Category Archives: Fiscal Reform

Twelve Adults and the CBO: How many adults in the room?

The much ballyhooed Congressional Joint Select Committee on Deficit Reduction–aka the “supercommittee”–was supposed to hear a history of the debt crisis today.

You can imagine how well that was going to go over.  Partisans from both sides were prepared, I’m sure, to lay blame for the federal government’s fiscal problems at their opponents feet.

“It was Bush’s fault!”

“Was not. It’s Obama’s fault!”

“Nuh, uh!”

And so one. Fortunately, there was an adult in the room, and he was, contrary to oft-repeated and oft delusional grandeur of parental responsibility, not President Obama.

In fact, it wasn’t even a politician, per se. As NPR tells it

Doug Elmendorf, the man who runs the nonpartisan Congressional Budget Office (CBO), immediately dispensed with the question of blame and laid out the options for the supercommittee.

“Putting the federal budget on a sustainable path will require significant changes in spending policies, significant changes in tax policies, or both,” Elmendorf said.

That’s a bitter pill, no matter what party you belong to. Elmendorf laid out the work before the committee. You have three issues before it, he said (and I’m quoting NPR, here):

  1. How much money the government is going to save;
  2. How quickly it is going to do it; and
  3. What mix of spending reductions (GOP choice) or tax increases (Democrat choice) it is going to use.

And partisan meat ain’t gonna cut it, alone. When Republican Senator John Kyl of Arizona suggested it could be recouped by stopping Medicare fraud or selling public lands, Elmendorf shut it down.

Neither of those would make up a very large part of the $1.2 trillion that the supercommittee is tasked with saving. (But he’d be glad to discuss those ideas, he said…just not on their own).

His idea, then? Raise spending or cut taxes now, and then later, raise taxes or cut spending. But lock it in now, with legislation in order to prevent future Congresses from waffling when the pressure is off.

Interesting idea, if something of a pipe dream. Check out the story from NPR.

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The Debt is Too Darn High

Apparently, that thing about ostriches sticking their head in the sand is no joke. Nor is it without parallel in the human world.

The other day I cited a study by a several prominent economists. Their research argued, quite persuasively, that excessive debt tends to inhibit economic growth. They looked a thirty year period,  included the debt levels of households, corporations and of 18 OECD governments (such as the UK, Australia, Germany, Norway, Portugal, France, Italy…and so on), and analyzed the effect of the debt on economic growth.

It’s a very interesting study, and coming on the heals of the debt ceiling debate, it reiterated, if indirectly, the arguments many people have made: the debt is too high, and it will hurt our economy.

Still, some people managed to dismiss it. Blithely. The following bullet points are their points.

Never mind that the statement is internally contradictory, here are the facts:

After World War II, the US had lost 418,500 persons, or .32% of its population. With the exception of Pearl Harbor, no battles were fought over US soil, our industrial base had been increased over the course of the war, and US debt was held primarily by American citizens. Further, rationing was utilized and women entered the labor force for the first time in high numbers, filling the gap left by men serving in the armed forces.

Logo used on aid delivered to European countri...

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In contrast, while the United States was building its industrial strength, the factories and infrastructure of the rest of the world was collapsing under bombs, bullets, and famine. While only .32% of the US population was killed in World War II (a smaller percentage than even the American Civil War, by the way),  the United Kingdom lost 450,900, or .94% of its population, three times as many killed as US killed. But even  that’s nothing. Recipient countries of the Marshall Plan (Austria, Belgium, Denmark, France, West Germany, the United Kingdom, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Sweden, Switzerland,  and Turkey) , the US’s aid program to rebuild Europe, were hit even worse. Austria lost 5.7% of its workforce, Germany between 8 and 10%, Greece between 4 and 11%, France 1.35%, Italy 1%, and Belgium 1%, to name a few. This doesn’t even account for the Soviet Union and its allies who were precluded from the Marshall Plan, or Japan.

Poland lost almost 17% of its population in the war. Lithuania and the Soviet Union each lost about 14% of their populations. In 1939 USSR terms, that means 23,000,000 total deaths.  China, while only losing between 2 and 4% of its population, still had casualties of over 20,000,000, greater than the combined populations of 1945 New York, Chicago, Philadelphia, Detroit, Los Angeles, Cleveland, Baltimore, St. Louis, and Boston. That to the American total casualties of under 500,000, few of which were civilian deaths.

To sum it up, the US left World War Two with high debt, a relatively untouched industrial base, few casualties compared with the rest of the world, and a global market decimated by  war. Is it any wonder we were able to grow dramatically after World War Two?

  • ” But what about crises? This data doesn’t take consider that were in a major crisis now, and we need to spend to get money into circulation.”

