Downgraded Outlook

When is bad news good?  It makes that transition when it alerts us of a problem that is resolvable.  On Monday, the rating agency Standard and Poor’s downgraded the outlook for the United States federal government from stable to negative because they believe that there is a significant risk that elected officials may not reach an agreement that addresses the country’s long-term fiscal imbalances caused by unfunded entitlement programs (“S&P Affirms US AAA Rating, Cuts Outlook to Negative”). 

Some believe that the political class is so polarized that compromise is impossible.  Others, knowing that voters to not like cuts in benefits nor increases in taxes and that any serious plan will require one or both, believe that any serious plan to resolve the problem offered by one party will be used as an effective campaign issue against the other.  Good politics usually trumps serious economic reform.

The Chinese government sees the problem.  As one of America’s biggest creditors with about 2 trillion in exchange reserves in dollar denominated assets “China Urges US to Protect Creditors After S&P Warning.”  China is as trapped by our debt as we are.  Any rush to sell dollar denominated assets, like United States Treasury bonds, will quickly lead to a collapse in price seriously damaging the value of remaining Chinese holdings. 

Of course, the impact on the federal government’s fiscal crisis would be monstrous as well. The Greek debt crisis may illustrate the worst case scenario of what we could face.  Greek debt currently has a yield of over 15% on 10-year bonds compared with the German rate of 3.27%, and the U.S. rate of 3.43% (“Greek PM: Ratings agencies running our lives”).  The average maturity of the U.S. government debt is approximately 5 years.  As a back of the envelope calculation, assume all debt is held in five years notes and the yield is 2.25%.  Interest payments comprise approximately 15% of all federal outlays.  If interest rates double to 4.5%, interest payments on the debt would rise to 30% of all current outlays.  If they rose to 10%, interest payments would rise to 60% of all outlays.  If interest rates rose to Greek levels of 15%, interest payments would rise to 100% of current outlays.   

Federal government outlays are currently 24% of GDP.  To maintain current levels of expenditures on all other programs, outlays would have to rise to 44% of GDP if interest rates rise to 15%.  Not to lose the main point, it is the projected growth in unfunded entitlements that threatens our country’s fiscal stability.  Rather than vote against a party that offers need reform, the wise voter will use time as a fulcrum to leverage future cuts in entitlements.    
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Consensus of Economists on the Debt?

(HT Mankiw) Economists believe that the mounting national debt threatens the long term financial stability of the United States.  Cutting waste, a solution from the right and taxing the rich, a solution from the left are inadequate; entitlement programs must be addressed.  Ten former chairmen and chairwomen of the Council of Economic Advisers, four who served Democratic presidents and six who served Republican presidents support the Bowles-Simpson report, “The Moment of Truth,” as the starting point of legislative action involving both parties (Politico, “Unsustainable budget threatens nation”).

While the actual deficit is likely to shrink over the next few years as the economy continues to recover, the aging of the baby-boom generation and rapidly rising health care costs are likely to create a large and growing gap between spending and revenues. These deficits will take a toll on private investment and economic growth. At some point, bond markets are likely to turn on the United States — leading to a crisis that could dwarf 2008…This is your teaser

“The Moment of Truth” documents that “the problem is real, and the solution will be painful.” It is tempting to act as if the long-run budget imbalance could be fixed by just cutting wasteful government spending or raising taxes on the wealthy. But the facts belie such easy answers.

Alice Rivlin, the first Director of the Congressional Budget Office, makes a similar observation (Brookings, “Address the Real Budget Issues”)

Squabbling over federal spending for the few months left in this fiscal year is a distraction from the serious deficit threats of the future. Threatening a costly, pointless government shutdown is just plain silly. Our elected leaders should turn to next year's budget and start sorting out needed government activities from lower priority ones we can live without. The president has offered cuts in long-standing programs to fund investment in future growth within a constrained total. He and Congress should work together to decide what we most want our government to do as we all tighten our belts. This will take hard work and willingness to compromise, not posturing and sound bites.

