February 22, 2018
My Dear Grandkids,
I want to write something today about governments spending more money than they have – called deficit spending – because there truly are some strange things happening. This is really important because you may be forced to pay for it.
The United States has now taken two actions, with a third proposed, that treat deficit spending as if it were not problematic. Now, before getting in to that, let’s pause for a moment and think out what can go wrong with deficit spending:
You have to pay for it. US has been spending less than $300 billion annually to service its debt. The Simpson Bowles Commission, circa 2009-2010, estimated that the deficit could cost as much as $800 billion by 2020, as interest rates returned to some kind of normal rate. Clearly, next to free money was not normal. This year, that cost is estimated at $400 billion, somewhat behind the schedule forecasted by S/B. Meanwhile, while the US debt was nominally $7 trillion when Obama entered office, it is next to $19 trillion today. Pause on that. It is conceivable that the cost to service US debt could get to $1 trillion annually by the end of the Trump Administration if the policies being put forth are sustained.
When countries become debtor nations there is a huge temptation to monetize their debt. The US has had an almost sacred belief since the Reagan years, after hitting double digit inflation rates during Carter’s tim, to keep the inflation rate very low, below 2% annually. Paul Volcker ran the Fed and developed that policy. But, can that idea continue? There is more and more conversation occurring among educated circles in the US that the inflation target of about 2% is too low. Chances are pretty good that the US, having allowed debt obligations to develop across many sectors of the land, both public and private – Social Security, public sector pensions promises, $1.5 trillion in student debt, and $19 trillion of total Federal debt – is going to loosen the grip of that debt by making it less valuable.
If a country like the US becomes less attractive as a safe harbor for serious money, then, serious money is going to charge more to fund the debt, or go elsewhere. The consequences of that are more pressure on Federal Government expenditures, more crowding out of discretionary spending, eventual threat to non discretionary spending, eventually more taxation, and a weakening role for US as the dominant actor in global economic stability.
So, the point is, ignoring deficits or saying they don’t matter seems to me to not be terribly wise.
So, first the Congress approves a tax cut that, over ten years, will add $1.5 trillion to the debt. Then, it agrees on a new two year budget deal that adds almost another $500 billion to the debt. And, finally, Trump puts forth a budget outline yesterday that would add even more. Now, all of this is put upon a rising deficit based solely on how we exited the Obama Administration. In 2016, the budget deficit hit $666 billion. Deficits this year will be the highest we have seen since flooding the economy with money in 2009. Warren Buffett has said that the US can do fine with a budget deficit of about 2.5% annually. In 2016, by my calculations, it was at least 3.5%. Given the three actions listed above, this deficit is going to bounce around 5%.
So, the question is, what the hell is going on here??
Let me give you my most sure answer: I don’t know!!
But here are the only ideas I can surface.
Recognize that all of this economic policy/taxation policy is creating a huge amount of stimulus. But, the US is already operating at 4.8% unemployment or lower. Economists generally feel that full employment is 5%. The theory of economic fiscal policy would have the US now increasing taxes and operating at a surplus. (Pure Keynesian.) Moreover, business elites tell us that the US actually has a very significant labor shortage in knowledge based jobs – people who actually have a specific skill, an education in the sciences, or technical knowledge. I have read numbers all over the place. I think it is safe to say that the shortage is in seven figures. Of course, there is no such thing as a shortage in economics. Equilibrium will be demanded. Prices must rise. Labor will be found. Higher prices will knock down demand. And sitting in the middle of all of this will be much higher inflation than the US has experienced in almost 40 years.
So, to put an optimistic light on the above, growth will be ready to climb to over 4%, labor shortage will hold it back, prices will go up. There will be some new tax revenue as a function of growth. And, in the end, the debt will be somewhat less valuable, it will be paid down with cheaper dollars, and at least some of the trends mentioned above will be lessened. For me, that’s best case scenario.
Obama’s Simpson Bowles Commission viewed the debt and deficit situation as a very serious problem. During those years, the Chairman of the Military Joint Chiefs of Staff viewed the deficit as the nation’s number one national security threat. Peter Peterson, a formed Secretary of Commerce, founder of Blackstone Group, and founder of the Peterson institute, which he endowed with one billion dollars, to increase awareness of the huge dangers of climbing Federal debt.
But, the US Congress doesn’t seem to think it matters. Obama didn’t think it mattered. Trump doesn’t think anything matters. Now, to listen to casual commentary, all of these groups are populated by silly people, ill informed, and non caring, looking out only for themselves – or at least the other side from your point of view. However, it is not my personal experience that these groups are populated by people who are dumb, ill informed, or fundamentally non caring. In fact, most of them are very patriotic, and are either quite idealistic or very conservative and responsible. So if not that, what???
We might ask, of the large governments in the world, is there a model country which is living within its means? Well, let’s start with China. Their budget target is a deficit of 3%. And, of course, in China economic uncertainty only begins with official reports. Generally, in life, when you roam around in the details, things do not look better. India? Their target for the current fiscal year is over 3.5 %. Japan recorded at 4.5% fiscal deficit in 2016. U.K.? In current year, about 1%. WOW. But when was the last time you read a report that the UK economy was the envy of the world. Anybody heard of Brexit? France? In 2016 their deficit was 3.6%. Mexico recorded a budget deficit of 2.6%, very near to the Buffett model. The big exception to the rule, and it is big, is Germany. Germany recored a 1.2% budget surplus, and that surplus combined all forms of German government, not just the Central Government. Remarkable. Let’s add a few more: Italy. Deficit 2.4%. Canada. Less than 1%. Brazil. Over 9%. Colombia. 4% of GDP.
So, what makes Germany different? Is it possible that their people do not feel as entitled as most of the peoples of the world? Is Germany responsible for making the European Community as strong as it is, or is something else happening?
What else can be said about the two moves and the one proposed move set before the US government, other than that it is borrowing a whole lot of money:
Some of the funds would go to infrastructure spending, planning to stimulate an X factor complimentary amount from the States and private interests. Money deployed in this fashion is constructive.
A lot more money would be going to the military, a material amount of that going for readiness. That is, the US defines its forces as so much of this, and so much of that. But, if 50% of your jets are not flying because they lack spare parts, aircraft carriers are staying in ports for much longer time periods because the funds are not available to fund long excursions there is a huge difference between your force and your readiness. Most of this additional money will not grow US defense capabilities. Rather, the funds will be used so that the announced size of force is close to the actual size of force.
A lot more money will be going for social programs. This is like paying current, inescapable costs with loans. May be good social policy. It is bad economic policy.
OK. I admitted above that I don’t know what is going on? But, it seems that there is a fundamental disbelief throughout most of the world that government deficits under 5% matter very much.
What do you think?
