on the debtors or banks, but on savers and retirees. The loss also falls more broadly on everyday Americans who don't see it coming. Keynes called inflation the most arbitrary form of confiscation and he was right.
Rick Santelli made some common sense points about debt relief. It does seem repugnant to those struggling to pay their mortgages and car loans and deal with their debts honorably. It does create moral hazard. Santelli touched a nerve and the White House knew it.
As a result, debt forgiveness seems to be off the table as a policy solution. This is not surprising. In addition to the political backlash that Santelli exposed, the banks are deeply opposed. If banks write-down first mortgages, their deeper losses on second mortgages and home equity loans will be revealed and lead to even deeper write-downs the banks cannot afford. The banks also covet fees on mortgage servicing, which are off-balance sheet items that go to the bottom line without requiring much capital. The banks are determined to suck the borrowers dry for as long as they can.
This leaves default and inflation as the only solutions. Default may come yet, but not if the Federal Reserve can help it. The Fed's programs of zero rates, quantitative easing, balance sheet maturity shifts, a weak dollar, and communications propaganda are all designed to get inflation rates above interest rates and jump start the lending and spending machine. Negative real rates induce borrowers to take loans. Inflation induces consumers to spend money faster. The combination of lending and spending increases the velocity of money and gets nominal GDP where the Fed needs it to pay down nominal debt.
Here is the irony of Rick Santelli and the Tea Party: Debt forgiveness is a straightforward solution that puts the losses where they belong—on rapacious banks and their investors. By taking debt forgiveness off the table, Santelli, the Tea Party and the White House have become strange bedfellows in promoting inflation because it is the only alternative to write-downs. Inflation, as we know, hurts those everyday Americans that Santelli and the Tea Party set out to defend.
Debt forgiveness hurts banks. Inflation hurts everyone except speculators. By putting a stake in the heart of debt forgiveness, Santelli and the Tea Party, with White House connivance, end up helping the banks and hurting the innocent through inflation. The law of unintended consequences is alive and well.
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