Even more important, we must also slow the long-term growth of Medicare and Medicaid and make Social Security solvent. We must reform our absurdly complex, inefficient tax code so it raises more money at lower rates. Otherwise, we face a debt catastrophe that could destroy our prosperity and world influence. These tough decisions must involve both parties working together so that neither side can blame the other for what has to be done.

Brave young people are risking their lives in the name of democracy in far places. Can't we show that our democracy works right here right now?

The added emphasis through bolding is mine. 
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Portents of Things to Come?

(HT Drudge Report)  Two articles highlight financial problems in France and Greece.  I believe that they illustrate how difficult it is for a government to cut government spending.  Given the size of our deficits and the growing unfunded entitlements, I fear that the United States is headed for similar social conflict.  From France, some protesters are not concerned with the consequences of mounting deficits (“French strikers, marchers defy Sarkozy on pensions.”)

PARIS (Reuters) - Striking public sector workers disrupted travel across France on Tuesday and sporadic violence flared at protest marches as opponents of President Nicolas Sarkozy's pension reform made a last-ditch attempt to stop it.

Refinery workers, airport staff, train drivers, teachers, postal workers and guards who supply cash machines went on strike and students set off rowdy protests in a day of action against plans to raise the minimum retirement age to 62 from 60.

At least a million protesters demonstrated in cities across France in the biggest and most persistent challenge to economic reforms anywhere in Europe, where governments are struggling to curb budget deficits and reduce debt mountains.

"To hell with the national debt. We'll give them nothing and we don't give a damn about their AAA!" read one protest sign, referring to the AAA credit rating the government says could be at risk unless it gets its pension shortfall under control.

From Greece, budget cuts are also protested (“Riot police, protesters clash at Acropolis.”)

Greece is in the midst of a tough austerity program which has cut public workers' salaries and trimmed pensions in an effort to pull the country out of a severe debt crisis. The austerity plan has led to a series of strikes and demonstrations as workers' unions protest the cutbacks.

Guards and workers at archaeological sites have long been complaining they are owed months of back pay, and they have shut down the Acropolis before in protest, though usually only for a few hours at a time.

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Rogoff on Debt, Interest Rates, Taxes and Spending

Aki Ito and Jason Clenfield of Bloomberg do a nice job of summarizing Kenneth Rogoff's remarks at a forum in Tokyo in "Harvard’s Rogoff Sees Sovereign Defaults, ‘Painful’ Austerity."  Rogoff does not express much hope for solutions on budgetary problems from the federal government.

Feb. 24 (Bloomberg) -- Ballooning debt is likely to force several countries to default and the U.S. to cut spending, according to Harvard University Professor Kenneth Rogoff, who in 2008 predicted the failure of big American banks.

Following banking crises, “we usually see a bunch of sovereign defaults, say in a few years,” Rogoff, a former chief economist at the International Monetary Fund, said at a forum in Tokyo yesterday. “I predict we will again.”

The U.S. is likely to tighten monetary policy before cutting government spending, sending “shockwaves” through financial markets, Rogoff said in an interview after the speech. Fiscal policy won’t be curbed until soaring bond yields trigger “very painful” tax increases and spending cuts, he said...

“Most countries have reached a point where it would be much wiser to phase out fiscal stimulus,” said Rogoff, who co- wrote a history of financial crises published in 2009. It would be better “to keep monetary policy soft and start gradually tightening fiscal policy even if it meant some inflation.”...

The U.S. government will delay any efforts to contain the deficit until Treasury yields reach around 6 percent to 7 percent, Rogoff said.

“The U.S. is in a state of paralysis in its fiscal policy,” he said. “Monetary policy will tighten first, and I don’t think it’s the right mix.”

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Clinton, Bush and Obama and Budgets

Our political process often highlights the difference between presidential administrations rather than their similarities. I wandered into Bankrupting America, through Cafe Hayek and found a couple of posts on the federal budget that are of interest.  The first, "The Odd Couple: 5 unfortunate similarities between Bush and Obama," gives a backward countdown of the similarities.

