PDA

View Full Version : The Cancer of Debt and Deficits



Dutch
03-13-2012, 07:33 AM
by John Maudlin


...........

We are coming to the point in the United States when even the US government will no longer be able to borrow at very low long-term rates. That point is a few years off, and we have time to change paths; but as I have shown in previous letters, the longer we wait to get the deficit under control, the fewer choices we have and the more painful they are. NO country can run deficits the size we are currently running, along with unfunded deficits over four times the size of the economy and a growing overall debt burden, without consequences. At some point, investors in bonds will start wondering exactly what the process is by which they will be repaid. And what will the value of those future payments be? One by one, the countries of Europe are losing their ability to sell their bonds at an interest rate that is sustainable for their economies and revenue bases without severe and socially disruptive restructuring, even if a central bank that will accommodate their spending by printing money or other countries will tax their citizens to pay for someone else's debts.
The US will soon be faced with that same problem if we do not act soon. Will it be 2014? 2015? 2016? I think it will be earlier rather than later, as the bond market will look at Europe and what will soon be an imploding Japan and decide that the US is only different in size and scale. The interest on the debt is a growing part of the overall budget, and any rise will put severe constraints on spending or force large tax increases or require the Federal Reserve to monetize the debt. None of those have positive outcomes. Ignored long enough, it will bring about another Depression.
This week we will explore some options to actually resolve the deficit and debt crisis. Cutting spending or raising taxes have consequences, but not all cuts and not all taxes are the same. For those who have been wanting more specific solutions from me, I am going to address the issues surrounding taxation and offer my thoughts as to what we should do. Let's see how many friends and readers I can upset this week. And I close with a few brief thoughts on writing, the coming employment crisis (will two billion jobs really disappear?), and advice for younger readers.
Before we dive in, I want to respond to a lot of letters and blogs about last week's letter, which also handily works as a preface to this week's musings. There were a lot of comments pro and con about my thoughts on various historical events. In quick review, I offered numerous thought experiments about what would have been different economically following a presidential election if their opponent had won. It was mostly an alternative-history type of speculative process. There are whole book series written with such a premise. What would have happened if the South had won the Civil War or Germany World War II? Total speculation as to the details, open to much disagreement.
And disagreement there was over certain interpretations of history. Would Al Gore (or pick your alternative president) have done certain things differently? Possibly, and maybe even probably. Such speculations are totally open for debate. But nearly all disagreements missed my main point, which was (and is) that presidents take the credit for good economic times and get blamed for bad times, when the reality is that they don't have all that much control over the economy, especially in their first four years in office. They take the oath of office and their first budget isn't even offered until 13 months later and then maybe adopted later in their second year, with lots of changes. With lots of compromises. Hardly time to radically affect the economy by year four of their term. Some changes? Yes, of course. But the main direction is already set, and they are really affecting the future more than their present time.

