Iceland is proof that the collapse of a financial system is not the end of the world—so long as its direct costs fall on those who deserve it and not the productive sectors of the economy. The productive sectors of an economy can build their way out of the financial fallout if they are left alone to do so, and not burdened with the costs of failed schemes. Therefore, the best way to contain the damage from a financial collapse is to prevent a bailout of the financial sector using the resources of the productive sectors of the economy.
The Compact's Balanced Budget Amendment does just that by limiting the federal government’s ability to draw on Federal Reserve credit with a hard constitutional debt limit and otherwise capping federal expenditures at tax receipts or the equivalent. Creative modes of financing any attempt to allow spending to evade the BBA's constitutional debt limit will run headlong into the amendment's express language that spending beyond taxes and the equivalent must be "exclusively" based on authorized debt.
Consequently, upon ratification of the Compact's BBA, the federal government will not have an unlimited ability to borrow from the Federal Reserve to finance any bailout of Wall Street, nor to print money itself and deposit those proceeds in the treasury to finance a bailout, nor to concoct side-deals with Wall Street to finance bailouts using creative debt instruments.
By minimizing the federal government’s ability to finance a bailout of the financial sector, the mere ratification of the Compact's Balanced Budget Amendment will simultaneously encourage market forces to demand a higher degree of prudence in Wall Street deal-making that would not otherwise exist, helping furnish a market-based self-correction to the worst abuses. Moreover, by limiting the federal government’s borrowing resources to a finite absolute dollar amount, the Balanced Budget Amendment will create a powerful institutional incentive in the federal government to oppose any inflationary actions by the Federal Reserve in any attempt to independently bailout the financial system—simply put, to preserve the real value of its borrowing authority, the federal government will suddenly discover a powerful institutional interest in preserving the value of the dollar.
Finally, and most importantly, by limiting the federal government to a finite amount of borrowing, the Compact’s Balanced Budget Amendment will help end the federal government’s financial dependency on the Federal Reserve. Without the BBA, the Federal Reserve can dish-out as much financing as the federal government wants. With the BBA, the federal government will run out of bonds to sell to the Federal Reserve. Only by breaking the federal government’s addiction to the Federal Reserve's cheap money in this way, will there be any hope of incentivizing meaningful reform to rein-in the Federal Reserve. Otherwise, the federal government will never bite the hand that feeds it.
Taken together, the Compact’s Balanced Budget Amendment would, in fact, establish a powerful structural reform that not only would curtail the worst excesses of the financial system by stopping the bailouts, but such a reform is absolutely necessary to lay the foundation of political will for real reform of the Federal Reserve itself.
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by Nick Dranias
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