Free Markets, Free People

borrowing

Can you solve the debt crisis by creating more debt?

Most intuitively know you can’t borrow your way out of debt, so it seems like a silly question on its face.  But the theory is that government spending creates a simulative effect that gets the economy going and pays back the deficit spending in increased tax revenues.  $14 trillion of debt argues strongly that the second part of that equation has never worked.

The current administration and any number of economists still believe that’s the answer to the debt crisis now and argue that deficit spending will indeed get us out of the economic doldrums we’re in.  William Gross at PIMCO tells you why that’s not going to work:

Structural growth problems in developed economies cannot be solved by a magic penny or a magic trillion dollar bill, for that matter. If (1) globalization is precluding the hiring of domestic labor due to cheaper alternatives in developing countries, then rock-bottom yields can do little to change the minds of corporate decision makers. If (2) technological innovation is destroying retail book and record stores, as well as theaters and retail shopping centers nationwide due to online retailers, then what do low cap rates matter to Macy’s or Walmart in terms of future store expansion? If (3) U.S. and Euroland boomers are beginning to retire or at least plan more seriously for retirement, why will lower interest rates cause them to spend more? As a matter of fact, savers will have to save more just to replicate their expected retirement income from bank CDs or Treasuries that used to yield 5% and now offer something close to nothing.

My original question – “Can you solve a debt crisis by creating more debt?” – must continue to be answered in the negative, because that debt – low yielding as it is – is not creating growth. Instead, we are seeing: minimal job creation, historically low investment, consumption turning into savings and GDP growth at less than New Normal levels.

Not good news, but certainly the reality of the situation.  Deficit spending has been the panacea that has been attempted by government whenever there has been an economic downturn.  Some will argue it has been effective in the past and some will argue otherwise.   But if you read through the 3 points Gross makes, even if you are a believer in deficit spending in times of economic downturn, you have to realize that there are other reasons – important reasons – that argue such intervention will be both expensive and basically useless.

We are in the middle of a global economy resetting itself.  Technology is one of the major drivers and its expansion is tearing apart traditional institutions in the favor of new ones that unfortunately don’t depend as heavily on workers.

Much of the public assumes we’ll return to the Old Normal.  But one has to wonder, as Gross points out, whether we’re not going to stay at the New Normal for quite some time as economies adjust.   And while it will be a short term negative, the Boomer retirements will actually end up being a good thing in the upcoming decades as there will be fewer workers competing for fewer jobs.

But what should be clear to all, without serious adjustments and changes, the welfare state, as we know it today, is over.  Economies can’t support it anymore.   That’s what you see going on in Europe today – its death throes.   And it isn’t a pretty picture.

So?  So increased government spending isn’t the answer.  And the answer to Gross’s question, as he says, is “no”. 

The next question is how do we get that across to the administration (and party) which seems to remain convinced that spending like a drunken sailor on shore leave in Hong Kong is the key to turning the economy around and to electoral salvation?

~McQ

Twitter: @McQandO

Talking the deficit talk, but – as usual – not walking the walk

Democrats and President Obama have been talking the talk about deficit reduction – yesirree. Why to hear them talk about what has to be done, you’d think they were the second coming of the Republican caucus.

But when it comes to walking the walk? Not so much:

A new White House forecast predicts that the federal budget deficit, which hit a record $1.4 trillion last year, will exceed that figure this year and again in 2011.

The $1.47 trillion budget gap predicted for 2010 — when 41 cents of every dollar spent by the federal government would be borrowed — represents a slight improvement over the administration’s February forecast. The estimated gap for next year, $1.42 trillion, is larger than what was predicted in February, primarily because of a drop in expected tax receipts from capital gains.

So here the government is in one of the biggest fiscal holes it has ever dug for itself, and the answer the Democrats come up with is “let’s dig it deeper and call it ‘fighting the deficit’”.

How else do you explain budgets like the one offered by the Obama administration and especially in light of Tim Geithner’s pronouncement yesterday (see below) that it was time for the private sector to start investing?   Forty one cents of every dollar spent under this budget from President Obama will be borrowed.

