Long-term yields for U.S. Treasuries should indeed firm but be tempered by a slowing as this phase o...
Honey, we bankrupted the kids!
02/09/2010 7:30 am EST
Good. You should be worried. Maybe then we’ll do something about the problem before it’s too late.
First, here’s the good news for those of us who live in the United States. (If you live in some other den of fiscal iniquity, just remember that the names of the characters may be different but the story is pretty much the same.)
The Federal budget deficit for fiscal 2010 (including a proposed $100 billion for new spending to create jobs) will be a record $1.6 trillion. This new record will beat the old post-World War II record (set in the distant past of fiscal 2009) by $150 billion. The 2010 budget deficit is equal to 11% of U.S. GDP. (For reference the budget deficit that has pushed Green into crisis is equal to 12.7% of Greek GDP.)
How can this possibly be good news? Because the new budget proposed by the Obama administration for fiscal 2011 (that’s the fiscal year that starts in October 2010) says the annual deficit will shrink to 4% of GDP by fiscal 2014.
And now for the bad news.
Ain’t gonna happen. At least not if we follow the spending and taxing policies laid out in the Obama administration’s budget.
That budget assumes 2.7% GDP growth in fiscal 2010. That’s reasonable. It’s certain close to the consensus among economists for this year.
But looking out toward fiscal 2014 the budget quickly arrives in fantasy land. The budget projections assume GDP growth of 3.2% to 4.3% for six consecutive years.
And this at a time when most economists—even the optimists at the Federal Reserve—are worried that this recovery will be weaker than most recoveries after a recession and that the long-term speed limit for growth in the U.S. economy is headed lower. From 1975 to 1995 full trend economic growth in the United States was about 3%. The Fed now estimates the speed limit to growth at 2.5%. Other economists, including those at the Congressional Budget Office, think it’s even lower at 2.3% annually or so.
In other words the U.S. can’t grow itself out of this hole nearly as easily as the Obama administration wishes.
Slower growth after the recession is one thing arguing against an easy solution—but it’s by no means the only problem.
The interest rate the U.S. pays on its debt is rising—just when the amount of debt has soared.
Cutting the budget looks—how shall I put it—impossible because our government, especially our wonderful Senate, is locked in gridlock. I find it hard to imagine how the Senate will even pass any kind of budget this year.
And even in the best of all political worlds, cutting the budget is hard. Only 40% or so of the Federal budget is what’s called discretionary (and that 40% includes the military budget.) the rest consists of entitlements such as Social Security, Medicare, and Medicaid. These entitlements are the hardest part of the budget to cut—and the fastest growing.
And we don’t have a huge window in which to act.
In my January 8, 2009 post http://jubakpicks.com/2010/01/08/the-u-s-and-the-rest-of-the-developed-world-is-near-the-point-where-debt-takes-a-big-bite-out-of-growth/ I wrote about research that argues that when a country’s accumulated gross debt rises above 90% of GDP it starts to reduce a country’s economic growth rate by a median of 1 percentage point and an average of 4 percentage points. On current trend the United States will show a debt to GDP ratio above 100% by 2012.
A slower economic growth rate caused by high debt levels makes it even harder to grow your way out of the hole.
And then, of course, there’s the long-term demographic trend. The United States is an aging country. We’re not aging as quickly as most of the developed world such as Japan and France and we’re not even aging as fast as some part of the developing world such as China. (For more on how the world is aging see my post http://jubakpicks.com/2010/02/05/how-to-build-a-global-portfolio-what-countries-do-you-want-to-own/ ) but aging relatively slowly doesn’t help in this situation. A country that is aging in absolute terms is getting older and can look forward to a slower rate of economic growth.
If all this makes the situation sound depressingly grave, I’m afraid I’ve got even worse news. The traditional solution the world has developed for fixing this kind of debt problem when it’s the result of a few years of financial mismanagement doesn’t work very well when we’re looking at a deeper and chronic problem shared by many of the world’s countries.
You can see the traditional solution—I’ll call it the IMF (International Monetary Fund) solution since the formula is one that the IMF has applied to developing countries for decades—in the plan proposed by the Greek government to end its financial crisis. To get the annual deficit down from 12.7% of GDP to 3% by 2012, the government has proposed cutting wages for all public sector jobs, cutting public sector jobs, cutting wages in the private sector to restore the economy’s global competitiveness, and raising taxes and cutting entitlement payments.
Aside for the high level of pain in such a “solution,” it’s not clear to me that the IMF formula can work when applied across the entire global economy. The plan really boils down to cutting wages so that the economy can export its way out of debt (while at the same time reducing the growth rate of that debt by cutting spending.
The entire globe growing its way out of debt by cutting wages and export more runs into a major problem: Where are the buyers if wages are down across the world? (For more on whether the Chinese consumer can save the global economy see my post http://jubakpicks.com/2010/02/02/can-the-chinese-consumer-save-the-global-economy/ )
According to some number crunching from Barclay Capital the IMF formula wouldn’t have to be that painful in the United States. The U.S. is comparatively lightly taxed (Shh! Don’t tell anyone in Washington) compared to its peers. Taxes in the United States come to just 27% of GDP on average over the last 20 years. In 2008 the figure for other developed countries in the Organization for Economic Cooperation and Development was 41%.
All then U.S. would have to do to start down the path toward reducing its deficits and the debt to GDP burden would be to raise taxes to 35% of GDP, freeze Social Security payments at current levels, and cut spending on everything else across the board.
That might be less painful in the short run, but 1) it’s hard to see how that big a tax hike wouldn’t reduce economic growth—you’re talking about taking money out of the economy to pay down debt, remember—and 2) if cutting spending in the United States was that easy we wouldn’t be in the hole that we’re in.
The traditional solution isn’t the only way out. If we could find some way to increase productivity, then we’d get more economic growth and have to raise taxes and cut spending less.
It’s not out of the question. Productivity in the United States has fluctuated widely in recent decades. From 1979-1990 U.S. productivity grew by a slow 1.4% annually. From 2000-2008 productivity grew at a 2.5% annual rate. And from 1995-2000 productivity grew an annual 2.8% rate.
Unfortunately, even if we’re measuring productivity accurately—and it’s not clear that we are—it’s hard to come up with solutions that raise productivity in the short run. Improved education, better in-career retraining so that workers stay unemployed for less time, more access to life-long education and training, and credits that improve the quality of the tools and equipment that workers use all work in the long run, although the research differs on exactly how much they contribute to raising productivity and over what period of time.
There’s no reason not to try these long-run solutions. They might help in the short-run too and the problem is certainly big enough and long-lasting enough that help that arrives in 2020 is still likely to be desperately needed.
In the short-run, though, probably the biggest help would be credible fiscal leadership. International investors and the bond markets need to be convinced that the U.S. is serious about fixing this problem and that it has a credible plan for a solution.
A big part of the crisis in Greece results from the bond markets not believing in either the government’s plan or its ability to deliver it.
The U.S. could easily wind up in crisis over the same lack of credibility.
I’m not hopeful that enough politicians in Washington will put aside their short-term goals for the 2010 elections long enough to come up with a budget plan. After all the Senate couldn’t even pass a proposal to set up a commission to recommend cuts that couldn’t take effect until fiscal 2012.
So I’ve started scouting around for a T-shirt I can give to my kids. It would read “My parents bankrupted the global economy and all I got was this lousy T-shirt.”
It’s not as good as a secure financial future, but, hey, it may be the best my generation can deliver.
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