How We Can Escape the Deficit – Depression Trap
WHY AN NEW DIRECTION IS INEVITABLE
The USA has thoroughly squandered its ability to “stimulate” the economy by the use of money injections. The Fed no longer has any safe macro-economic manipulation tools, while the main government is paralyzed by a staggering debt load.
The President’s deficit reduction group, having leaked its draconian recommendations this week, proposes that they only be implemented until later, when the “recovery” takes hold.
Good luck with that.
The current crisis is far, far more serious than the President and the lame duck congress have acknowledged, and the culpability for getting us into this mess is too bipartisan for any snarky recriminations.
This is the first of a series of posts in which I intend to chart our optimum path out of this abyss.
The Keynesian experiment is over. Federal borrowing has reached its limit. Federal money creation may, at most, temporarily stimulate consumer spending for foreign-made goods and services while driving up prices for everything. Meantime, new business starts remain paralyzed by hostile and fluctuating taxation and an enterprise-suppressing regulatory environment. The Fed has run out of ammunition and the current administration is clueless about what to do.
We will not get out of this hole by spending more federal money than incoming federal revenue, and certainly not get there by imposing crippling new taxes.
Over the last half century, federal deficit financing has been adopted as the primary funding mechanism for a growing suite of entitlement programs. This was unsustainable over the long haul. Reality has just caught up with government practice. So far, nothing the government has done to pull the economy out of its slow-growth, high-unemployment doldrums has worked. Until the paradigm changes, nothing will.
Yesterday’s buzz was all about the President’s deficit commission –
The Bowles Simpson Commission – proposes a both budget cuts and tax increases, cutting federal spending to 22% of the GNP while holding revenues at 21%. This prompted the New York Times to carp, “In a misguided provision, it assumes that spending and revenues should not exceed 21 percent of gross domestic product — a numeric limit that could make it impossible to meet future national needs.”
That peroration was followed by another, this by Dr. Krugman, the former practicing economist, now then ideologically-driven columnist. Paul Krugman struck the same rhetorical note; he actually seems to believe that the USA can safely borrow, create fiat money in the twelve figures, and spend its way out of the current impasse.
The numbers suggest otherwise.
Here’s the deal: The adjustments required to avert a sovereign debt crisis are at cross purposes with the measures that Keynesian theory calls for the government to take by buying our way out of the current economic slump.
Even the deficit commission didn’t have the guts – or votes – to propose spending lower than revenues. Can it be that no one inside the Beltway understands that adding to the immensely bloated sovereign debt is a potentially fatal addiction? The debt commission is prepared to accept deficit spending at one percent of the GNP per year (22%-21%). This is beyond folly, not unlike the heroin addict who leaves rehab with the promise to chip a little less.
Enter Fed Chairman Bernanke with his latest ploy; the injection of .6 trillion dollars of fiat money into the economy over the next few months. He risks igniting catastrophic inflation while doing little to stimulate much of anything except some trickle down consumer spending on foreign goods.
KEYNES: ABUSED, MISAPPLIED & OUT OF ‘FAVOUR’
The desperation of the Fed is symptomatic of a failed paradigm – the Keynesian Free Lunch.
John Maynard Keynes (1993-1946), the British economist who proposed that the government could eliminate periodic unemployment by increasing the money supply during recessions, has inspired the economic policy in the Western world since 1970.
But the whole Keynesian scheme has crucially depended on six assumptions, to wit:
(1) THAT the core productive capacity of the nation would remain intact, such that it could be scaled up as soon as money is injected into the economy;
BUT: We in the USA are no longer living in a consumption-driven economy. Injected money first goes to consumers, most of whose consumption choices serve foreign workers and businesses.
(2) THAT crippling inflation could be avoided when government money is injected into the economy;
BUT: In the USA, a huge reservoir of private funds is parked with banks and corporations, and that reservoir – including foreign investment money – is ready to stoke demand for scarce resources. In this context, the improvident injection of government fiat money can suddenly tip the economy over into crippling hyperinflation. There are several examples. Consider Argentina (1975-1991) that “fixed” a run of deficit spending with fiat money-generated paralyzing inflation, reaching 30% in a single hour. A total collapse of the economy followed.
(3) THAT the resulting reallocation of economic resources by government intervention (read by politics) would be rational and efficient.
BUT: The .8 billion $ Stimulus Bill (the American Recovery and Reinvestment Act of 2009) was a purely political reallocation of resources that failed to live up to its hype because funds mostly went to other government agencies, not to business starts. Unemployment remained unimproved.
(4) THAT national exports would balance or exceed imports;
BUT: the US net trade deficit was 19.4 Billion in 1980 and has been growing ever since – to .69 Trillion in 2008. This is the cost of running a consumption-driven economy.