Of course, Obama has told us that the goal is to balance the federal budget by 2015.  That’s what he’s said – and for what its worth, that’s certainly a worthy goal.  But you have to do more than try to talk it down.   The action taken have to reflect that goal.  And this budget doesn’t.   Nor, really, do his future ones.

The Committee for a Responsible Federal Budget reviewed this year’s presidential budget proposal and the deficit reduction plan and this may come as a surprise to you, but it is all smoke and mirrors.

The budget proposes $3.8 trillion in spending and receipts of $2.6 trillion, resulting in a deficit of $1.3 trillion – or 8.3 percent of GDP. This is higher than the 7.4 percent deficit projected from the Administration’s proposals in its August Mid-Session Review (MSR) and significantly higher than the 6.0 percent deficit projected under their “current law” (BEA) baseline. It is a decrease from the 9.9 percent deficit in FY 2009, and the projected 10.6 percent deficit in FY 2010.

Over the ten year window from 2011 through 2020, deficits are estimated to total $8.5 trillion – or 4.5 percent of GDP. This is significantly higher the $5.5 trillion (2.8 percent of GDP) deficit projected under “current law” which assumes expiring policies would end as planned.

Or under the “current law”, deficit stays at 6% of GDP (still too much) but under the “deficit reduction/balanced budget” plan of the administration, it balloons up to 8.3% GDP (way freakin’ too much).

So we’re being sold a load of unicorns with this totally misleading nonsense being spouted by Obama and Democrats.  Their budgets do only one thing for deficits (and the debt) – they add to them.   And, if followed, by 2020, here is what the debt will be:

Under OMB’s new estimate of the President’s budget, the debt held by the public would grow continuously as a share of the economy, passing 60 percent this year, 70 percent in 2012, and 77 percent in 2020.

Now someone, anyone – tell me how this plan of theirs reduces the important number in all of this – the debt?  Obviously it doesn’t.  They’re talking about spending less borrowed money than they have previously, that’s all.  And when you are spending trillions in deficits, dropping it down to 900 billion in deficit spending is “deficit reduction”.

Don’t let them sell you the bill of goods they’ve prepared here. 

Cut spending, cut it now and do what is necessary to reduce the debt.

~McQ

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US credit rating in jeopardy if Obama budgets pass

I’m not sure how much more of a blatant warning than this can be sounded over the financial path the Obama administration plans on taking us:

Moody’s Investor Service, the credit rating agency, will fire a warning shot at the US on Monday, saying that unless the country gets public finances into better shape than the Obama administration projects there would be “downward pressure” on its triple A credit rating.

Examining the administration’s outlook for the federal budget deficit, the agency said: “If such a trajectory were to materialise, there would at some point be downward pressure on the triple A rating of the federal government.”

That’s a very civilized way of saying “cut spending and cut borrowing or we’ll cut your credit rating so you can’t borrow and can’t spend”. The budget deficits projected by the Obama administration would eventually see 15% of the government’s future revenue committed to debt service – about the same as in 1983. However:

This time the servicing burden would be harder to reverse, however, because it would not be caused by high interest rates but by high debt levels.

Moody’s says it doubts the political will to raise taxes significantly from their present 14.8% of national income level or to cut spending from 25.4% of national income. That, of course, means an ever increasing gap between revenue and spending and jeopardizes the nation’s credit rating.

Moody’s isn’t the first rating firm to issue this type warning:

The report follows concerns recently expressed about the US public finances from the other large rating agencies. Standard & Poor’s warned last week the triple A status of the US was at risk unless the country adopted a credible medium-term plan to rein in fiscal spending. Fitch Ratings issued a critical report on the US in January.

Fitch said: “In the absence of measures to reduce the budget deficit over the next three to five years, government indebtedness will start to approach levels by the latter half of the decade that will bring pressure to bear on the triple A status.”

Or, we’re headed toward a financial cliff and right now our leadership is hitting the accelerator. If you think we have financial problems now, watch what happens of we suffer through the downgrading of our national credit rating.

~McQ

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Quote Of The Day – Debt Edition

Has anyone ever considered the fact that so much debt and borrowing is a national security problem?