Dutch
03-13-2012, 07:34 AM
I argued that you really have to go back to Reagan to get serious change of direction, and even then you can argue that it was Carter that appointed Volcker (though I doubt he thought Volcker would create a major recession in an election year). Does anyone really think Reagan wanted a second double-dip recession in his second year in office? The legacy of Reagan was just beginning in 1984, and I will argue below that it was the restructuring of taxes in 1986 that provided the largest and most lasting contribution in terms of economics. The Answer We Don't Want to KnowFurther, I believe that dealing with the deficit crisis is the single most important factor for the future of the Republic. I closed last week with these paragraphs:
"This (upcoming) election is ultimately about dealing (or not dealing) with the deficit, and putting the country on a path to a sustainable budget deficit, one that is less than the growth rate of the country. As I have argued elsewhere, and will argue in future letters, that is the paramount issue. Not dealing with the deficit runs the very real risk of the bond market treating us just as it is treating Italy and any other country that gets to the point where its debt is unsustainable. Not this year or the next for the US, but almost certainly before 2016. And once the bond market loses faith in a country, it takes a massive restructuring to restore that confidence. And we can see how that is playing out in Europe.
"The next president must have the ability to get a consensus. Let me shock a few of my fellow Republicans and say that I think the deficit is such a deadly disease that it would be better for the country for the Democrats to be in power and forced to deal with the situation than to do nothing. I would not like their solution, and I think it would be harmful, but not as harmful as a second Depression, brought on by not dealing with the deficits and entitlement problems.
"As a businessman, I would rather pay higher taxes on profits than to have no profits at all. Just tell me the rules and I will figure out how to adjust. A Depression 2 would mean 20% unemployment (at least) and a real lost decade, with the Boomer generation trying to figure out how to deal with no money and no jobs and being old.
"And the choices we would be forced to make? The spending cuts would be far deeper than anyone can now imagine, and the taxes needed far greater. Think what happens when any country has hit that debt limit. Greece is not having fun. And either Italy is going to be unhappy with the longer-term recession it will have, or Germany is going to be unhappy with the ECB backing Italian debt at below-market rates for a long time, which means printing money and a much lower euro. Actually, I think both must happen if the euro is to remain a viable currency. That's just what happens when you don't deal with deficits before they become a problem. If Italy is to remain in the euro, there must be a back-door bailout by the ECB, accompanied by Italian austerity (is that an oxymoron?). And don't forget Spain.
"What would the Fed do in such an event? Does it succumb to the worst fears of the Austrian economic crowd and monetize the debt in an effort to fight deflation and depression? Does it trash the dollar and make gold bugs happy? Or does it find its inner Bundesbank (Austrian) core and eschew the easier way out, forcing the federal government to cut spending and raise taxes while interest rates are rising?
"This is a question to which we do not want the answer. Whether it's yes or no, the answer is a disaster. Just choose the form of disaster you prefer. To the unemployed, retirees, and the young, it will make little difference. Ask our grandparents (or my father and mother), who lived through the Depression.
"And doing nothing will mean that we find the answer to that question. The very answer we want to never know in real life. It makes for interesting speculation now, but living through it will be hell."

Dutch
03-13-2012, 07:34 AM
The Cancer of Debt and DeficitsThe growing debt and the deficit is a deadly cancer on the economy. It will deliver a mortal blow to the economy if not dealt with. As I recently experienced in my family, it is better to deal with a cancer as soon as possible. Putting off treatment will not make the cancer go away by itself, and the cancer of our debt is clearly growing and malignant. It will soon overwhelm our national economic body. But dealing with a cancer is not without cost and pain, whether on a real personal level or a metaphorical national level.
The problem is solvable. It is not that there are not a lot of solutions. It is that we have not yet found the political will to decide what course of treatment is needed. Let's start with a few basic presuppositions that I think must be addressed in order to marshall an effective set of choices.

It has to be politically feasible. The Right would like to address the problem with spending cuts and reforms. Reforms and spending cuts are necessary but not sufficient to deal with the problems. For instance, disability payments are now running $200 billion a year and growing rapidly. Some 25% of those unemployed since the beginning of this crisis have somehow qualified for disability payments. We can cut the time allowed for unemployment benefits, but that does not offer large numbers. Government transfers now account for 22% of household income. Cutting that will be politically difficult.

The real problem is health care. How much do we want and how do we want to pay for it? Health care must be thoroughly reformed, but the will (the votes) to go back to the 1990s is just not there. Rising costs can be controlled but not eliminated. The same goes for Social Security. We can raise the retirement age, do means testing, and make other changes; but the fact is that there are more Baby Boomers retiring each year. There is no Social Security Trust Fund. The money was spent on other projects, and now Social Security runs in the red each year. What Republican is running on a platform of taking away Social Security from those who are presently receiving it or will be eligible for Social Security within 10 years? Want to cut defense? Military pensions? Government pensions.

And the Left wants to solve the problem by raising taxes on "the rich." We are down well over $1 trillion a year in our deficit. Obama's new plan raise taxes a lot and still has $1.3 trillion in deficits, with very rosy assumptions.

"According to the New York Times, the president's plan to abolish the Bush tax cuts for those making more than $250,000 is expected to bring in merely $0.7 trillion over the next decade, or about 0.4 percent of Gross Domestic Product per year [about $60 billion in the coming years, under optimistic projections that assume higher growth and no recessions]. As a comparison, the Congressional Budget Office estimates that the deficit over the same period is going to be $13 trillion, more than 6 percent of GDP per year.