5. They love to spend. Bush passed a $3 trillion budget for 2009.  Obama posted a $3.5 trillion budget in 2010.  Bush doubled the debt to almost $6 trillion and Obama’s plans would leave us with an IOU of an additional $8.5 trillion by 2020.

4. They shop at the same stores. Contrary to popular belief, defense and homeland security spending only made up about 40 percent of Bush’s new spending.  He increased spending across most non-defense categories – like education, Medicare, Medicaid, income security and regional development – by four to six times the rate of inflation.  In Obama’s first half year in office, as he demanded a departure from the “investment deficit” years under Bush, these budgets rose another 70 percent or 40 times the rate of inflation.

3. They dabble with stimulants. In 2001 and 2008, Bush spent billions on rebates to stimulate consumer spending.  In 2009, Obama upped the ante with his $862 billion stimulus package.

2. They give sweetheart deals to failing corporations. Obama carried out Bush’s unpopular $700 billion bailout for failing corporations.  Together, the presidents have bailed out over 600 businesses since Spring 2008.

1. They enjoy regulating in their free time. Once again contrary to popular belief, President Bush was the biggest regulator since Richard Nixon.  Under his leadership in 2007, the number of pages of regulation added to the Federal Register reached an all-time high of 78,090  – a 21 percent increase from Bush’s first year.  And spending on regulatory activities rose to $42 billion in 2009 – a 62 percent increase.  Since taking office, Obama has proposed a large and sweeping increase in regulation that many worry could lead to another financial crisis in the future.

The second post, "A quick ode to the relative fiscal restraint of the Clinton years," correctly notes that President Clinton is the odd man out in spending and wishes the former president a speedy recovery from hearth surgery.  I concur. 
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Weisberg on Voters

In "Cruseturner on Democrats and Republicans," I blamed voters for electing officials who promised benefits through government programs that cannot realistically be filled as unsustainable levels of deficits and debt mount.  Jacob Weisberg writing for Slate ("Down With the People") who appears to politically left of center agrees with my hypothesis that voters want the impossible, lots of unfunded government programs, but offers an explanation for the seemingly irrational behavior: voters are ambivalent toward government.  I have no ambivalence, I want a small government sector, but he may be right. 

At the root of this kind of self-contradiction is our historical, nationally characterological ambivalence about government. We want Washington and the states to fix all of our problems now. At the same time, we want government to shrink, spend less, and reduce our taxes. We dislike government in the abstract: According to CNN, 67 percent of people favor balancing the budget even when the country is in a recession or a war, which is madness. But we love government in the particular: Even larger majorities oppose the kind of spending cuts that would reduce projected deficits, let alone eliminate them. Nearly half the public wants to cancel the Obama stimulus, and a strong majority doesn't want another round of it. But 80-plus percent of people want to extend unemployment benefits and to spend more money on roads and bridges. There's another term for that stuff: more stimulus spending...
...Increasingly, the crucial distinction is between the minority of serious politicians in either party who are prepared to speak directly about our choices, on the one hand, and the majority who indulge the public's delusions, on the other. I would put President Obama and his economic team in the first group, along with California Gov. Arnold Schwarzenegger. Republicans are more indulgent of the public's unrealism in general, but Democrats have spent years fostering their own forms of denial. Where Republicans encourage popular myths about taxes, spending, and climate change, Democrats tend to stoke our fantasies about the sustainability of entitlement spending as well as about the cost of new programs.

Our inability to address long-term challenges makes a strong case that the United States now faces an era of historical decline. Our reluctance to recognize economic choices also portends negative effects for the rest of the world. To change this story line, we need to stop blaming the rascals we elect to office and start looking to ourselves.

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Ideas to Reduce the Deficit

David Rogers writes that the Obama administration will attempt to join deficit hawks (David Rogers, "Obama endorses deficit commission plan," Politico, Jan. 23, 2010).

...President Barack Obama formally endorsed legislation Saturday creating an independent commission with the power to force Congress to vote on major deficit reduction steps this year, after the November elections.

