Daily Archives: July 15, 2011
I have to admit, I sometimes get tired of being the voice of doom. Sadly, our political class–Republicans and Democrats alike–seems determined to follow the worst policy options available. So, doom slouches closer. The proximate doom they’re fiddling with this time is the approaching debt limit. Now, I yield to no man in my hatred for ever-increasing government spending, but this debt-limit battle is pointless. We will increase the debt limit. We have no choice.
Here’s the current situation:
OMB estimates federal revenues for 2011 will hit $2.17 trillion. Granny, our servicemen, and other such untouchables — by which I take him to mean Social Security, Medicare, national defense, and debt-service payments — will add up to $2.21 trillion, meaning that even if we cut the rest of the federal budget to $0.00 — no Medicaid, no food stamps, no Air Force One — revenues still would not cover these untouchables, according to OMB estimates…
Our deficit is about 40 percent of spending this year; continued recovery, if the estimates hold, will do some of the work for the 2013 regime, but even under current forecasts that are arguably too rosy, we’ll still be running a 26 percent deficit in 2013.
Even if we eliminate every penny of spending this year except for Social Security, Medicare, and Defense, we still can’t cover this year’s spending. And next year’s spending projects an economic recovery will save us, and reduce the deficit to 26% of spending. Absent such a recovery, next year we’ll be back to another 40% deficit.
And the politicians of both parties are nowhere near to making the appropriate cuts in the budget in years farther out than that. The biggest deficit reduction package currently on the table is for $4 trillion over the next 10 years. Which sounds impressive, until you remember that the actual projected budget deficit over the next 10 years is $13 trillion. So, we’re still $9 trillion short of closing the budget deficit for the next 10 years.
But, wait! It gets better! This $13 trillion figure assumes that interest rates will remain stable where the currently are. If interest rates for treasuries go up by 1%, that wil add 1.3 trillion to the deficit over the same period. As the moment, the Office of Management and the Budget (OMB) projections are for a stable average interest rate of 2.5%. Of course, the current 20-year average is closer to 5.5%, so a return even to normal interest rates will add up to $3.9 trillion to the deficit.
But the magic doesn’t stop yet! OMB forecasts growth rates of between 4%-4.5% from 2014 to 2014. The average trend rate of growth is between 2.5%-3% however. So, if we don’t get the strong growth the OMB is predicting over the next three years, and the following years, we’ll need to add another $3 trillion or so to the deficit over the next decade. And, frankly, if you believe Goldman Sachs today, a return to trend rates of growth seems..unlikely, as they’ve lowered 2Q GDP growth to 1.5% from 2.5% and 3Q to 2.5% from 3.25%. They also forecast unemployment at end of 2012 to be 8.75%.
So, the best case scenario is that we’ll add $9 trillion to the deficit over the next decade. A return to historical growth and interest rates–even if we assume the $4 trillion of budget cuts will actually happen–means a 10-year deficit of $16 trillion. Essentially, we will more than double the National Debt, pushing the debt to GDP ratio to about 160% by 2021.
And that’s the good news.
The bad news is that, in the current debate over the debt ceiling, everyone involved seems determined to play chicken with a default–even if only a selective default–of US treasury obligations.
Tim Pawlenty even suggested that a technical default might be exactly what Washington needs to send a wake-up call to the politicians about how serious the situation is. Others, like Michelle Bachmann, and a not inconsequential number of Tea Party caucus members are steadfastly against raising the debt ceiling for any reason at all.
This is insanity.
Any sort of default, even a selective default that would suspend interest payments only to securities held by the government, while paying all private bondholders in full, will have completely unpredictable results. The least predictable result, however, would be business as usual. A technical default–i.e., delaying interest payments for a few days–or selective default, or any other kind of default is…well…a default. It is a failure to make interest payments.
The most obvious possible result of any sort of default will be to eliminate the US Treasury’s AAA rating, and push interest rates up sharply. If we’re lucky, we’d be talking about a yield of 9%-10%…and an additional $5 trillion added to the deficit (running total in 2021: $21 trillion added to the national debt).
And, again, that’s a best case scenario. Because it assumes that everyone will be willing to hold their T-Notes through all of this. If any major overseas institution or government–say, China–decides to unload their holdings, it could be the start of a flight from treasuries that will destroy the US Dollar in the FOREX, vastly increase the price of imported goods, like, say, oil, and spark uncontrollable hyperinflation in the US. The life savings of every person and institution would be wiped out.
