James Pethokoukis

Politics and policy from inside Washington

Taleb: Suck it up, America!

Sep 16, 2009 14:25 UTC

Nassim Nicholas Taleb (via The Globe and Mail) on why the banks should not have been bailed out and why China should not buy our bonds:

Today we still have the same amount of debt, but it belongs to governments. Normally debt would get destroyed and turn to air. Debt is a mistake between lender and borrower, and both should suffer. But the government is socializing all these losses by transforming them into liabilities for your children and grandchildren and great-grandchildren. What is the effect? The doctor has shown up and relieved the patient’s symptoms – and transformed the tumour into a metastatic tumour. We still have the same disease. We still have too much debt, too many big banks, too much state sponsorship of risk-taking. And now we have six million more Americans who are unemployed – a lot more than that if you count hidden unemployment. …  A lot of the growth of the past few years was fake growth from debt. So swallow the losses, be dignified and move on. Suck it up. I gather you’re not too impressed with the folks in Washington who are handling this crisis.

Ben Bernanke saved nothing! He shouldn’t be allowed in Washington. He’s like a doctor who misses the metastatic tumour and says the patient is doing very well. The first thing I would tell Chinese officials is, how can you buy U.S. bonds as long as Larry Summers is there? He’s a textbook case of overconfidence. Look what happened to Harvard’s finances. They took a lot of risk they didn’t understand, and it was a disaster. That’s the Larry Summers mentality.

The government bubble

Sep 14, 2009 18:51 UTC

Ed Yardeni gets it right, again:

Central banks, including the Fed, caused the housing bubble. Now they are once again conspiring to inflate the next bubble, i.e., the US Government Bubble. Over the past 12 months through August, they purchased $868.9bn of US Treasuries. Over this same period, the federal deficit totaled $1332.6bn and publicly-held federal debt soared $2005.0bn. This helps to explain the most recent conundrum in the bond market, i.e., why yields remain so low despite huge current and projected federal budget deficits.

The question is how much longer will foreign central banks be willing to fund so much of the US government’s deficit? By funding the housing bubble in the US, they were benefitting their exporters. Now, they are increasingly funding the expansion of the social welfare state in America. How will we ever be able to repay their generosity?

Inflate away the debt? Yes, that is a stupid idea …

Sep 11, 2009 14:53 UTC

As Bruce Bartlett correct observes:

Although it is thought that inflation is an effective way of
reducing the burden of debt, this is no longer true. For one thing, a
declining portion of the debt is financed with long-term securities.
Today, just 3% of the debt consists of bonds with maturities of 20
years or more; 10 years ago, the proportion was four times greater. To
the extent that the debt consists of short-term securities that must
constantly be rolled over, inflation does nothing to erode its value
because interest rates just rise to compensate, raising interest
payments and borrowing, thus maintaining the real value of the debt.

Inflation
will also cause the dollar to fall on international markets, which will
cause foreigners to dump their bonds. With foreigners now owning more
than 50% of the privately held debt, this may force the Treasury to
issue foreign currency denominated bonds. At this point, our finances
will effectively be controlled by foreigners and the International
Monetary Fund (IMF), just like Third World countries.

No one knows the point at which debt becomes unsustainable. According to an IMF report,
the critical point is when a government is borrowing just to pay
interest on the debt. According to the CBO, we will reach that point in
2019 when the federal government is expected to borrow $722 billion and
its net interest expense will also be $722 billion.

COMMENT

Thanks! That’s a sobering new perspective. Of course, one should never play cards with a magician…

Posted by Pete Cann | Report as abusive

The worrisome fiscal situation of states

Sep 4, 2009 13:36 UTC

A fun factoid from Gov. Mitch Daniels of Indiana shows just how much trouble states are in (via WSJ):

From 1930 to 2008, our national average annual real GDP growth rate was 3.49%. After crunching the numbers, my team has estimated that it would take GDP growth of at least twice the historical average to return state tax revenues to their previous long-term trend line by 2012.

The consequences of massive budget deficits

Sep 3, 2009 12:38 UTC

The Cleveland Fed gives the bad news:

First, without a correction on the spending side, more tax revenue will need to be raised, with the consequence of subjecting the economy to greater tax-associated inefficiencies.

The risk of default may also increase, leading to higher risk premiums, higher interest payments, and a greater cost to be sustained in the future to address the fiscal imbalance.

In addition, a sustained demand for funds by the government sector will likely put upward pressure on future real interest rates, with adverse consequences for private investment and growth.

The increase in domestic interest rates will likely attract further financial flows from countries with higher saving rates, which may lead to a dollar appreciation and a worsening of our current account deficit.

Do we need a Fiscal Fed for fiscal policy?

