Deficits As Far As The Eye Can See

The sea of red ink is swelling at an awesome rate. One of the reasons that Obama pushed forward his announcement about Bernanke was to drive the various reports issued yesterday about the Federal Deficit off the front page. At least that’s my guess. If it was his plan he failed miserably: today’s Financial Times has a banner headline announcing the impending doom of civilization – apparently – because of the new estimates of the deficit.

“The economy, like the law, may grind slowly, but grind it most assuredly does.”

Both the administration’s own estimate, from the Office of Management and Budget [OMB], and that of the non-partisan Congressional Budget Office [CBO] point in the same direction: that the Federal Deficit is both huge – in the order of $1.6 to $2 trillion this year alone – and long lasting. There isn’t a year in the next decade where the deficit is projected to be eliminated.

That is, of course, assuming a continuation of current policies.

I have hammered away at this issue before: I have two beefs with the folks who are running around in near panic when they read about this deficit.

One: where were you when the roots of the deficit were laid by the tax cuts of the Bush administration? If you didn’t panic back then you shouldn’t be upset now.

And

Two: this level of debt is entirely manageable in an economy the size of the US – focusing on the growth of the deficit misses the point that the economy also grows over the same time. The statistic we should pay attention to is not the size of the deficit but its ratio to the economy. Running around in panic about a massive deficit is plainly silly if the economy is even more massive and makes paying off the debt quite easy.

Nevertheless the media fumes away at the size of the deficit as if it is the be all and end all of policy. And those who are of a right wing persuasion chuckle that it means the end of Obama’s reforms: after all how can he pay for reform if we are already in hock up to our eyeballs?

First let me state unequivocally that I think run-away deficits are a very bad thing.

But.

There is a big difference between a temporary or ‘cyclical’ deficit, and a permanent or ‘structural’ one.

Our issue is simple: we have both kinds – cyclical and structural – rolled into one right now.

Obviously the cyclical deficit results from the recession. Not only have we had to spend hundreds of billions of dollars to keep the economy afloat, but Federal tax revenues have fallen dramatically as unemployment has risen and business has fallen. So we had to pay for the stimulus and bail-outs by borrowing. No big deal. This is a good thing. It is both sensible and pragmatic economic policy that we can afford. There is no good having the world’s highest credit rating if we don’t use it when we need to.

The deeper problem is that we have inherited a nasty structural deficit from the lunacy of the Bush tax cuts. They were insane at the time and they are hurting us deeply now. As economic policy those tax cuts were a disaster: they did not help the economy at all. Supporters of Bush simply deny the reality of the statistics: after those tax cuts the economy turned in its worst post-war performance. Wages stagnated, employment faltered, and only profits boomed. More importantly this awful set of results came at a massive cost. The federal budget fell into a long term, and permanent, deficit. There was no attempt to close the gap. None. Why? Because no one would vote for the kind of budget cutting that is needed. So the cynicism of the Bush era is wretched. Anyone who supported those tax cuts is disqualified from commenting about our current situation unless they first tell us how to remedy the damage done back in 2001/2003.

So we face two different problems: reversing the cyclical deficit, and undoing the structural deficit.

The first is relatively easy: as the economy rebounds revenues will recover to narrow the annual gap quickly. After two or three years the cyclical gap will have been eliminated. this will leave us with the cyclical debt incurred during recession to pay off, but in the context of a healthy and growing US economy that additional cyclical debt is, while not trivial, easily managed.

Getting rid of the Bush era damage is another matter entirely. That will involve expanding the revenue base – raising taxes – and controlling costs right across the board. As a nation we simply cannot remain profligate the way we were during the entire Reagan/Bush era. It is absurd for the world’s richest nation to rely on deficits to keep up its spending habits. We need to reconstruct the economy around thrift and fiscal rigor. And, however we might not like it, that means higher taxes.

Neither the OMB nor the CBO forecasts include tax increases of any substance. American politics is so bizarre that it is very difficult to have an adult conversation about fiscal responsibility: it is assumed that the electorate will revolt both against taxes and spending cuts, so nothing gets done about either.

Frankly that’s childish.

We, the people, cannot have it both ways. The cynicism of the Reagan/Bush era was that voters were told repeatedly that they could. And we bought the lie because it was wrapped in silly imagery and a near xenophobic mythology about American greatness.

Too many nations have travelled the road to penury before us for their history to have no relevance. At some point reality bites and cuts away the myth leaving an electorate irate and feeling betrayed by its leadership. We are fast approaching that point.

I have said repeatedly that I do not think the current level of debt is something we should worry about. Our economy is big enough to absorb the debt and sustain the repayments.

But that goes only so far. We cannot keep adding to the debt ad infinitum. There is a limit that even we cannot breach. Sometime within the next five years we will need to address those Bush errors. And fix them. Fiscal responsibility will have to be re-asserted. This country has lived in a debt riddled dream world for the best part of thirty years: we have deliberately underfunded key parts of our infrastructure – education is an obvious example – in order to maintain the pretense that we are still creating wealth the way we did prior to the first oil shock. It was an illusion. We became addicted to debt because other countries were willing to pump cash into us so that we could continue to buy their goods: China, Japan, Germany and the big oil exporters are key examples of this. They underspend just as much as we overspend. They are just as addicted to our debt as we are.

But that game is now at an end.

Those big exporters cannot continue to underspend if they want to grow for precisely the same reason we can no longer overspend: we need to control our debt. The more debt we pile up the less it is worth. That drives interest rates up. It is this potential effect that has the Financial Times all a-twitter today. They are misreading the data in the short term, but their point is valid long term.

Eventually we will reach the tipping point where no one wants our debt. The wheels well and truly come off the Reagan/Bush illusion at that point. A grown up country tries to avoid that eventuality.

Are we grown up enough?

Looking at the puerile and poisoned nature of our political process – the ‘debate’ over health care reform is a national embarrassment – I must admit to a certain pessimism.

Have we got the stomach to cut into Social Security – maybe by raising the retirement age; reduce our offense defense spending back to manageable levels – maybe by exiting all the Bush wars and fending off the military/industrial complex that has totally captured our purchasing process; and limiting discretionary spending sufficiently to get a balanced budget with only small tax increases? If not, then at some time we will face draconian tax increases. The economy, like the law, may grind slowly, but grind it most assuredly does.

I know which outcome I would prefer.

Whether we are adult enough to get there I will leave you to ponder.