(5) THAT government deficits would be sufficiently balanced by surpluses to avoid a sovereign debt crisis;
BUT: “Based on the 2010 U.S. budget, total national debt will nearly double in dollar terms between 2008 and 2015 and will grow to nearly 100% of GDP, versus a level of approximately 80% in early 2009.” So says the OMB.
(6) THAT the national money supply would retain its virtual monopoly as the medium of transactional exchange in the USA.
BUT: “The surge in the U.S. money supply was thus matched by a surge in the money supplies of countries linked to the U.S. dollar. The result was a temporary worldwide credit bubble, followed by a wave of loan defaults, falling housing prices, banking losses and a dramatic tightening of bank lending.” (J Sachs in The Scientific American, 5-21-09)
The Keynesian economic express has just hit the wall. Our fiscal deficits that were not repaired by balancing by surpluses became sovereign debt. The US has now accumulated an almost insurmountable pile of unpaid obligations, and we are too big to bail out.
This sorry circumstance was allowed to happen because both conservatives and liberals bought into converging variations of the Keynes-inspired “kick the debt can down the road and hope for growth” delusion.
Conservatives were willing to contain spending by cutting social programs, while liberals were only willing to cut military expenditures. President Reagan, for example, submitted balanced budgets to a democratic congress that were declared “dead on arrival.” When the smoke cleared, the president’s military buildup expenditures were preserved, no counterbalancing domestic cuts were agreed and another deficit followed.
Over the years, the “compromise” between White house and the Congress was that nothing was meaningfully cut, and the deficits continued to pile up in the form of sovereign dept that will soon exceed the annual GNP of the US. Much of which is owned by another sovereign creditor – China.
On 9/30/1985, the national debt was 1.8 trillion, in 1990 is was 3.2 trillion, in 2000 it was 5.6 trillion, on September 30, 2005 it was 7.9 trillion, and today it is estimated to be $13.7 trillion, and the administration’s 2009 projections for 2019 were 23 trillion. This is being called an “unsustainable trajectory”, an understatement in the same league with a 707 pilot’s last words as the airliner heads earthward without engine power.
A significant moment of truth will arrive when the major foreign lenders decide in their own interests, or out of political malice, or because of their own domestic unrest, to cease funding the great American borrowing machine. The painful adjustments that are now just being floated “for discussion” will then be made swiftly, brutally and on an emergency basis.
None of the assumptions supporting the Keynesian scheme still hold water.
Much of America’s productive capacity has been effectively shipped to other nations and what remains is not currently sufficient to pay for the nation’s appetite for imports. As a country, we are making very little in the way of goods and services that can generate additional foreign sales income. That needs to change but current government policy is an impediment, not a help. Deficit financed government expenditures continue to be irrationally allocated to pay off political constituencies for unproductive activities that generate little or no new employment, little or no exportable goods and services and no new business activities that could generate American jobs. The history of Latin American hyperinflation foreshadows the effects of a general surge in the US money supply – a run of crippling inflation is likely. The US has lost all fine tuned control of is real money supply because of international trade. The global economy has produced a global currency exchange system that severely undercuts any one nation’s ability (including the USA) to calibrate its own money supply. For example, excessive sovereign debt leads to much higher borrowing costs, and an eventual borrowing freeze. Arbitrary increases in the money supply via fiat money (as in Fed. Chair Bernanke’s current round “quantitative easing”) can easily lead to hyperinflation and international currency retaliation. All Western nations have abused Keynesian theory, by using deficits to subsidize otherwise unaffordable social programs over a 50 year period without any concerted attempt to balance those deficits with surpluses. Most have reached their borrowing limit.
What the h*** do we do NOW?
Free market economists use the term, “overgrazing the commons” to describe an untenable situation that always develops when a given finite resource, like a public grazing area, is treated as if is an inexhaustible cornucopia. In the long term, the area is overgrazed, reduced to unproductive rubble. In the short term it becomes the object of a lot of shooting.
When the economic safety nets of the Western economies became public commons, a dynamic was set up that would inevitably lead to collapse. No pension scheme, no welfare scheme – no entitlement scheme, however well intentioned, can survive when the rights to its benefits are purely need-driven, because human need is an open-ended sink. The available resources to satisfy human needs at any given time are finite. Country by country, the “borrow, spend & pretend” game is hitting its logical endpoint, leading either to an epic train-wreck or to painful readjustments.
In our case, the painful readjustment period was delayed about 50 years, during which the scope of entitlements was greatly expanded, all funded by deficit spending in the vain hope that our debt-loaded economy would maintain robust growth forever.
When entitlement schemes began to run out of appropriated money, the game began to change. Regulatory schemes were tweaked to accomplish “social justice” ends, thus offloading and concealing the economic costs of naked economic redistribution. Some of these schemes were more effective in helping their intended beneficiaries; others were less effective, but the cumulative effect was the same: An increasingly burdensome political load was imposed on commerce.