"The rich in America obviously have lots of money, but there are simply not enough of them to fund the presidentīs preferred level of spending." (American.com)

The hard reality is that the rich just don't make enough to cover our current deficit. If we raised taxes to something like 60% on the top 10% of income earners, not just the 1%, we might get enough tax revenue, if the "rich" cooperated by making the same income they do now. That type of tax rate is just not politically feasible under any conceivable elected Congress.

It will require both spending cuts AND different and higher forms of revenue to get a deficit reduction plan through Congress, even a majority Right or Left Congress. If Obama could not get higher taxes (except for health care in the future) in his first two years, with a decidedly Democratic Congress, it is very unlikely to happen in time to deal with the deficit crisis. Something must be done SOON. We don't have another five election cycles to debate this.

We have unfunded liabilities that simply cannot be paid under any tax scheme. Those promises will not be kept, because we will not have the money in future years, and it gets worse with each passing year.

Tax rates matter to the growth of the economy. Even a low estimate of the results of raising taxes by 10% reduces GDP by about 0.4% of the increase in taxes. There are studies by very credible economists of both political parties, which I have written about in detail, that show that tax cuts and increases have a multiplier of as much as 3, as to their effects (Romer, as an example). An average estimate would give you something like a multiplier of 2. I have read no studies based on actual statistics and not some untested theory that suggests that taxes have a neutral effect. To suggest taxes have no effect on the economy makes for good sound bites and is nice in theory, but the studies of actual statistics simply do not support that idea. Increasing the taxes on the rich may be "fair," but it is not GDP-neutral.

Kennedy, Reagan, and Bush cut taxes, and the economy grew and more taxes were collected in total within a few years. But we are no longer able to cut marginal income tax rates and borrow to pay the deficit, waiting for growth to happen to make the cuts "pay for themselves." We have simply borrowed too much. We are close to the limit. We must find other options.

Some taxes appear to have less effect on economic growth, although I cannot argue that we have enough data points or serious academic studies to prove it. Reagan cut marginal income tax rates in 1986, but paid for it by getting rid of numerous tax deductions; so the overall affect was revenue-neutral, but the economy sure did grow after that. People (at least US citizens) clearly adjust their spending, investments, and incomes in response to marginal income tax rates. I am not arguing "fair share" or the morality of income distribution, simply observing a fact.

The principle is if you want more of something, then lower the taxes on whatever it is, and vice versa. If you want to increase overall national income (again not talking about the fairness or how it is distributed), then tax it less.

This idea is not radical. Rather, it is well accepted by nearly all political types. Congress (both parties) has passed over 3,000 laws giving tax breaks to encourage certain types of economic behavior they deem to be good. Mortgage interest-rate deductions, charitable deductions, tax breaks for married couples and children, and so on down to very minor and industry-specific breaks. They all assume that taxes affect behavior.

Some level of government spending is necessary, although what is necessary by one person's lights may be seen as a waste by another. But governments should provide for the common need what a free market would not do. Defense as an example. Is health care a common right? A majority of voters certainly think so. Education? Roads? Regulations on certain industries? Again, a serious majority of voters think so. One might argue for something less, and certainly Ron Paul does so rather well, with a growing following over the years I have known him; but such a vision is not politically feasible in the next four years.

Dutch
03-13-2012, 07:35 AM
Income Measures What You Contribute to Society
There are some ideas that are fundamental to the growth of the economy, capitalism, and free markets as we know them today. Thomas Hobbes argued that income measures what you contribute to society and spending measures what take from it. Adam Smith argued that it is the wealth of nations and not the wealth of governments (or kings) that matters. His idea was that it was more important to grow the economy than the government.

Without economic growth the average person will be left worse off. If our population grows 1% a year, then if GDP does not grow by 1%, there is less for each person to share. And private-sector growth is what is needed for general prosperity. Notice in the chart below (courtesy of Rob Arnott and Research Affiliates) that private (non-government) GDP has not grown for well over 10 years. This is about the same time period in which wages and private incomes have been flat. There has to be growth in the private economy (in total) for those employed in the private economy to make more money (in total).

more
http://www.johnmauldin.com/frontlinethoughts/the-cancer-of-debt-and-deficits/

John Smith
03-13-2012, 08:38 AM
A lot of words. They don't mean much from one who wants to go back to Reagan, who tripled our debt/deficit.

