The 'Bond Vigilante vs. Fed' Mantra Makes No Sense

NEW YORK ( TheStreet) -- There is a new macroeconomic mantra that has spread itself across the markets and on CNBC in the last couple of months in particular. It goes something like this:

1. The U.S. Treasury issues $1.3 trillion per year in deficit financing;

2. The Federal Reserve buys over 80% of the deficit -- $85 billion per month;

3. The "Bond Vigilantes" are dead because the Fed buys essentially all the bonds;

4. There is no inflation, and interest rates will stay low forever simply because the Fed has unlimited buying power;

5. Downgrading U.S. government debt by rating agencies don't matter, because after they did it last time (August 2011) interest rates only went down.

Turn on CNBC and you will hear some minor version of this "new reality" more times per day than you can count. Listening to this you could be excused for thinking there is no reason to worry, ever. Deficits don't matter, and interest rates can never rise.

Here is what you have to ask yourself: If it's this easy, why doesn't everyone do it all the time?

What we have in the U.S. right now is massive, painless government spending: The government essentially spends whatever it wants, because its compliant Federal Reserve simply prints up the difference between tax revenue and spending.

As you can see from this data series , cumulative federal spending was $28 trillion over the last 10 years. For the next 10 years, the most conservative outlook is $46 trillion, a 65% increase over the previous 10 years.

Back to the central question: If it's this easy, why doesn't everyone do it?

The cost of this policy appears to be nothing, zero:
  • No inflation
  • No high interest rates
  • No economic collapse
  • No need to cut any government program, ever
  • No currency crisis

It's all sweetness, light and jingles. Candy all the way, no hard work, no saving, no deferral of spending, no pain, no problem.

Let's cut a few decimal points off this Federal government equation to show what it would mean for an individual. You make $250,000 per year, you spend $380,000, you borrow $30,000 and you go to your basement printing press for $100,000 in $20 bills to pay for your drug habit.

Anything wrong with this picture?

We are being told there is no penalty for this policy. We are immune to any need to cut our excessive spending habit because can print almost all of the deficit. There is, therefore, no price to pay.

Why even bother discussing austerity programs, whether in Greece, Spain, Italy, Portugal or right here in the U.S.? If the U.S. can be just fine simply printing almost its entire deficit, why can't Europe do the same? If there truly is no cost to doing this, why hold back?

It's, like, "Why didn't anyone think of this before?"

The bond vigilantes have been neutered, we are told, because the Fed simply assumed unlimited powers. So it is therefore metaphysically impossible for interest rates to rise. If the Fed just buys all debt, then interest rates will be as low as the Fed wants forever, right?

Throughout history, all sorts of countries have been forced to cut back on spending when the basic forces of financial gravity have set in. You have to cut the budget in various places until you don't spend more than you take in. Just ask the Greeks right now.

Looking at the U.S. situation right now, why aren't all of these other countries asking themselves: Why don't we just establish a Fed as well, and then we can increase spending infinitely and simply have our own central bank buy all the debt? No pain, no problem.

Standard economic theory for centuries tells us this policy generates massive inflation, currency devaluation, rapidly rising interest rates. We need only go back to the 1970s right here in the U.S., and at that time the money-printing was a pittance compared to today.

The Fed's inflationary policy, in order to "accommodate" the federal government's spending binge -- 65% or more increase over 10 years -- has come with zero economic penalty. Interest rates are down and we are constantly being told by our government that we have essentially zero inflation.

Some people would say the effects of this policy is only a matter of time. Some time! Given the magnitude, if it hasn't happened already, the "catch-up" impact when we have to pay for all of this through higher interest rates would be as epic as the fall of Rome.

Just look at the data series of federal government spending :
  • 1996: $1.6 trillion
  • 2005: $2.5 trillion
  • 2009: $2.8 trillion
  • 2012: $3.8 trillion

Current (2012) tax revenue: $2.5 trillion. In other words, if federal spending were just kept to the 2005 level -- which included Iraq, Hurricane Katrina, etc -- the federal budget would be in 100% balance, right now.

But why bother keeping a budget anywhere near a balance if it's free to just spend an unlimited amount of money on top of it? The Fed buying all the extra deficit spending is, after all, free, we are told. No adverse impact on inflation, interest rates, the dollar or anything else. The price is not showing up in any column.

Small wonder Washington, D.C., has us increasing federal spending to an average of at least $4.6 trillion for each the next 10 years. If it doesn't cost anything, why not? And why stop there? Why not $5 trillion per year? $6 trillion? Hey, pick any number you want.

Bottom line: If we return to a world where the laws of economic gravity come back to reality, the crash will be epic and sudden. Is there any way to protect yourself other than to buy GLD?

At the time of publication the author had a position in GLD.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.