The Free Thinker

Scoundrels' Last Refuge: Blame Bush

This chart was posted at Daily Kos:

Now, I'm a bit skeptical. How was this made? How does one trace the effects of different policies? But even if, for the sake of argument, we take the chart at face value, it doesn't get Obama off the hook. While Bush was in office, the deficit looked close to sustainable. It was a couple of percent of GDP. If you ignore long-term entitlement liabilities-- which you shouldn't, but that's another story-- it was more or less manageable, normal. Now, I think Bush shouldn't have passed the Medicare prescription drug benefit, should have vetoed a lot more pork, and then maybe we would have had surpluses like under Clinton. But at the time the deficit was a problem, a mistake, but not a national emergency.

Now it is. The deficit is way above any sustainable level. It's driving up interest rates, crowding out private business investment, and spooking the Chinese. And on current trends it's going to stay at unsustainable levels indefinitely. If some of that is because of Bush's policies, Obama should be working on repealing those, e.g., roll back the prescription drug benefit. And/or find new ways to cut spending, or raising taxes. It's Obama's responsibility, and if he doesn't deal with it, he, and the Democratic Congress, deserve the blame.

"The Democrats' senior problem" (Politico):

Democrats have a senior citizen problem.

Frustrated older Americans are packing the town halls on health care. They are incredibly passionate about their Medicare benefits. Polls show senior citizens largely disapprove of health care reform ideas so far.

And of course, they vote — in larger numbers than any other demographic.

But so far, Democrats have focused much of their health care sales pitch on middle-class Americans and the uninsured — a slight that has been noticed by senior citizens, who hold great influence with members of Congress.

At his Tuesday town hall event in New Hampshire, President Barack Obama made a point to reach out to seniors, noting the low support in polls for his health care proposals.

“We are not talking about cutting Medicare benefits,” Obama said, trying to assuage the audience.

But Obama is talking about finding hundreds of billions in savings from Medicare — cuts supporters say will trim fat from the program — including slashing $156 billion in subsidies to Medicare Advantage, a privately administered Medicare program.

“Seniors are one of the most attentive and engaged constituencies, especially on health care issues, and we’ve seen that in the Medicare Advantage programs,” said Robert Zirkelbach, a spokesman for America’s Health Insurance Plans.

A July 31 Gallup Poll found that just 20 percent of Americans aged 65 and older believe health care reform would improve their own situation, noticeably lower than the 27 percent of 18- to 49-year olds and 26 percent of 50-to-64-year-olds who say the same.

The senior citizen problem could pose a serious problem for the 2010 election cycle.

Obamacare will increase the deficit, so it will be good if it fails.  But the reason it's in trouble is disturbing.  This country is ruining itself by spending too much on seniors.  It would be good to see cuts to Medicare, just as it would have been good to get Social Security reform in 2005.  Hopefully the Republicans will not be opportunist and exploit a senior backlash.  But that might be too much to hope for.

"Obama will repeal Medicare" (Dick Morris):

Obama’s health care proposal is, in effect, the repeal of the Medicare program as we know it. The elderly will go from being the group with the most access to free medical care to the one with the least access. Indeed, the principal impact of the Obama health care program will be to reduce sharply the medical services the elderly can use. No longer will their every medical need be met, their every medication prescribed, their every need to improve their quality of life answered.

It is so ironic that the elderly - who were so vigilant when Bush proposed to change Social Security - are so relaxed about the Obama health care proposals. Bush’s Social Security plan, which did not cut their benefits at all, aroused the strongest opposition among the elderly. But Obama’s plan, which will totally gut Medicare and replace it with government-managed care and rationing, has elicited little more than a yawn from most senior citizens.

And this: 

House Democrats announced a plan yesterday that would force the richest 2 million U.S. taxpayers to shoulder much of the cost of an expansion of the nation's health-care system, by imposing a surtax of as much as 5.4 percent on income above $350,000 a year.

About half of the cost would be covered by reducing spending on federal health programs, primarily Medicare, which serves the elderly and the disabled. But much of the rest of the money would come from a new tax on families earning more than $350,000 a year and individuals earning more than $280,000. The taxes, which would take effect in 2011, would affect about 2.1 million taxpayers, the nonprofit Tax Policy Center projected.

Raising taxes, cutting spending.  This seems like a new departure, a move towards responsibility after the recklessness of the stimulus.  It's too bad the savings will finance more spending rather than deficit reduction.  But this would at least put on the brakes to stop the fiscal train wreck that the Obama administration has been so far.

Of course, taxing the rich can have bad effects too, reducing the incentive to work, acquire human capital, take entrepreneurial risks, etc., and diverting money into tax shelters.  But taxes are better than deficits.

Arthur Laffer (WSJ) "Get Ready for Inflation and Higher Interest Rates":

Rahm Emanuel was only giving voice to widespread political wisdom when he said that a crisis should never be "wasted." Crises enable vastly accelerated political agendas and initiatives scarcely conceivable under calmer circumstances. So it goes now.

Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That's more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers' expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid -- are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

One thing to remember, though, is that housing prices have been falling lately.  Housing prices are not included in the price indices; if they were, we would already have seen official deflation.  Rising prices could help mitigate the problems associated with the popping of the housing bubble, and ease the burden of the debt.  Beyond that, further monetizing of the debt would probably be worse than the alternative of tax hikes.  What is desperately needed is to cut government spending and curtail entitlement commitments.  But we're unlikely to see that without a political revolution on the order of 1980 or 1994.

More: "A Red (Ink) Letter Day for Government: $1,000,000,000 in 8 Months" (IBD):

In September 1981, William Proxmire took to the Senate floor for a 16-hour filibuster. The Wisconsin Democrat's purpose was not to stop legislation — he spoke through the night but relinquished the floor at dawn.

Instead, he seized the chamber to focus attention on a momentous act that he was afraid his peers might take too lightly: Congress was considering legislation that would authorize the debt ceiling of the U.S. to exceed $1 trillion for the first time in history.  

On Wednesday, we will likely learn that in the last fortnight, Sen. Proxmire's worries about popular numbness to a fiscally irresponsible government have been realized. We are passing through an even more dangerous threshold. 

Proxmire was fretting over hitting $1,000,000,000,000 in debt — which is the total of all past annual deficits that we haven't yet paid off. This time, we are talking not about our cumulative debt, but about only this year's deficit.

Drowning In IOUs

Just since Sept. 1, when the federal fiscal year began, our leaders have written $1,000,000,000,000 in new IOUs for our children and grandchildren to struggle under. It took two centuries from the nation's founding until the early 1980s for Washington to overspend by a cumulative total of a trillion dollars. We have just accomplished the same feat in eight months. 

Where will this end? 

"History lessons for economists in thrall to Keynes" (Niall Ferguson, FT)

On Wednesday last week, yields on 10-year US Treasuries – generally seen as the benchmark for long-term interest rates – rose above 3.73 per cent. Once upon a time that would have been considered rather low. But the financial crisis has changed all that: at the end of last year, the yield on the 10-year fell to 2.06 per cent. In other words, long-term rates have risen by 167 basis points in the space of five months. In relative terms, that represents an 81 per cent jump.

Most commentators were unnerved by this development, coinciding as it did with warnings about the fiscal health of the US. For me, however, it was good news. For it settled a rather public argument between me and the Princeton economist Paul Krugman.

It is a brave or foolhardy man who picks a fight with Mr Krugman, the most recent recipient of the Nobel Prize for Economics. Yet a cat may look at a king, and sometimes a historian can challenge an economist.

A month ago Mr Krugman and I sat on a panel convened in New York to discuss the financial crisis. I made the point that “the running of massive fiscal deficits in excess of 12 per cent of gross domestic product this year, and the issuance therefore of vast quantities of freshly-minted bonds” was likely to push long-term interest rates up, at a time when the Federal Reserve aims at keeping them down. I predicted a “painful tug-of-war between our monetary policy and our fiscal policy, as the markets realise just what a vast quantity of bonds are going to have to be absorbed by the financial system this year”.

De haut en bas came the patronising response: I belonged to a “Dark Age” of economics. It was “really sad” that my knowledge of the dismal science had not even got up to 1937 (the year after Keynes’s General Theory was published), much less its zenith in 2005 (the year Mr Krugman’s macro-economics textbook appeared). Did I not grasp that the key to the crisis was “a vast excess of desired savings over willing investment”? “We have a global savings glut,” explained Mr Krugman, “which is why there is, in fact, no upward pressure on interest rates.”

Keynes had some genuine, albeit marginal, contributions to make, but where he posed as an antagonist of traditional economics, tradition was generally vaguely right and Keynes was generally guilty of logical or empirical errors.  That economists made Keynes the most influential economist of the 20th century was just a mistake on their part.  Yes, deficits do raise interest rates.

Ricardian Equivalence

"Americans Get Even Thriftier as Fears Persist" (WSJ)

Americans are saving more of their paychecks than at any time since February 1995, a shift toward thrift that could prolong the recession but strengthen the financial health of U.S. households and the overall economy if it lasts.

Even as income grew, personal saving as a percentage of after-tax income rose to 5.7% in April, the Commerce Department said Monday, up from 4.5% in March and well above the zero savings rate reported a year earlier.

The turnaround reflects Americans' deep concerns over the weak job market, declining home values and volatility in the stock market. The saving rate also was boosted by the government's stimulus package, which extended unemployment benefits in many states, and gave most Americans an extra few dollars in their weekly paycheck.

Personal income rose a seasonally adjusted 0.5% in April from March. After-tax income increased $121.8 billion, or 1.1%, due to reduced taxes and increased government benefits for unemployment and other programs. Government stimulus efforts added about $44 billion to American households' after-tax income in April, and households overall increased their saving by $131.5 billion Personal consumption declined 0.1%.