I'm among those who complained when Regan did this. I'm among those who commplained when both Bushes did this.

I was told, "Deficits don't matter." Suddenly they matter when Obama is president. All this shows is the conservatives are hypocrites.

Bill Clinton handed a balanced budget to G.W. Bush. Bush destroyed it. Now you and others blame Obama.

Give me a break.

Waddie
03-13-2012, 08:49 AM
Dutch, I've read most of Mauldin's columns and End Game. Much of what he says I agree with, but I think he under-estimates the power of the American economy. And I say this as a fiscal conservative. The US is not nearly at it's credit limit. If Japan can borrow to over 200% of GDP, and still at reasonable rates, so can the US. We have advantages that most other countries do not. We are still the world's reserve currency. Which means we can print our way out of a lot of trouble. Up to a point, granted. We are also the largest market in the world, the third largest exporter, and most of the rest of the world's economies are tied to us. Contrary to popular opinion, we have a strong manufacturing sector and the world's best agricultural system, due in large part to our excellent Mississippi river basin and tributary rivers which makes distribution worldwide possible at relatively cheap transport costs. We also benefit from a strong central banking system and an entire continent with standardized laws, measures and transport system. Our demographics, due in large part to immigration, look much better than most developed countries. So don't underestimate the American economic machine.

At the same time, we face some serious challenges. We can no longer be the world's policeman. Even we can't afford it any longer, and it simply doesn't work. The days are gone when a super power can walk in and change a country. There will never again be another British Empire. I would hope that the UN would grow a set and take over the role of global policeman. The UN needs to raise a volunteer force, train it in nation building, and begin assuming the responsibilities that the UN was designed for. (American soldiers are trained for warfare, not nation building. Ideally, the members of this UN force would be a little older and better educated than the average 18yr old American soldier with an M16).

We are going to need all the borrowing power we can get over the next 20-30 years. So it's good that we have such a generous borrowing ability, and we will need it with over 78 million baby boomers retiring over the next 20 years. That's 10,000 per day, every day, for 20 years. They will need health care, housing, help with utilities, food assistance, and since less than half of them have anything saved for retirement, they will need lots of additional programs if they aren't to be left in the gutter to die. The average SS check for baby boomers will not cover the basics, yet that's all half of them will have as income.

Already half of our working population pays no federal income tax. I suspect most of the people in that category already receive government assistance of some kind. Most of them make so little that they owe no federal tax. That's because most of the new jobs being created pay a lot less than the jobs we've lost. The point is that these workers/citizens will not be contributing much to the general fund, in fact they will be a drag on expenses for most of their working lives and in to retirement.

So, as powerful as we are, we will need to cut spending where we can, raise taxes where we can ( especially on the rich - they're the only ones with extra money now), and we will still need to borrow a lot of money. The real cost of borrowing all that money is that it will impair growth, even at near zero interest rates. And long term it will increase inflation, especially if the world economy gets going again to any extent. But we have to get over the 20 year "hump" caused by the need to address the extensive needs brought on primarily by the aging baby boomers.

regards,
Waddie

Nicholas Scheuer
03-13-2012, 09:11 AM
John Smith pretty well sums it up.

Obama should announce a rash of Military Base closings across Republican states, so we could enjoy the howl of protest from the Speaker Of The House and the Senate Minority Leader.

Two can play this game.

Gerarddm
03-13-2012, 09:13 AM
The very best time to borrow is right now, when the cost of doing so is basically nothing, percentage wise. Paul Krugman in the NYTimes recently pointed out how austerity is strangling various countries, and is NOT being rewarded in the financial markets as some hoped for.Overall deficits do matter, contrary to what war criminal Richard Bruce Cheney once opined. The trick is to get the economy going better whilst setting the big table for leaner dinners down the road. Some ways of doing that are lifting the poor from poverty ( which Business Week recently noted has explosively propelled Third World economies upward ) buttressing the middle class, and significantly reforming money hog systems like health care and Defense. Tilting the table in favor of the One Percent, shying away from true reform in entrenched systems, and tolerating bloat are not paths to greatness.

David G
03-13-2012, 10:24 AM
Waddie,

Carefully considered and nuanced. Thanks.