The solution is to find ways to restart and maintain the engines of economic growth while maintaining the economic social net at a much reduced, long term-sustainable level.
Fortunately, the USA has several advantages.
We still have a tradition of robust capitalism. This is not the old Soviet Union where capitalism had to be built form scratch on the ruins of the great socialist collapse. We are sitting on a cache of natural resources, exceeding our own immediate needs, the marketing of which – if we choose to do so – can fund the difficult transition ahead. The very political and legal tools that the entitlement humanitarians created to regulate commerce have provided us with the means to liberate commerce.
PART TWO: THE THIRD ELEMENT will develop the last point [C] in more detail.
Here is the core idea: We will use the Commerce Clause as an engine of economic liberation.
In some respects, California and Greece are the USA writ small. In all three cases, the illusion that some easy rescue is just around the corner persists like the stubborn hope that a kidnapped child will suddenly return five years after her abduction by a serial killer. But the hope of a meaningful bailout is just as unreasonable. The long term addiction to borrowing has just run its course. The horrors of withdrawal are postponed until the day after tomorrow. The political classes and their dependents are living in the sunshine, while an impending class five hurricane is just over the horizon.
The path out consists of three elements, the first two of which are very hard.
- Austerity in the form of sharply curtailed federal spending, even more draconian than that proposed by the deficit commission (recalling that 1% gap), one that generates an ongoing small surplus dedicated to reducing that mountain of sovereign debt (thirteen trillion $ and rapidly growing).
Restructured federal spending guided by two overriding principles: [a] protecting the core functions of the government, national and homeland security, crime control law and justice, achieving all possible efficiencies; [b] redirecting the remaining expenditures, as feasible, to promote, not hinder, productive commercial activity.
- Improve federal revenues using measures that encourage and strengthen the profitable commercial activities that generate private income.
The key is the Third Element. It consists in strongly implemented policy changes, small and large, local and national, aimed at the liberation of the private economy from the bureaucratic shackles and restrictions that have attached themselves over the last half century like barnacles on the hull of a swift sailing vessel. Collectively, these constitute the political load on commerce. The good news is that, cumulatively, their burden is so severe that their amelioration (especially in the context of a long term reform platform that allows businesses to plan) will have a swift and measurable positive effect on the entire economy.
Going in the proponents of element three need to be forewarned that almost every micro-liberation will stir up opponents linked to vested interests and energize politicians and activists willing to fight with every means at their disposal to preserve the status quo.
Here is just one excellent example. The USA contains the largest, easily extracted coal reserves on planet earth. It is said that we are the Saudi Arabia of coal. There are relatively clean technologies by which coal can be converted into natural gas that then can be exported at a profit and used locally for relatively clean electricity generation and even for significantly cleaner automobile engines, whether in a hybrid or used directly. Most of the obstacles to an energy boom based on American coal are regulatory, of federal origin, the product of well-meaning idealism, the result of which is development paralysis.
Setting aside any issues you might have with coal development, this story about the political load on commerce is replicated in a wide range of other situations across the entire economic landscape in the USA and in Europe. Surely, in the name of economic survival and the revitalization of a sick economy we can find substantial areas of agreement.
This leaves the not-insignificant “how” questions. As luck with have it, the same political and ideological trends that have imposed a suffocating political load on commerce have generated a powerful legal tool to lift that burden. As I will develop more fully in the next scheduled article, Breakout, Part Two, THE THIRD ELEMENT, the power of the federal government to regulate interstate commerce has been expanded over the last century such that not a sparrow falls in the woods without creating an interstate commercial ripple. This has enabled the federal government to criminalize the production of a cannabis sativa plant is one’s own backyard for sale to neighbors on the grounds that a gram of ganja might find its way into the stream of interstate commerce. It follows that what the government has accomplished using the commerce clause, (Article I, Section 8, Clause 3 of the US Constitution) can be modified, repaired or undone by the same means.
Jay B Gaskill is a California lawyer who served as the Alameda County Public defender before her left his “life of crime” to devote full time to writing. His profile is posted at www.jaygaskill.com/Profile.pdf .
 See the Heritage foundation evaluation by A. A Fraser — http://www.heritage.org/research/reports/2010/11/bowles-simpson-commission-co-chair-report-a-good-and-welcome-first-step
 Spending trends since 1990: http://www.heritage.org/research/reports/2010/06/federal-spending-by-the-numbers-2010. See also– http://www.whitehouse.gov/sites/default/files/omb/budget/fy2005/pdf/hist.pdf
 Under Ronald Reagan’s presidency GDP grew from a negative .3% to a positive 41.%, but the national debt went from $900 billion to $2.8 trillion.