Aug 31, 2009 14:05 UTC

Long after the American economy returns to growth mode, the national debt will continue to soar. According to the Congressional Budget Office, the national debt — as low as 33 percent of GDP in 2001 — will reach 54 percent of GDP this year and grow to at least 68 percent by 2019. Beyond that, the increasing cost of mandatory social insurance spending will certainly push the U.S. debt-to-GDP ratio ever higher in the decades ahead.

So how will policymakers deal with the debt? Well, at some point they will raise taxes and cut spending. (No inflating away the debt, right? Promise?) Indeed, the inevitability of such actions seems an article of faith among bond investors who continue to lend cheaply to America. But uncertainties remain. Which taxes will be raised? Which programs will be cut? And by how much? And when?

For all the talk about the need for transparency in monetary policy, there is precious little in the area of fiscal policy. And this is most unfortunate. Eric Leeper, an economics professor at Indiana University, argues in a new paper that enhanced fiscal transparency “can help anchor expectations of fiscal policy and make fiscal actions more predictable and effective … Fiscal policy is too important to be left to the vagaries of the political process.”

Of course, the political process is tough to escape in a democracy. Any budgetary limits Congress imposes on itself eventually can and likely will be evaded. But imagine, if you will, an amped-up version of the Congressional Budget Office. Like the Federal Reserve, the chairman and members of this “fiscal council” would be nominated by the president. And they would explicitly be tasked with the authority to recommend, or even set, deficit and debt targets.

The head of the council would regularly testify before Congress, as does the Fed chairman, on the nation’s fiscal soundness and whether particular new policies would make things better or worse. Leeper notes that in 2007 Sweden established an eight-member Fiscal Policy Council that offers an independent, no-holds-barred analysis of whether the government’s fiscal policy objectives are being met and are sustainable over the long term.

A U.S. version, for instance, might testify as to whether Congress is ignoring pay-as-you-go budget rules. Or it might actually set a debt target that Congress would have to vote up or down on. The key here is to create an institution with as high a profile as the Fed’s that can highlight current fiscal policy and its real-world budgetary impacts, as well as solutions.

And if the budget situation continues to deteriorate, the council might even be given the power to set some broad budgetary parameters, such as federal spending increases being limited to population growth plus inflation.

And who would be the first chairman of the Fiscal Council? You could do a lot worse than master communicator, legendary tightwad and respected financier Warren Buffett.

COMMENT

I would like to clarify one important point. The term “Fiscal Fed,” though catchy and alliterative, appears nowhere in my paper and I find it to be counterproductive. Dedemocratizing fiscal policy is not my intent. And suggestions to do so bring to a screeching halt precisely the conversation I’d like to encourage.

The remainder of your column is constructive and does get to the heart of the issues I have tried to raise.

Krugman: U.S. budget is fine if nothing goes wrong. What?

Aug 28, 2009 16:28 UTC

What a weird column from Paul Krugman. He says Americans shouldn’t worry about the ten-year budget forecasts ($9tr debt,  70 percent of GDP) because a) plenty of other nations have had far higher ratios, b) other countries continue to lend to the US, and c) it’s the longer-term liabilities that are the problem.

But at what point do interest rates rise — especially since huge current deficits give markets scant confidence that America is serious about fiscal soundness? And the current deficits make the fixes to entitlements harder to do. Clearly Krugman wants a Stimulus 2.0 program. He should take a look at my plan to create fiscal space in the present by dealing with entitlements now. And heaven help us if we get another financial crisis within the next generation …

COMMENT

I understand your criticisms of his article, but you should look at it two ways.

First, he was emphasizing that we should not reign in various stimuli too quickly, since this could further damage the economic recovery. Second, while US debt will be a high ratio, it must be perceived from a relative perspective. Countries like Japan and Italy, have not collapsed under the weight of massive debt, yet….

I believe Krugman does not want the spectre of future debt to cloud present judgment. While he does endorse addressing long term entitlements in other articles, I think he is not yet comfortable with the current economic rebound, and is still in “staring into the abyss” mode.

He often has many good insights and opinions, but I will admit that lately he has been off his game. Its almost as if since Obama became president, he no longer has a Bush administration to eviscerate. This makes some of his arguments seems contradictory and aimless, like he is just thinking out loud.

Posted by Greg | Report as abusive

The U.S. debt trap: the odds on seven solutions

Aug 28, 2009 16:08 UTC

How will America escape its debt trap? The indispensable Arnold Kling puts some odds on various scenarios. An excerpt:

1. Muddle through. No major change in policy, and no major change in economic growth, but somehow the ratio of debt to GDP remains stable. I give this a 10 percent chance, although it implies that I am miscalculating the path that we are on

2. Technology to the rescue. Some major technologies, probably either wet or dry nanotech, produce so much economic growth that the ratio of debt to GDP stays under control. I give this a 20 percent chance.