“From 1789 through 2008, the U.S. government borrowed a total of $5.8 trillion. In 2009, the federal budget deficit exceeded $1.4 trillion. The administration now expects the 2010 deficit to break that record, topping $1.6 trillion. And in 2011, it would only fall to about $1.3 trillion. Thus, in just three years, the debt will have jumped an astonishing $4.2 trillion.” – James Capretta, a Fellow at the Ethics and Public Policy Center

Those to whom we own money – especially as much as we do – hold some pretty powerful leverage. The Chinese military has been stomping around all week urging their government to use it. They want China to sell some US bonds to deliver a little “economic punch” to get our attention, apparently.

“Bush made me do it” won’t work when piling up this much debt.  The GOP’s ready-made economic and national security issue is found within the quote.  That assumes they don’t just placidly go along with the mammoth increase in the debt.  And that’s never a safe assumption.

~McQ

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Understatement of the Week

China expresses some … um … “concern” about whether or not it will ever see its money back:

The Chinese prime minister, Wen Jiabao, expressed unusually blunt concern on Friday about the safety of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to provide assurances that the securities would maintain their value in the face of a global financial crisis.

"How much chance China get repaid?"

How much chance China get repaid?\


Speaking ahead of a meeting of finance ministers and bankers this weekend in London to lay the groundwork for next month’s G20 summit, Mr. Wen said he was “worried” about China’s holdings of United States Treasury bonds and other debt, and that China was watching economic developments in the United States closely.

“President Obama and his new government have adopted a series of measures to deal with the financial crisis. We have expectations as to the effects of these measures,” Mr. Wen said. “We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.”

Just a little? There’s an old saying to the effect of “if you owe the bank $1 Million, then the bank owns you; if you owe the bank $1 Trillion, then you own the bank.” China’s feeling pretty nervous because it knows it can’t sell its holdings except at a tremendous loss — both from the normal discount expected, and from the fact that it is by far the largest mover in the market (e.g. what do you think would happen to Microsoft stock if Bill Gates started selling off?) — and it doesn’t see a whole lot coming out of Washington to instill confidence.

But there’s no need to fret PM Jiabao! Unnamed economists are here to save the day:

While economists dismissed the possibility of the United States defaulting on its obligations, they said China could face steep losses in the event of a sharp rise in United States interest rates or a plunge in the value of the dollar.

Whew! That was close. Nothing but a little market risk to worry about there, Jiabao. Default? Pffft … never gonna happen.

Back in the land called “reality” however, default is plays a bigger part since, aside from reneging on the debt, there are only three other ways for the government to pay for its spending binge: higher taxes, printing more money, or borrowing. Higher taxes impedes growth and leads to less revenue. Printing money leads to hyper-inflation. So, even though those two choices will be used to a certain extent, further borrowing is the only viable alternative to default. But who’s going to lend to us?

Maybe China?

The bulk of China’s investment in the United States consists of bonds issued by the Treasury and government-sponsored enterprises and purchased by the State Administration of Foreign Exchange, which is part of the People’s Bank of China … much of the Treasury debt China purchased in recent years carries a low interest rate, and would plunge in value if interest rates were to rise sharply in the United States. Some financial experts have warned that measures taken to combat the financial crisis — running large budget deficits and expanding the money supply — may eventually create price inflation, which would lead to higher interest rates.

This puts the Chinese government in a difficult position. The smaller the United States stimulus, the less its borrowing, which could help prevent interest rates from rising. But less government spending in the United States could also mean a slower recovery for the American economy and reduced American demand for Chinese goods.

It may just be the case that China’s best option is to support its investment by propping up its best customer with yet more loans. Unfortunately, that means that Washington will have little incentive to slow down spending (since it owns the bank). The nasty little cycle of borrowing > spending > inflation > rising interest rates > falling dollar, will continue necessitating even more borrowing. China, in turn, will have serious questions about the value of its investment, and the US will start having serious discussions about declaring a default.

In short, China’s not just “worried” about the current fiscal mess. It’s crapping its collectivist shorts.