Richard Fisher, President of the Federal Reserve Bank of Dallas, spoke today in front the Commonwealth Club of California, the country’s oldest and largest public affairs forum. A transcript of what he said in entirety can be found on the Dallas Fed’s website, here. Cliff Notes on the other side of the jump.

Fisher begins by recalling a speech made by the longest reigning Fed Chairman, William McChesney Martin (April 2, 1951 to January 31, 1970, or 19 years and 5 presidents!) at Columbia University some forty-three years ago:

The opening lines of that Columbia address were as follows: “When economic prospects are at their brightest, the dangers of complacency and recklessness are greatest. As our prosperity proceeds on its record-breaking path, it behooves every one of us to scan the horizon of our national and international economy for danger signals so as to be ready for any storm.”

Fast forward to today, and Fisher believes that we have “fallen victim to the complacency and recklessness Martin warned against.” [snip parts absolving the Fed / we're not here to debate present Fed policy tonight disclaimer]

In keeping with Bill Martin’s advice, I have been scanning the horizon for danger signals even as we continue working to recover from the recent turmoil. In the distance, I see a frightful storm brewing in the form of untethered government debt. I choose the words-”frightful storm”-deliberately to avoid hyperbole. Unless we take steps to deal with it, the long-term fiscal situation of the federal government will be unimaginably more devastating to our economic prosperity than the subprime debacle and the recent debauching of credit markets that we are now working so hard to correct.

You might wonder why a central banker would be concerned with fiscal matters. Fiscal policy is, after all, the responsibility of the Congress, not the Federal Reserve. Congress, and Congress alone, has the power to tax and spend. From this monetary policymaker’s point of view, though, deficits matter for what we do at the Fed. There are many reasons why. Economists have found that structural deficits raise long-run interest rates, complicating the Fed’s dual mandate to develop a monetary policy that promotes sustainable, noninflationary growth. The even more disturbing dark and dirty secret about deficits-especially when they careen out of control-is that they create political pressure on central bankers to adopt looser monetary policy down the road. I will return to that shortly. First, let me give you the unvarnished facts of our nation’s fiscal predicament.

Fisher explains the brief budget surplus from the late ’90s, and subsequent return to budget deficits. Anyone smart enough to question the current administration’s dodgy math will quickly find that they’ve cooked the books. Less rose-tinted figures reveal that the deficit is here to stay, but it gets even worse. [snip typical complaint about Social Security's insolvency.]

The good news is this Social Security shortfall might be manageable. While the issues regarding Social Security reform are complex, it is at least possible to imagine how Congress might find, within a $14 trillion economy, ways to wrestle with a $13 trillion unfunded liability. The bad news is that Social Security is the lesser of our entitlement worries. It is but the tip of the unfunded liability iceberg. The much bigger concern is Medicare, a program established in 1965, the same prosperous year that Bill Martin cautioned his Columbia University audience to be wary of complacency and storms on the horizon…

The infinite-horizon present discounted value of the unfunded liability for Medicare A is $34.4 trillion. The unfunded liability of Medicare B is an additional $34 trillion. The shortfall for Medicare D adds another $17.2 trillion. The total? If you wanted to cover the unfunded liability of all three programs today, you would be stuck with an $85.6 trillion bill. That is more than six times as large as the bill for Social Security. It is more than six times the annual output of the entire U.S. economy…

Add together the unfunded liabilities from Medicare and Social Security, and it comes to $99.2 trillion over the infinite horizon…

I want to remind you that I am only talking about the unfunded portions of Social Security and Medicare.

Awesome. 8-O Bile’s Gross National Debt ticker on the right hand side pales in comparison. So why is the President of the Federal Reserve Bank of Dallas talking about government sponsored entitlement programs anyway?

Now that you are all thoroughly depressed, let me come back to monetary policy and the Fed.

It is only natural to cast about for a solution-any solution-to avoid the fiscal pain we know is necessary because we succumbed to complacency and put off dealing with this looming fiscal disaster. Throughout history, many nations, when confronted by sizable debts they were unable or unwilling to repay, have seized upon an apparently painless solution to this dilemma: monetization. Just have the monetary authority run cash off the printing presses until the debt is repaid, the story goes, then promise to be responsible from that point on and hope your sins will be forgiven by God and Milton Friedman and everyone else.

We know from centuries of evidence in countless economies, from ancient Rome to today’s Zimbabwe, that running the printing press to pay off today’s bills leads to much worse problems later on. The inflation that results from the flood of money into the economy turns out to be far worse than the fiscal pain those countries hoped to avoid.

Earlier I mentioned the Fed’s dual mandate to manage growth and inflation. In the long run, growth cannot be sustained if markets are undermined by inflation. Stable prices go hand in hand with achieving sustainable economic growth. I have said many, many times that inflation is a sinister beast that, if uncaged, devours savings, erodes consumers’ purchasing power, decimates returns on capital, undermines the reliability of financial accounting, distracts the attention of corporate management, undercuts employment growth and real wages, and debases the currency.

Purging rampant inflation and a debased currency requires administering a harsh medicine. We have been there, and we know the cure that was wrought by the FOMC under Paul Volcker. Even the perception that the Fed is pursuing a cheap-money strategy to accommodate fiscal burdens, should it take root, is a paramount risk to the long-term welfare of the U.S. economy. The Federal Reserve will never let this happen. It is not an option. Ever. Period.

[snip political call to arms and placement of the blame on the voters at large.]

After reading what Richer Fisher had to say, a few questions spring to mind: Haven’t Americans already assumed the Federal Reserve to be pursuing “a cheap-money strategy” by lower rates? Is Fisher simply deflecting criticism of the Fed by tattling on Congress? He throws some strong words out there, promising harsh medicine from the Fed, but really what can they do if Congress is hell bent on destroying our currency? (These words seem toothless after his desperate plea for a political fix at the end.) Tougher question — what politician is going to willingly cut these programs?

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