David G
03-13-2012, 10:24 AM
The very best time to borrow is right now, when the cost of doing so is basically nothing, percentage wise. Paul Krugman in the NYTimes recently pointed out how austerity is strangling various countries, and is NOT being rewarded in the financial markets as some hoped for.Overall deficits do matter, contrary to what war criminal Richard Bruce Cheney once opined. The trick is to get the economy going better whilst setting the big table for leaner dinners down the road. Some ways of doing that are lifting the poor from poverty ( which Business Week recently noted has explosively propelled Third World economies upward ) buttressing the middle class, and significantly reforming money hog systems like health care and Defense. Tilting the table in favor of the One Percent, shying away from true reform in entrenched systems, and tolerating bloat are not paths to greatness.

Just so.

Dutch
03-13-2012, 11:58 AM
so you borrowers want to borrow money ad initum? from who and who will pay the bill?

there is no 20 year " hump " that we have to get over - this is a freight train headed in our direction. the american government, state governments, down to the local governments have gotten us into this mess with overspending in order to ensure themselves greater power for as long as the can possibly hold it. and the american public has complacently sat by and partaken of the bread and circus acts they have put on for us while it was happening.

I got bad news for yall - the bill is coming due - and it isnt going to be pretty when the payors find out what we have saddled them with.

John Smith
03-13-2012, 12:10 PM
John Smith pretty well sums it up.

Obama should announce a rash of Military Base closings across Republican states, so we could enjoy the howl of protest from the Speaker Of The House and the Senate Minority Leader.

Two can play this game.

The incredible hypocrisy is, well, incredible.

However, good bad or indifferent, our economy is based on consumption. That means we need a middle class with spending money to create demand, and we need manufacturers here to give the middle class that spending money and the product for them to consume.

It doesn't take some long winded econmist to figure out that we need to manufacture stuff here, and a very large part of our current economic predicament comes from decades of outsourcing manufacturing jobs. The money, IMO, ends up in the country of manufacture. Just like we export money for oil, we export money for those goods we import.

I am appalled and amazed that there is a single person in this country who opposed the idea of rebuilding and modernizing our infrastructure, WHICH MUST BE DONE, using all material made in this country. Yes, that would require borrowing money. It would also put millions of people to work in private sector jobs. Those millions of people would have spending money with which to consume, which will create more jobs in the private sector.

If we can connect this to strong incentives for corporations to build their factories here, the debt and the deficit will take care of themselves.

It's kind of like having a large balance on your credit card. If you're making more money, the balance doesn't seem so big.

John Smith
03-13-2012, 12:14 PM
so you borrowers want to borrow money ad initum? from who and who will pay the bill?

there is no 20 year " hump " that we have to get over - this is a freight train headed in our direction. the american government, state governments, down to the local governments have gotten us into this mess with overspending in order to ensure themselves greater power for as long as the can possibly hold it. and the american public has complacently sat by and partaken of the bread and circus acts they have put on for us while it was happening.

I got bad news for yall - the bill is coming due - and it isnt going to be pretty when the payors find out what we have saddled them with.

I can only speak for myself. I don't like my nation being in debt. I have been consistant in that opinion, rather than holding that opinion based on who is driving our debt up.

It is, however, necessary to borrow more money at this point in order to move us in a direction where we can pay the debt down. Squeezing our government won't work. Rebuilding/modernizing our infrastructure with steel etc. made here will work.

SaltyBoatr
03-13-2012, 12:22 PM
so you borrowers want to borrow money ad initum? from who and who will pay the bill?

Real questions, faulty premise. To view a central bank as if it was a person 'borrowing' is illogical. Central banks can 'print' money. So the 'borrow' analogy is wrong.

It is perfectly fine (even desirable) to print money forever, as long as the printing goes at the same speed as the gross domestic production.

Keep an eye on inflation. Presently inflation is near zero, or even negative, so the 'printing money' thing is not a problem now. If inflation goes up (not likely any day soon), then printing money should be slow. If inflation goes negative, print more money faster.

Dutch
03-13-2012, 12:37 PM
Real questions, faulty premise. To view a central bank as if it was a person 'borrowing' is illogical. Central banks can 'print' money. So the 'borrow' analogy is wrong.