In the words of Bart Simpson, “Au contraire, mon frere.” The data actually controls for banking crises.  In fact, high debt may be the cause of such crises in the first place.

[R]elated to the crisis variable, we note that high levels of debt for a country as a whole or for one of its sectors may be a reason why a country may end up facing a banking crisis. But it may also be the reason why a given downturn, originating from events outside the country or the indebted sector, may turn out to be worse than it could have been otherwise. Using this variable thus allows us to check whether or not the effects of debt on growth are related with periods of financial stress.

Worse than it could have been otherwise…kind of makes you wonder if economic growth, which by all reports is now stalled, might be growing instead.

Ok, so I added that last part. The “evil” part.

As for failed, I’d hardly say that. In fact, that we are in the longest period of recession since the Great Depression, that we are increasing our public, person, and corporate debt at an unsustainable rate, and that economists and the credit rating bureaus are starting to engage in dialogue about unsustainable entitlement programs, all seem to show just one result: we need to change what we are doing.

The debt is just too darn high.

Frankly, this has nothing to do with Republicans or Democrats. It has to do with spending. As anyone who has read here with enough regularity knows, I don’t lay the blame for our high debt at the feet of Democrats alone. The Republicans have their pet projects, too, and neither party’s elected officials stand blameless.

However, I did not approach this as a partisan issue. I approached it from the perspective of reporting a highly credible report that just happens to support Republican stands during the debt ceiling debate.

Again, au contraire. This isn’t about what the government needs to do to help people get back to work. It’s what the government needs to stop doing to prevent them from getting back to work.

Don’t get me wrong. I believe that there is a place for government, that government can and does assist the economy, and that no government is a recipe for Somalia. No, I am not making a “smaller government” argument.

What I am arguing is this: the debt is too darn high.

Do I need to say it again? The DEBT IS TOO DARN HIGH.

And it’s hurting the economy.  Some debt is good. Debt, and My Better-half, put me through law school. But research is showing that at a certain level, too much debt begins to sap economic growth. It is, as the report states, a “double-edged sword.”

Enter the long quote:

As debt levels increase, borrowers’ ability to repay becomes progressively more sensitive to drops in income and sales as well as hikes in the interest rate. For a given shock, higher debt raises the probability of defaulting. Even for a mild shock, highly indebted borrowers may suddenly no longer be regarded as creditworthy. And when lenders stop lending, consumption and investment fall. If the downturn is bad enough, defaults, deficient demand and high unemployment might be the grim result. The higher the level of debt, the bigger the drop for a given size of shock to the economy. And the bigger the drop in aggregate activity, the higher the probability that borrowers will not be able to make payments on their non-state-contingent debt. In other words, higher debt raises real volatility, increases financial fragility and reduces average growth.

Hence, instead of high, stable growth with low, stable inflation, economies experience disruptive financial cycles, alternating between credit-fuelled booms and default-driven busts. When the busts are deep enough, the financial system collapses, bringing down the real economy too.

 So the recommendations?

Back to the study and the economists’ suggestions:

  1. Since aging drives up government expenditure (i.e. non-discretionary spending on Social Security, Medicare, Medicaid, etc), we need to increase our labor base. In other words, we need to streamline immigration. The immigration problem needs to stop being a problem so that people who want to work, pay into the system, and grow the economy are permitted to come here and do that.
  2. The United States—as a people, business environment, and government—needs to  shore up its financial markets so that it remains a low risk investment for emerging economies that have younger populations and higher savings rates.
  3. Free trade. The authors suggest that trade may “reduce the need for more radical changes in the composition of demand that aging otherwise brings.” But then, you  and I both know that free trade, as much as it works, is counterintuitive to the average voter.

What can you do? Save. Save. Save. Because, at the end of it all, savings is the only way out.

As with government debt, we have known for some time that when the private non-financial sector becomes highly indebted, the real economy can suffer.39 But, what should we do about it? Current efforts focus on raising the cost of credit and making funding less readily available to would-be borrowers. Maybe we should go further, reducing both direct government subsidies and the preferential treatment debt receives. In the end, the only way out is to increase saving.

[VIA]

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Debt too high saps economic growth.

Debt. You don’t like it. I don’t like it. No one likes it.

And yet, without it, much of the prosperity and technological progress we rely upon would not be possible. Finance and the power of compound interest has thrust our economy forward faster than any in history. Yet, compound interest is not a tool you want to be used against you. As New York Times columnist Carl Richards notes, “It’s always been one of the most powerful forces in the financial universe.”