Naturally, yields on interest-bearing instruments would then pull back on the stick and climb for the skies. Not that it’d matter much at that point, since the currency would merely be ornately engraved pieces of durable paper. Suitable for burning in the Franklin Stoves with which we will be heating our homes, in the absence of oil.
Flirting with default is extraordinarily reckless. I don’t even have the words to begin to describe how badly any sort of default might go.
The thing is, we don’t know–we can’t know–what the results of a technical or selective default might be. It might be the judgement of worldwide investors that there are no better alternatives to US-denominated securities, so they’ll just have to ride out a technical default, and accept their interest payments coming a few days late. It might be their judgement that unloading their US-denominated securities and losing a little money is better than the risk of losing everything through a currency collapse. It might be a lot of things, and we have no way of knowing which of those things might come to pass.
As Tim Pawlenty says, a default might be a wake up call. From an exploding phone filled with napalm and plutonium.
Whatever political points might be at stake, is it worth this level of risk?
The safe path here is a simple $500 billion debt limit increase. That’ll give us 6 months to figure things out, and try to discover some way to get our fiscal picture under control, and avoid a default. Government spending is out of control, but a default is really not the best way to impose fiscal discipline.
With these debt ceiling negotiations underway, it is useful to remind ourselves, especially with an election year looming, how we got in this spot that has Moody’s threatening to downgrade our bonds based on the possibility of default on the debt.
On spending, it is important to recall how extraordinary the blowout of the last three years has been. We’ve seen nothing like it since World War II. Nothing close. The nearby chart tracks federal outlays as a share of GDP since 1960. The early peaks coincide with the rise of the Great Society, the recession of 1974-75, and then a high of 23.5% with the recession of 1982 and the Reagan defense buildup.
From there, spending declines, most rapidly during the 1990s as defense outlays fell to 3% of GDP in 2000 from its Reagan peak of 6.2% in 1986. The early George W. Bush years saw spending bounce up to a plateau of roughly 20% of GDP, but no more than 20.7% as recently as 2008.
Then came the Obama blowout, in league with Nancy Pelosi’s Congress. With the recession as a rationale, Democrats consciously blew up the national balance sheet, lifting federal outlays to 25% in 2009, the highest level since 1945. (Even in 1946, with millions still in the military, spending was only 24.8% of GDP. In 1947 it fell to 14.8%.) Though the recession ended in June 2009, spending in 2010 stayed high at nearly 24%, and this year it is heading back toward 25%.
This is the main reason that federal debt held by the public as a share of GDP has climbed from 40.3% in 2008, to 53.5% in 2009, 62.2% in 2010 and an estimated 72% this year, and is expected to keep rising in the future. These are heights not seen since the Korean War, and many analysts think U.S. debt will soon hit 90% or 100% of GDP.
Here’s the WSJ chart talked about above:
In terms of percentage of the GDP, only WWII compares to the outlays we’ve seen in the past 3 years. And not only did the Democratic Congress and Obama “consciously blow up” the debt, they never offered a budget as required by law. This was just money thrown to the wind with the hope it would land somewhere where it might help. To call what they did a “plan” is to give real plans a bad name.
Now, suddenly, Obama is “serious” about this stuff, making demands that a fix be found, etc. Where the heck was he when this money was going out faster than little Timmy Geithner could print it? So let’s be clear, as Obama likes to say:
Congress is responsible for the way so much of this spending was wasted, resulting in little job creation and the slowest economic recovery since the 1930s. But in the U.S. political system, Presidents are supposed to be the fiscal adults. When they abdicate, the teenagers invite over their special interest friends and blow the inheritance.
The President is now claiming to have found fiscal virtue, but notice how hard he has fought House Republicans as they’ve sought to abate the spending boom. First he used the threat of a government shutdown to whittle the fiscal 2011 spending cuts down to very little. Then he invited Paul Ryan to sit in the front row for a speech while he called his House budget un-American.
How does one take this President seriously given this litany?