It is perfectly fine (even desirable) to print money forever, as long as the printing goes at the same speed as the gross domestic production.

Keep an eye on inflation. Presently inflation is near zero, or even negative, so the 'printing money' thing is not a problem now. If inflation goes up (not likely any day soon), then printing money should be slow. If inflation goes negative, print more money faster.

Ive figured it out -this guy is living in lala land

John Smith
03-13-2012, 12:47 PM
I've always viewed money as something that needs to keep circulating. Kind of like blood to our bodies or water to our planet.

In my view, the way capitalism is supposed to work is the workers make things, which are sold to the people, who are also the workers. The profits from these things trickle up to those who own/run the business. They invest in expanding their business if the market is there, or they simply invest in funds that will invest in new businesses that will, hopefully grow.

I once knew a guy who ran a Dairy Queen franchise. He explained that out of every individual item I bought, three cents trickled up to the owner of all the franchises. Obviously, the more burgers, milkshakes, fries, etc. the people bought, the more money trickled up and the wealthier that guy got.

Opening more stores would increase his wealth. However, no matter how many locations he might open, if the middle class can't afford to stop and buy the ice cream cone, he makes nothing. He has a vested interest in the middle/working class having money to spend.

SaltyBoatr
03-13-2012, 12:54 PM
Ive figured it out -this guy is living in lala land

Care to explain the reason you say this?

This is simple economics.

http://en.wikipedia.org/wiki/Central_bank

It is silly to paint a central bank as having 'debt' like you or I have debt.

A central bank doesn't have any debt that they cannot simply print money to pay.

Central banks are allowed to print money by definition. They can safely print as much money as they want, as long as inflation stays under control. Presently, inflation is under control.

Rather than stick your fingers in your ears and say "la la", try saying what is wrong with my logic.

David G
03-13-2012, 12:57 PM
Ive figured it out -this guy is living in lala land

Sorry, but your stubborn ignorance, and reliance on faulty sources does not equate to someone else being out in left field. Based on past performance, you've been the one who is incorrect in your judgements - yet you seem to learn nothing.

Here's how it works. If you can grasp this mechanism, you can begin to understand that your concerns are, while not completely inappropriate, inappropriately prioritized. It's far more important that we get the economy back humming than it is that we reduced the deficit... at this time. Later, that emphasis should switch, and deficit reduction should come to the fore.

http://krugman.blogs.nytimes.com/2010/07/07/self-defeating-austerity/

SaltyBoatr
03-13-2012, 01:10 PM
It is also silly to say "cancer of debt and deficit". The real issue is the amount of debt compared with our total production. And, the debt that matters is the total debt of the country, not just the governmental debt. (That is a huge fallacy of the Tea Party, focusing only on governmental debt, when other types of debt are bigger.)

Compared with the rest of the world, the USA is in pretty good shape, plus, the USA is actually trending in a favorable direction. Doomsaying Tea Party not withstanding... It is economically stupid to not avail ourselves of our good debt/GDP ratio now by pumping stimulus money into our economy. Stupid Tea Party. Learn economics!

http://crescat.net/wp-content/uploads/image0011.png

David G
03-13-2012, 01:12 PM
I've always viewed money as something that needs to keep circulating. Kind of like blood to our bodies or water to our planet.

In my view, the way capitalism is supposed to work is the workers make things, which are sold to the people, who are also the workers. The profits from these things trickle up to those who own/run the business. They invest in expanding their business if the market is there, or they simply invest in funds that will invest in new businesses that will, hopefully grow.

I once knew a guy who ran a Dairy Queen franchise. He explained that out of every individual item I bought, three cents trickled up to the owner of all the franchises. Obviously, the more burgers, milkshakes, fries, etc. the people bought, the more money trickled up and the wealthier that guy got.

Opening more stores would increase his wealth. However, no matter how many locations he might open, if the middle class can't afford to stop and buy the ice cream cone, he makes nothing. He has a vested interest in the middle/working class having money to spend.

In economics jargon - it's called the Velocity of Money. Here's a basic exposition:

http://en.wikipedia.org/wiki/Velocity_of_money

And - another, more detailed explanation:

http://inflationdata.com/articles/2011/09/17/velocity-of-money/