The foundation of the current global financial system is the "fractional reserve system". With 10% reserve ratio, the banking system has the capability of creating a leverage of 10 times, and the shadowy banking system could increase that number even higher. During the "go-go" years of 1980-2007, the banking system and shadowy banking system have "printed" lots of money and have rendered the sense of prosperity.
Many people have focused on the QE1, QE2, QE3 conducted by the Federal Reserve, a private institution by the way, during the past few years, but the fact is that the "fractional reserve system" had allowed the banking system to print money and put huge leverage on the economic system during the "go-go" years, and the artificial injection of the emergency fund by the central bank became necessary only after the large part of the banking and shadowy banking system had been badly damaged and the process of massive deleveraging had set in.
In other word, the QEs or large budget deficits can only slow down the deleveraging process, but are not powerful enough to push the economic back to the long-run sustainable growth path.
The other interesting fact is that the massive amount of money "printed" by the banking system during the "go-go" year was somewhat "invisible" to the public. But the budget deficits have to be paid for by debt liability recorded on the national balancesheet. At this moment, the US national debt has reached $16.3 trillion, and is expected to reach at least $20 trillion by 2020. I think that $22-24 trillion might be reasonable estimate if nothing changes significantly.
But this is not the worst. During the "go-go" years, all levels of government have instituted tremendous amount of chronicle public spending, such as federal employee pension, entitlement, programs, etc, to "balance-out" the increase in tax revenue and the assumption of "perpetual" increase in tax revenues. Prior to the 2007 financial crisis, the experts have been expecting the "entitlement problem" to become a headache in 2030s. Now, many of them have moved their forecast closer to 2020. In my view, those expected future spending have to be cut at least by 30% to make the system solvent in the long-run. But will any federal employee accept a 30% pension cut willingly during the normal time???
Well, even if people agree to tighten their belt, will all the problems be resolved?? The answer is NO. The spending cut and/or tax hike will exacerbate the deleveraging process -- low or negative GDP growth, lower asset prices, etc. which in turn will lead to loss of tax revenue. ......
I really do not see any incremental way out of this economic "black-hole". A large RESET is needed
Is the dump coming??
There is really no easy way out of this MESS: small deficit cut will lead to smaller negative impact on the short-term economic growth but will also lead to higher interest rates for the short-term and long-term; bigger deficit cut will lead to bigger negative impact on the economic growth which could deteriorate the outlook of the long-term fiscal sustainability as lower growth would likely exacerbate the debt problem.
So there is not easy solution.