We can’t afford this. As of November, 2008 our debt crossed the $10.8 Trillion mark. This debt comprises 71% as a percentage of GDP and does not include the federal guarantees made since last June nor does it include the estimated $2 Trillion in debt between the recently agreed to spending bill and the proposed bank bailout to be debated next week. The following chart shows that we’ve been here before but what is different this time makes this increasing percentage of debt unsustainable.
The Root Cause. On August 15, 1971 Richard Nixon decoupled the US dollar from the gold standard. This began a period where the dollar no longer held an intrinsic value but became worth what the issuer said it was worth, hence a “fiat” currency. This decoupling allowed the US, freed from the fiscal restraints of gold-based currency to issue debt as it pleased, based on the creditworthiness of the issuer. In the ‘70s, ‘80s and ‘90s this wasn’t a problem since the US enjoyed a Triple-A credit rating and each dollar or Treasury Bond was backed by the “full faith and credit of the United States,” and debt to GDP hovered around 30-40%.Things have changed. Compared to a post-war expansionary period that produced unprecedented growth, we no longer have the means to expect the kind of growth in GDP that we previously enjoyed. In post-war America there was the absence of a looming crisis in entitlement programs we now have. These entitlements make up an additional 400% of current GDP which will certainly affect our ability to sell more debt through US Treasuries. In fact, just last week the NY Times reported that China is “losing its taste for US debt” and the Federal Reserve is assuring us that it is prepared to buy US Treasuries if it needed to, which could be problematic in much the same way as writing youself a check to cover your credit card payment. Japan, the second largest holder of US debt is also pondering a reduction in the purchase of US debt.
With foreign investors rightly shying away from even more purchasing of US debt, the only way we can finance both the spending bill and next week’s bank bailout, part II is to issue dubious treasury notes. If no buyers are found and the Federal Reserve has to buy these notes, interest rates are sure to rise and the value of the dollar is almost certain to halve from today’s value once the current deflationary environment ends.
Non-stimulus Contrary to congressional opinion, this economy does not need to be “jump-started” by expanding the social programs offerings that we can’t afford, that will be “paid for” the same way that helped to bring about the current mess we are in – by selling US debt, assuming that buyers of nearly $2 Trillion in US debt exist.
Two things: 1. The deflationary environment we’re experiencing is psychologically based, or at least it began that way. Currently, those of us who still have jobs are worried we might not keep them much longer. That’s why we’re not spending and that is what is leading to more and more job cuts each month. This deflationary spiral will not end until the social mood improves. 2. 70% of our economy is based on the consumer so the way to stimulate the economy is to get people to spend. To get the folks to spend we need to get them back to work. To get them back to work we need to encourage employers to hire back the millions that have been laid off. Employers can’t hire back people that they can’t pay and they can’t pay these people with the credit markets the way they are. So it stands to reason that if the government truly wants to help with the crisis, they need to unfreeze the credit markets first and foremost.
After the credit markets have thawed we need to promote economic growth. At the risk of starting a political fight here, economists across the country agree that permanent tax cuts, not temporary tax rebates are the best avenue for promoting economic growth. Specifically, a permanent reduction in the corporate income tax to reduce the cost of doing business and a cut in the capital gains tax to encourage capital investment would be all that we need to do.
Bringing domestic growth back to a respectable level of around 2-3% should be primary, not building tennis courts in Bryan, FL ($1.4 Million), providing light bulbs in Hollywood FL ($8 Million), resuscitating Amtrak ($10 Million), or buying digital TV converters ($600 Million), among many, many other trivial items and pork projects that have no stimulus effect whatsoever. When we’re back to where we should be, then we can look into providing the means for American television sets to tune into digital television signals. But let’s not delude ourselves into thinking this spending program will “stimulate” anything regarding the economy. We cannot spend out way out of this!
“We have tried spending money. We are spending more than we have ever spent before and it does not work.” – FDR’s Treasury Sec. Henry Morgenthau Jr., architect of the New Deal.