3. Policy changes. Congress increases taxes (but does not enact a wealth tax) and/or takes steps to rein in Medicare and Social Security spending.  I give this a 25 percent chance.

4. Inflate away the debt with moderate inflation (between 5 and 10 percent per year). I think this would be politically costly, and it might not be enough to really inflate away the debt (it depends on how quickly bond investors adjust expectations and raise the inflation premium in nominal interest rates). I gives this a 15 percent chance.

5. Wealth tax. The government takes, say, 5 percent of everyone’s personal assets above $100,000. It does this on a one-time basis (or so it says). I give this a 25 percent chance.

6. Hyperinflation. This would certainly expunge the debt, but it would be political suicide.

7. Default. The U.S. simply refuses to pay some or all of its debt.  I think that the combined chances of (6) and (7) are no more than 5 percent, with (7) even less likely than (6).

Me: I think #3 is mostly likely, though I hope #2 happens — and there is a greater chance of that happening than most policymakers realize.

COMMENT

im betting on the gold price. ive taken on many long positions in gold stocks to hedge against the rest of my porfolio. i really beleive that the high level of debt will continue to erode the dollar well into 2020. from this outlook (and the nearly inverse correllation between the gold price and the usdx) i am quite confident. i use http://www.goldalert.com to check the spot gold price. i would definietly recommend gold investment to gain better leverage within the market.

Posted by john major | Report as abusive

America’s perilous fiscal future: slow growth, high taxes

Aug 26, 2009 19:18 UTC

Howard Gleckman over at TaxVox does a great job on the new government budget forecasts. This is my favorite bit (bold is mine):

Even once the economy gets back on its feet, the White House projects spending will settle in at about 23 percent of Gross Domestic Product. That is a substantial increase from the average of 19 percent or so in recent decades, and significantly more than estimated tax revenues. We can try to run deficits of 4 percent of GDP as far as the eye can see, but only if the Chinese continue to help out.

Finally, take a look at both CBO and OMB forecasts of long-term trend economic growth: OMB figures it will be roughly 2.5 percent once all the effects of the recession and the stimulus package wash out. CBO is even more pessimistic. These forecasts are not new, but they are worth keeping in mind. Over the next decade and beyond, the economy will grow significantly more slowly than in recent years, in large part because many more Americans will be retiring than joining the workforce. And that will put growing pressure on fiscal policy.

When Budget Director Peter Orszag and others talk about medical costs being unsustainable, this mismatch between health spending and economic growth is exactly what they have in mind. In the decade 1998 to 2007, both Medicare and Medicaid grew at more than 7 percent per year. And you don’t need to be an economist to understand what will happen if medical costs keeping rising at 7 percent while the resources to pay for them grow at only 2.5 percent.

COMMENT

I suggest we put the “Logan’s Run” scenario on the table to fix this issue.

Posted by Idea | Report as abusive

10 reasons why the next budget debate will be a doozy

Aug 26, 2009 17:57 UTC

Maybe it should be a trillion reasons. But budget guru Stan Collender paints a picture of the future:

But regardless of who is to blame for the deficit, there’s no doubt that it’s Obama’s responsibility to deal with it. That leads to the most important result of the mid-session reviews: it’s now far more likely that the fiscal 2011 budget debate, which will start next year when the president submits his budget to Congress in late January or early February, will be among the most difficult, vicious, and painful of any that has taken place in the past 30 years.

Here’s why:

1. It will be an election year

2. Partisanship in Washington is much stronger now than it was during any of the previously budget figthts. This includes the Gramm-Rudman-Hollings debate in 1985 and the Clinton-Gingrich debate in the mid-1990s that resulted in government shutdowns.

3. The deficit is much larger now both nominally and as a percentage of GDP than it has been since World War II.

4. The national debt is much larger now than it was when GRH was debated and Clinton and Gingrich sparred. The much greater interest being paid on the national debt will put far more pressure on all other spending in the budget and tax increases.

5. More than 50 Blue Dog Democrats will push the White House to deal with the deficit.

6. The deficit will be a big issue for the first-term Democrats who were elected from what had been Republican districts. They will be facing what could be the toughest reelection battles of their careers and will need to show their constituents that, because of them and their party, some progress has been made on the deficit.

7. The bond market will push for deficit reductions.

8. Foreign creditors, especially the Chinese, will push for deficit reductions.

9. Some on Wall Street and elsewhere will express extreme concern about inflation and interest rates stopping the recovery in its tracks unless deficit reductions are put in place.

10. Obama, who promised deficit reductions once the economy started to recover, will be hard-pressed not to live up to that promise. He will be pressured to do so by the Blue Dogs, many of which supported the White House this year because they were told that the deficit would become a front burner.

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