James Pethokoukis

Politics and policy from inside Washington

How Greek debt crisis could save America

May 24, 2010 22:21 UTC

It’s absurd. Uncle Sam is likely to run up an additional $11 trillion in debt over the next decade. But Washington only replies with minor budgetary tweaks. First, the Obama administration says it wants to freeze some domestic spending for three years. Then it creates a new healthcare entitlement program “paid for” through tax increases and unlikely spending cuts. Next up, the Obama administration creates a deficit reduction panel that not even its members think will work. And now the Obama administration wants new “rescission” authority to cut billions from congressional spending bills — excepts it’s “trillions” that are the problem. None of these measures favorably alters the budget’s perilous trajectory.

Little wonder that many observers think Washington will do nothing substantial about the exploding debt problem without some sort of financial market crisis. It is the bond market vigilantes that will come to the rescue and enforce fiscal discipline. Here is one scenario devised by the Committee for a Responsible Federal Budget:

Under this scenario, at some point financial markets or foreign lenders decide we are no longer a good credit risk, possibly due to debt affordability concerns. They conclude the United States cannot escape basic economic and financial “laws of gravity” forever. They stop buying our debt securities or demand dramatically higher interest rates due to increased perceived risk. With the sudden shift and large rise in interest rates, the economy goes into a severe recession. … Unlike the past two years, we cannot, however, borrow to stimulate the economy because the crisis was caused by excessive debt and lost confidence. … Creditors concerned with hyperinflation or even default will not buy U.S. debt.

Presumably, that would be the moment when Democrats unveil their “emergency fiscal plan” to calm markets through a massive value-added tax. It would be TARP all over again. But the costs would be many magnitudes higher. But I think the conventional political wisdom is deeply flawed. First, Americans intuitively understand that there is something deeply wrong about running trillion-dollar budget deficits as far as the eye can see. Maybe deficits didn’t politically matter in the 1980s, but debt as a share of GDP was only 50 percent. Now it is 60 percent only its way to 100 percent in a decade.

This is why we didn’t see a second trillion-dollar stimulus. Although plenty of liberal economists though it was needed, even congressional Democrats understood that Stimulus 2.0 would not fly with voters freaked  by all the red ink.

Second, America doesn’t need a domestic debt crisis. Voters can easily track the one happening with Greece and the EU. Runaway spending. Overpaid civil servants. A loss of confidence. Trillion-dollar bailouts. Falling standards of living. National decline.

That all adds up to a pretty compelling case for action in America. And Republicans (along with fiscally responsible Democrats) who want to see true spending reform — of the sort outlined in Rep. Paul Ryan’s Roadmap for America — would do well to frequently mention Greece on the campaign trail. Kind of a “don’t let this happen to us” sort of thing. They should also note that lower spending plus smart tax cuts to boost growth are the best recipe for restoring fiscal order — not massive tax increases which politicians will only divert to more spending.


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New Obama budget knife a dull blade

May 24, 2010 19:41 UTC

If I was a U.S. taxpayer or holder of U.S. Treasuries, I would not take much comfort from President Barack Obama’s proposed Reduce Unnecessary Spending Act. Points for effort, I suppose. But fast tracking and streamlining the current fiscal process that allows the White House to submit proposed budget cuts from spending bills would do little.

1. As the Heritage Foundation notes, since 1990, presidents have proposed clawing back only $20 billion of legislated spending, with Congress approving just $6 billion of these rescissions. That’s just .01 percent of all federal spending.

2. A study by Douglas Holtz-Eakin, former head of the Congressional Budget Office, found that an even tougher measure, a line item veto, has a poor track record — at least at the state level. (Here is a good summary of research on the topic via the NY Fed.)

Holtz-Eakin noted that in studying the effect of line-item vetoes at the state level, he found they produced mixed results. He found no major differences in spending between states where governors had this power and states where they did not.

3. Some two-thirds of the budget — mandatory entitlement spending would be off limits.

4. Such expanded powers might work in reverse. It would give the White House power to cajole Congress into supporting its spending policies by threatening to cut the pet projects of individual members.

5. To be fair, this new proposal is just another step in controlling spending – not a solution in and of itself. Obama has already proposed a temporary freeze in some domestic programs and created a deficit panel to suggest more comprehensive solutions. The move also keeps the danger of deficits firm in the public consciousness, though Europe’s woes should be reminder enough. But the White House must be careful about deluding the electorate into thinking that current efforts by the government to trim waste will be sufficient. Investors in Treasuries surely expect bolder fiscal action.


An easy way to rout government spending would be a 10-year surge of inflation. For example, between 1973 and 1982 inclusive the US experienced an 85% aggregate increase in the CPI, which translates into sharp cuts in national debt and entitlements spending. Moreover, a national referendum is not even required. More at:

http://wjmc.blogspot.com/2010/05/student -recently-remarked-to-me-that.html

Thank you for the opportunity to comment…

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Mind the (budget) gap

May 24, 2010 19:33 UTC

This Strategas chart shows just how badly things have gone off track:


The danger of small banks

May 24, 2010 17:59 UTC

Binyamin Appelbaum of the NYT tries to simply things for me:  ”Broadly speaking, there were two ways for the federal government to respond to the financial crisis. The Obama administration chose more regulation.”

And that is bad news because regulators and their political overlords like bailouts with taxpayer money rather than market discipline. But shrinking the banks, while superficially appealing, is no magic bullet — as this Italian study argues:  ”A world with only small and domestic banks is no safer. The key benefit of multinational banks – being able to mobilise funds across countries – could still be extremely useful for maintaining stability in times of distress.”

Why Larry Summers may not make it until 2011

May 24, 2010 17:09 UTC

David Warsh dismisses reports that Larry Summers may stick around longer than many in Washington expect:

Defense is one possibility. Who wants to be seen as a lame duck while there are eight months to go on the clock – including the mid-term-elections? Offense is equally likely. No doubt the president would like to keep his chief economic adviser for another eighteen months.  Perhaps the administration is lobbying Harvard.

Summers’ other opportunities weigh in the balance: a successful marriage to Harvard English professor Elisa New (between them they have six children, all from previous marriages); the prerogatives that come with being one of Harvard’s fewer than twenty university professors, including the freedom to teach precisely what and where he wishes (or not at all); membership on the executive committee of an economics department that is one of the three or four best in the nation; and, of course, the famous day-a-week of consulting time that Harvard professors are permitted to spend in the moneyed world.


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Will seniors nix spending cuts to fix deficit?

May 24, 2010 17:08 UTC

My pal Bruce Bartlett says U.S. demographics support his position that America will need massive tax increases rather than massive entitlement cuts to get its fiscal house in order:

In short, what we see is that over the next ten years the percentage of the population that benefits from Social Security and Medicare is going to rise significantly and that this group of the population votes in higher percentages than those that pay for these programs. And those that will, over their lifetimes, bear the heaviest burden of paying for entitlement programs–the young–vote at the lowest rate of any age group.

Me: He might well be correct. Then again, most of the reform plans I have seen pretty much leave the current system in place for those who are, says over 50 or 55. I also don’t understand why a broad-based tax increase would be any more palatable to people than getting their expected benefits cuts. Not to mention that getting spending under control is a better way to restore solvency than tax hikes.