Easy answer – you don’t. I mean, look at this:
Now Mr. Obama is using the debt-ceiling debate as a battering ram not to control spending but to command a tax increase. We’re told the White House list of immediate budget savings, the ones that matter most because they are enforceable by the current Congress, are negligible. His offer for immediate domestic nondefense discretionary cuts: $2 billion.
As for Mr. Obama’s proposed entitlement cuts, they are all nibbling around the edges of programs that are growing far faster than inflation. He’s offering few reforms that would make a difference in the long run. Oh, and ObamaCare is untouchable, despite its $1 trillion in new spending over the next several years, growing even faster after that.
And this goes to the point of my previous post. When you look at how we got here and who is responsible (yeah, he didn’t inherit this – this is all his) it is hard to find any grounds for confidence that the same people have any idea or desire to change their ways. And yet they’re going to try to convince the American people that Obama should keep his job and Nancy Pelosi should be returned to the House speakership (with a sweeping victory putting a Democratic majority back in the House).
It’s enough to make a grown man cry.
Rick Perry (Governor of Texas) and Nikki Haley (Governor of South Carolina) have a piece in the Washington Post in which they offer a solution to that problem we’re now experiencing:
We oppose an increase in the federal debt limit unless three common-sense conditions are met: substantial cuts in spending; enforceable spending caps to put the country on a path to a balanced budget; and congressional passage of a balanced-budget amendment to the U.S. Constitution. That amendment should include a requirement for a congressional supermajority to approve any increases in taxes.
We can quibble about the particulars but in general I’m in agreement. That said, I have little hope that a balanced budget amendment will ever pass or that a congressional supermajority will become a requirement for tax increases. But the basic premise – cuts in spending, enforceable spending caps and difficulty in passing new taxes would indeed help begin to bring the national government under some semblance of control.
Here’s the crux of the problem with the Federal government:
Washington’s ability to continuously vote itself more fiscal breathing room may help Congress — at least in the short term — avoid making the kinds of tough decisions made by states, businesses and families. But ignoring economic realities will lead to even more painful choices down the road and increases the potential for a financial collapse that could permanently cost America its role as the world’s leading economic power.
Unfortunately, the system in Washington makes it easier for elected officials to bury their heads in the sand, avoid responsibility and make the easiest choice of all: borrow more, plunge our nation deeper into debt and allow this generation to punt the tough decisions to our children and grandchildren.
Such moves may be good politics, since they mean officials don’t have to say no to anyone, but as a matter of policy they are indefensible.
That “reality” and the trump of politics over statesmanship are the reason we’re in this deep hole and most of us don’t expect to see anything serious about correcting it come out of Washington. After all, those that have to alter the reality inside the beltway are the same ones who have put us in this position in the first place (and I mean as a group going back decades). The proverbial fox guarding the hen house situation. That’s why it is difficult not to be cynical and skeptical about “solutions” – even this political show we see going on over the debt ceiling.
Perry and Haley are touting a pledge they’ve signed called the “Cap, Cut and Balance” pledge:
The only way to get the federal government to end this indefensible practice is to draw a line and finally hold Washington accountable. The pledge we’ve signed represents an important step in this process.
It calls for the kinds of budget cuts Washington needs now and for a hard cap on all future spending. And it finally moves us to a mandatory balanced budget that will end the era of national debt, raging deficits and failed “stimulus” programs that have negatively affected so many aspects of American life.
Americans must continue to stand up for the principles that served as the foundation for our nation’s unparalleled successes. The principles of a limited federal government and responsible fiscal leadership have sustained us during tough times, and they can lead us out of this period of sluggish economic growth.
Yeah, pledges are nice and sure it makes us feel better and focuses us on the problem. However, we’ve heard political pledges from politicians for years which have essentially promised to fix the problem in Washington. And here we are.
That’s not to say that Perry and Haley aren’t right. They are. It’s to say we’ve heard all this before, we’ve seen pledges come and go, and we’ve seen solutions offered that were perfectly reasonable that have never seen the light of legislative day.
We seem to have a class of politicians who seem to find it difficult to deal in the reality the rest of the country deals with every day – spending within our means, meeting budgets, and being responsible. I’d like to say I knew how to fix that, but after half a century of watching these nincompoops at work and how they’re seemingly rewarded for doing exactly what we’re now lamenting, I’m not sure the system can be fixed.
My cynical take on the day.