By Terry Coxon, Casey Research

"A rock and a hard place" is a long-running theme of Casey Research publications. It refers to the dilemma the US government has wandered into with its continued policy of rescue inflation. The "rock" is what will happen if the Fed pauses for long in printing still more money – the collapse of an economy burdened by an accumulation of mistakes that rescue inflation has been keeping at bay. The "hard place" is the disruptive price inflation that becomes more likely (and likely more severe) with every new dollar the Fed prints to keep the effects of those mistakes suppressed.

When the dollar was cut loose from the gold standard in 1971, the Federal Reserve was freed to create as much new money as it saw fit, whenever it saw fit. Enabled, it turned with enthusiasm to doing what central bankers imagine they are supposed to do – eliminate downturns in the economy. The Fed fancied itself as being on the answering end of a 911 system: whenever the financial markets signaled distress, whenever the economy came down with the flutters, the Federal Reserve would dispatch a van, an ambulance, a fire engine or even an assault vehicle, whatever seemed right but in every case full of cash.

To most people, rescue inflation was entirely agreeable. It made their world more comfortable and seemed to make it safer. Comfortable, yes. Safer, no. The pernicious but entirely welcome effect of rescue inflation was to cover up mistakes and keep them going. It allowed people – especially people handling other people's money – to make progressively bigger mistakes. Lending on implausible mortgages and buying securities tied to those mortgages are the most recent examples, follies that required decades of training.

Rescue inflation allowed everyone to get away with everything. The assurance that a high-speed vehicle with flashing lights on top would always arrive in time let individuals pay for houses with a little cash and a big mortgage. It let corporate managers rely on borrowing heavily, rather than selling stock, to raise capital. It let investors cheerfully accumulate junk bonds. And it let banks hire and set loose bright young minds to design financial gizmos with astounding leverage guaranteed to deliver excellently profitable results for so long as the economy continued on its excellent and guaranteed way. All of those hang-glider stunts seemed safe because if at any point the prices of the assets underlying anyone’s commitment failed to rise... a Federal Reserve rescue inflation vehicle would surely dash to the scene. That’s what FedVans are for.

And rescue inflation let the politicians dodge the consequences of their own thoughtlessness. The economic drag of the tax rules the politicians found convenient to enact and the effects that deficit spending has on economic growth and on living standards were obscured by the ready supply of that all-purpose balm and lubricant, new money.

But problems that are hidden don't go away; they accumulate; and they grow. Answering its most recent 911 call (the one that rang in 2008), the Fed dispatched an entire fleet of trucks stuffed with cash. It increased the money supply by 40%, yet today the economy is barely staggering forward. At this point, creating more cash might buy some time, but it can't buy a solution.

The problem, unless you think there isn’t one, seems impossible to solve. But rather than dismissing the possibility of a way out, it would be more circumspect to consider how the economy might in fact navigate between the rock and the hard place. That won't happen simply because we've found a way for it to happen. The White House hasn’t called me in a long time. But if we understand what it would take to slip past the rock and the hard place, we can judge how likely such a passage is.

The economy doesn't need anyone to fix it. It's all that fixing for the last 40 years that is the problem. Unmolested, the economy will right itself. The only thing needed is for the Great Molester, the government, to surrender to a serious regimen of behavior modification and let the economy operate without suffocating interference. Then it would be able to shed its problems – not painlessly but quickly and with a minimum of pain. Here's the protocol.

Bring out your dead. Even after catching the trillions in bailout money thrown at them, some financial institutions remain under water – closer to the surface than before but still snorkeling. Let them go. Release them from their zombie state. Bless them with the peace of zero assistance and the promise of unbeing. Paying the dead to mimic the living casts a blight on all the banks that are competently managed, and it leaves trillions of dollars of capital to be allocated by hired hands who've shown by their performance that their talents call them to some other line of work.

And give up on mouth-to-mouth for the biggest corpse of all. Stop trying to prop up housing prices by financing the banking system's huge inventory of foreclosed property and by funding programs to slow the foreclosure rate. The housing market won’t recover its health until prices reach a market-clearing level.

Stop the acknowledged deficits now. That means cutting federal spending drastically. There's already unanimous lip service for doing so, but even if there were a genuine resolve to do it, there are an infinite number of ways to go about it. A clean starting point would be to revert to the last Clinton budget, which would almost certainly require getting by on one war at a time. Stopping the deficits is essential to allowing the economy to heal itself because it slows the wasting of resources and because it eliminates the fear of higher tax rates, which is a fear that retards business investment.

Make tax rules a little less stupid. The two most mischievous features of the Internal Revenue Code are the double-taxation of corporate profits and the deduction for home mortgage interest. The former is a powerful and dangerous invitation for high debt-to-equity ratios; make dividends tax-deductible for the paying company, and the problem goes away. The deductibility of mortgage interest has operated as an amplifier for everything the government does to encourage overinvestment in housing. Yes, eliminating the mortgage deduction will be another blow to the housing market, but since we're committed to bringing out the dead, let’s think about cremating the remains.

Stabilize tax rules. High tax rates are bad enough for the economy. Not knowing what next year's tax rates are going to be is much worse. It paralyzes business decisions. Make the current rates "permanent" in the sense that it would take further legislation to change them.

Reduce the legal minimum wage to zero. Minimum wage laws are convenient for labor unions whose members are somewhat skilled, but they toss the unskilled into the economic dumpster. A minimum wage law effectively prohibits the unskilled and inexperienced from working by pricing them out of the market. It’s an unemployment guarantee program for millions of the economically weakest people in the country. I’d miss the minimum wage, because there is nothing that shouts louder that government uses the poor as human shields to protect the state. But to let the economy recover, let it go.

Destrangulate. Repeal the Sarbanes-Oxley law and its weird spawn, Dodd-Frank. Repeal Obamacare. Allow individual states to license drugs without waiting on the FDA. End all prohibitions on insider trading. Charge banks for FDIC insurance at rates tied to a balance sheet formula – and then free them to make their own lending decisions. (You might like even more deregulation than that, but we're not building utopia, we're only trying to avoid camping in dystopia.)

Euthanasia for Social Security and Medicare. Raise the eligibility age by one month every year. The unfunded net liabilities for those programs (variously estimated at $60 trillion to $80 trillion) will evaporate, and everyone who has been counting on impossible promises being kept will have plenty of time to come to terms with reality.

That would do it, and that or something similar is what it would take. The economy might need a year or so for the dust to settle. A certain number of mental breakdowns would be provoked by the trashing of heart-felt assumptions, but for the other 99.9999999% of us, the Greater Depression would be canceled.

It's not politically impossible. Everyone, politician and politician-afflicted alike, is capable of a 180-degree course change when fear and pain become great enough. It's not impossible at all. And unicorns aren’t impossible. Typically, they get started when a pony is fighting a cowlick.

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