How to pull ourselves out of the debt quicksand pit

The monetary policy mistakes that we are suffering from today started in 2008.

Fed chair Ben Bernanke embarked on a new, unproven and dangerous policy called Modern Monetary Theory, or MMT. The Federal Reserve's FOMC abandoned Austrian Economics and embraced its opposite, MMT. Chairs Yellen and Powell followed. The new chairman of the Federal Reserves, Kevin Warsh, says he will not. I pray he will reduce the amount of liquidity in the economy.

MMT's Achilles heel is the failed belief that the Federal Reserve could create unlimited amounts of currency (U.S. dollars) with no repercussions. The Fed embarked on Quantitative Easing in 2008 and created 8 trillion new "dollars."

What happens to a commodity when there is too much of it? Its value declines. Dollars are no exception.

When the Federal Reserve ballooned its balance sheet from $800 billion to $9 trillion, the end game was set. Economist Brian Wesbury calls this "abundant reserve." Bankers call it excess liquidity. Bottom line: The number of dollars in circulation makes a difference in the purchasing power or strength of the dollar.

More dollars in circulation leads to less purchasing power of those dollars. Devaluing the dollar's purchasing power leads to price inflation.

The Federal Reserve's first objective is to hold the value of the dollar and not to let it decline. Excess money supply devalues the dollar's purchasing power. That is the root of inflation.

As the value of the U.S. dollar declines, it can buy less. This causes price inflation — the buyer must give more dollars for the same commodity. Today's inflation is caused not by scarcity, but by dollar devaluation.

There are three parts to the MMT and Q.E. puzzle: The Federal Reserve "printed" U.S. dollars (actually increased the amount of liquidity), the Treasury Department issued Treasury debt (bonds, bills, and notes), and Congress spent the excess money on more government programs.

Instead of living within our means, politicians decided to go into debt. They don't pay that debt back; we do. So why elect a politician who puts you into crushing debt?

The solution is simple, painful, and absolutely mandatory. The Federal Reserve must reduce its balance sheet by destroying excess U.S. dollars (reducing liquidity, or money supply).

And now for the rest of the story. The Fed can't just "print" a bunch of dollars. It needs a counter-entry provided by the Treasury Department. Each dollar created using Q.E. is counter-balanced by a Treasury Bond, Bill or Note. Debt.

Ergo, when the Fed destroys excess liquidity in the economy, the Department of Treasury must also redeem and retire Treasury debt instruments. We should rejoice, because that means we citizens have less debt to pay off. Yes, we pay the debt when the Treasury issues bonds and notes.

The third leg is Congress. It must severely reduce spending. The current, and past, level of federal spending is absolutely not sustainable. Everyone's favorite pork project has to be cut. The size and scope of our government must be constrained.

Over the past century, we have become addicted to deficit spending, going into debt more and more just to continue our profligate spending habits. Our politicians must also live within their means. We individuals have this discipline in our own lives; now we must demand the same discipline of bureaucrats and politicians of both parties.

Even with $38 trillion in hard debt and another $40 trillion in unfunded commitments, our private economy is strong enough to pay down this massive debt in a decade if we start now, by severely reducing spending and retiring federal debt instruments when they mature.

The formula is simple: Limit federal spending to 2 percent below GDP and dedicate another 2 percent of tax revenue to actively paying down the debt. Neither bureaucrats nor politicians can be trusted to limit their spending on themselves. We citizens must do it. Future generations will appreciate this. We will have done our duty to pass along a constitutional republic.

Jay Davidson is founder and CEO of a commercial bank, a student of the Austrian School of Economics, and a dedicated capitalist. There is a direct connection between individual right and responsibility, our Constitution, capitalism, and the intent of our Creator.

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