Don’t think it matters? Just consider the result of the downgrade of American credit:

Think about that for a minute. If those worst-case-scenario interest rates came to pass and persisted, we’d be approaching a trillion dollars in interest payments per year. That’s what compound interest looks like when it’s working against you.

If that trillion dollar number doesn’t do it for you (that’s 1,000,000,000,000), consider it on a more personal scale.

On a personal scale, you get a taste of it every month if you get careless with credit cards. Take a look at a bill. For every month you carry a balance, there’s a minimum payment required.

Use carefully, it’s a great tool for growth.

Without financing, countries–and businesses and families–are poor and stay poor. Whether it’s a student loan to get through college and get a job that pays better, a business loan to cover the cash flow gap between invoice and payment, or money to build infrastructure and fund the armed forces, finance is a necessary part of growth and getting out of poverty.

Yes, taking on debt creates vulnerabilities for any of these parties; however,  debt managed and controlled brings prosperity.

On the other hand, debt out of control creates financial crises. It stops = growth and harms economies.

When the ratio of debt to income rises to a certain level, a new study shows, financial crises–be it household debt, corporate debt, or a national government’s debt–“become both more likely and more severe.” In other words, too much debt is not a good thing.

Well, duh.

The study, entitled blandly but descriptively “The real effects of debt,” was reported by Stephen G. Cecchetti, M.S. Mohanty, and Fabrizio Zampolli, economists at the Bank for International Settlements, at the “Achieving Maximum Long-Run Growth” Symposium in Jackson Hole last week.

I can only imagine that the report’s findings threw a lot of cold water on the “more stimulus/raise the debt ceiling” crowd (aka “New Keynesian orthodoxy” believers, according to the economists), including Fed Chairman Ben Bernanke, fresh back from scolding Republicans for their reticence to raise the debt ceiling.

Why? Because, at least in part, the finding vindicates Republican fears about the malignant effect debt can have, and is having, on the national economy.

From the Introduction:

Our result for public debt has the immediate implication that highly indebted governments should aim not only at stabilising their debt but also at reducing it to sufficiently low levels that do not retard growth. Prudence dictates that governments should also aim to keep their debt well below the estimated thresholds so that even extraordinary events are unlikely to push their debt to levels that become damaging to growth.

Emphasis my own.

Which leads to the question: at what levels does begin to hurt and retard growth? The empirical results of the study, based on review of debt levels in 18 OECD countries from 1980 to 2010, show that:

  • Households can handle a threshold of about 85% of debt to income.
  • For corporations (non-financial), the number is about 90%.
  • Governments can borrow between 80 and 100% of GDP.

But that’s just in the short-term. Looking at advanced economies–in other words, Western Europe and the United States, Japan, and Australia– the problem is

compounded by unfavorable demographics. The ageing of populations and the rise in dependency ratios have also the potential to slow growth, making it more difficult to escape the negative debt dynamics that are now looming.

In other words, in our economy more of our population is getting old and few children are being born, which means that Social Security, Medicare, and Medicaid all have fewer  people paying for them and more and more people drawing on them.

If I’ve learned nothing from leaving the bachelor world for the role of a family man, buying too many Happy Meals for the kids may make me feel good, but it’s more expensive than a BBQ at home, and its less healthy, too. And when costs are going up faster than my income, that’s not the time to go out and get more debt.

What is our current federal debt ratio to GDP, then? Check out the chart below, and how it compares over our history. Note that, prior to recent history, the level of debt is only comparable to times when we have been at war.

World wide war.

In the meantime, we’ve become addicted to the Happy Meals as a national economy. While Social Security, Medicaid, and Medicare were all begun with the laudable, and often successful, goal of caring for the poor, sick, and elderly, they have expanded to bloat our national budget to a place where our ability to help those needy groups will someday become questionable.

And I do emphasis will. It is inevitable that if we continue on our current track we will be unable to aid those in need. The time for reform was last year, and the longer we delay, the more difficult it will be. We’re not getting any younger as a nation, and we’re not getting any richer either.

The debt is just too damn high.

[via CNBC, New York Times, and BIS]

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Downgrade.

From the S&P report (via HollyontheHill):

Political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. Thestatutory debt ceiling and the threat of default have becomepolitical bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently…. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden.

Perspectives on last week’s debt debate: two sides of the same coin

How the “left” sees the recent debt ceiling debate/crisis…

And how the “right” sees it…

Is it any surprise that the politicians had a hard time finding a middle ground? They don’t see eye to eye on what the problem is in the first place.

Also, what’s with this “super committee” that’s lacking any deficit hawks? Or Rep. Jason Chaffetz, for that matter? No, seriously. Why is he not on it.

In the meantime, Utah has its act together. Wonder if the feds might take a page from our book?

(h/t to Geeks are Sexy)

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