Americans' thrift puts the Obama administration in a quandary. On the one hand, it is preaching the need for Americans to live within their means and exercise more fiscal responsibility. But on the other, to get the economy back on firm footing, Americans need to return to spending, from large-ticket items such as cars to smaller impulse buys like perfume and chocolate.

This is a reminder of the stupidity of what is euphemistically called the "stimulus."  The concept of "Ricardian equivalence," in economics, is the idea that it makes no difference whether government spending is financed by taxes or deficits, because people will just anticipate future taxes and save in order to pay for them.  Strict Ricardian equivalence surely does not hold, but people probably do save more when they're afraid of future tax hikes.  The government and the people are working at cross-purposes: people are trying to secure their futures, while the government is making people's futures less secure by drowning us in debt.

The Deficit

Irwin Stelzer notes that Obama has turned his back on his protectionist stance from the campaign trail:

Nothing the President will do on the trade issue, either to free up the international flow of goods and services, or to tip the scales in favor of American firms, will in the end matter as much as his reckless fiscal policy. His budgets project deficits totaling close to $10 trillion by 2019 -- and that assumes that his health care plan will cost only the $635 billion "down-payment" he has put into his budget, rather than the $1.2 trillion experts are predicting. And that he will succeed in a close-to-freeze on defense spending.

That means the U.S. Treasury will be peddling billions of IOUs to investors such as China which already have trillions of that paper in their vaults and whose "appetite for American debt may be shrinking", according to The Economist. So far, so good: the recession-induced flight from risk has led overseas investors to seek a haven in dollar assets. But as the printing presses keep running overtime, and the recession eases, investors will find the mounting risk of being paid in dollars that have shriveled in value too much to bear.

Which is why the dollar hit its lowest level of the year this week, and why for a while it cost less to buy insurance against a default by hamburger-seller MacDonald's than against a default by the world's only superpower. More important, it is why China and Brazil are trying to cobble a trade deal that will allow them to bypass the dollar completely, and pay in their own currencies. This might well be the first step in China's announced intention to develop a currency to compete with the dollar as the world's reserve currency. If it pursues that goal it might bring to reality the prediction of professors Menzie Chinn and Jeffrey Frankel, of the University of Wisconsin and Harvard University, respectively.

"We find that the euro could overtake the dollar as early as 2015 . When combined with other political developments, it might even spell the end of economic and political hegemony . If the euro were to overtake the dollar in a few decades, it would be a once-in-a-century event. But it happened to the pound in the last century, so who is to say it could not happen to the dollar in this?"

Would it be a bad thing if the dollar hegemony collapsed?  Probably, because it tends to create a lot of financial chaos and impede trade.  How would it affect the US economy if a loss of trust in the federal dollar led to a flight to a private currency, say, Visabucks?  It would probably increase transactions costs and hurt the economy.  A decline of the dollar could do the same thing to the global economy.

On the other hand, I'm starting to think that it's a curse that the US can borrow in its own currency, which just encourages more and more profligate spending.  A compulsive shopaholic might have reason to rejoice if his credit card is cancelled.

UPDATE: Paul Krugman writes:

Last week Bill Gross of Pimco, the giant bond fund, warned that the U.S. government may lose its AAA debt rating in a few years, thanks to the trillions it’s spending to rescue the economy and the banks. Is that a real possibility?

Well, in a rational world Mr. Gross’s warning would make no sense. America’s projected deficits may sound large, yet it would take only a modest tax increase to cover the expected rise in interest payments — and right now American taxes are well below those in most other wealthy countries. The fiscal consequences of the current crisis, in other words, should be manageable.

Those "other wealthy countries" are Western Europe and Japan, which, however, are mostly a good deal (20-30%) poorer than the US, in substantial part because of higher taxes and more anti-competitive regulations, and which free-ride on some global public goods, such as defense and medical innovation, provided by America.  So American voters tend sensibly not to elect politicians who want to hike taxes to European levels.  Barack Obama ran, please note, on tax cuts; indeed, it seems likely that the modal voter knew nothing about Obama's platform except tax cuts, since he said little of substance in his famously eloquent (though the term "vapid" is more apt) speeches, which voters had little incentive to read since they probably suspected, as events have since shown, that the content of the website was mostly either insincere or naive, and was a poor predictor of the policies that would be passed under the new administration.  Obama not only ran on tax cuts, he accused McCain of planning to raise taxes.

Were Obama to raise taxes "modestly" to Western European levels, this would be a diametric reversal of his one salient campaign promise.  The alternative is to cut spending, but since the majority of voters rejected McCain that policy also seems to lack a democratic mandate.  Shamefully enough, I think it would be an undeserved compliment to the voters of 2008 to say they voted for anything other than fiscal recklessness leading to stagflation and, unless we change our minds sometime in the next decade or so, de facto default through inflation and devaluation.