Although I applaud efforts to reduce the deficit, I can't resist the cheap shot that the votes will be scheduled for after the election.  Apparently, most members who support reducing deficits believe that it will be unpopular with constituents.  If our elected officials are correct, and there is evidence to suggest that they are, it is our fault and not theirs.  Here are just a few ideas that the independent commission might consider that I believe will reduce the deficit and/or increase the dynamic efficiency of the economy.

1.  Do away with the Selective Service System (SSS).  I know that this is small fry but their is no need for ongoing registration of young men when we have an effective volunteer army and no prospects for a war that would require a draft.  If we were ever endangered, the SSS could be reestablished quickly.  Besides, I am tired of hearing commercials telling young men of the governmental benefits that they would lose if they don't register. 

2.  Sell the TV band spectrum, raising between $40 and $60 billion and creating consumer benefits in excess of $50 billion annually.  The sale of this spectrum would have the additional benefit of unleashing innovation of a creative sector of the economy (Thomas Hazlett "A letter to the new FCC chair, Mr Julius Genachowski," Financial Times, June 2, 2009).

3.  End all ethanol subsides including the forced use of ethanol as a gasoline additive saving taxpayers an estimated $5 billion annually.  Consumers would benefit from lower cost fuel and a cleaner environment (John Stossel, "The Many Myths of Ethanol," Real Clear Politics, May 23, 2007 and Jeff St. John, "Corn Ethanol's Subsidy Glut," greentechmedia, Jan. 9, 2009).  While we are at it, we should end all price subsidies to farmers. 

4.  Repeal Sarbanes Oxley.  The bill was passed as emergency legislation in response to a couple of giant accounting sandals.  Compliance costs are high, particularly for small firms that are more likely to be innovative, and benefits are low.  Ivy Xiying Zhang estimates that the bill lowered stock market values by $1.4 trillion ("Economic Consequences of the Sarbanes-Oxley Act of 2002," Feb. 2005).  Roberta Romano suggests that, "The paper's conclusion is that SOX's corporate governance provisions should be stripped of their mandatory force and rendered optional."  ("The Sarbanes-Oxley Act and the Making of Quack Corporate Governance," Yale Law Journal, Vol. 114, 2005).

5.  Repeal corporate average fuel economy (CAFE) standards.  They are an expensive way to promote vehicle fuel efficiency.  If the country desires a more efficient fleet, raise taxes on gasoline (Robert Crandall, "Don't Drink the CAFE Kool-Aid," Brookings, Jan. 25, 2010).

My list is just a start not even touching on non discretionary policy.  Feel free to disagree with my list or add items of your own.
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Bernanke As A Deficit Hawk

Craig Torres and Brian Faler writing in "Bernanke Warns Deficits Threaten Financial Stability (Update4)," for Bloomberg on June 3 describe Federal Reserve Chairman Bernanke's most recent comments before the House Budget Committee.  I have bolded several phrases to highlight the Chairman's concern is long term, that deficits, if not dramatically reduced, will affect long term financial stability and economic growth.  Deficit reduction must come from increasing taxes or reducing spending.

Federal Reserve Chairman Ben S. Bernanke said large U.S. budget deficits threaten financial stability and the government can’t continue indefinitely to borrow at the current rate to finance the shortfall.

“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,” Bernanke said in testimony to lawmakers today. “Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance.”...

...He said the Fed won’t finance government spending over the long term, while warning that the financial industry remains under stress and the credit crunch continues to limit spending...

The budget deficit this year is projected to reach $1.85 trillion, equivalent to 13 percent of the nation’s economy, according to the nonpartisan Congressional Budget Office.

“Either cuts in spending or increases in taxes will be necessary to stabilize the fiscal situation,” Bernanke said in response to a question. “The Federal Reserve will not monetize the debt.”...

Rising government spending, forecasts for a record fiscal deficit and an unprecedented expansion of central bank credit have also fueled investor concerns that inflation will rise. Bernanke said inflation “will remain low” as the economy operates with slack resource use.

I have a modest suggestion for cutting spending now.  Recent improvement in economic conditions is not a result of February's emergency $787 billion stimulus package.  As Russ Robert reports at Cafe Hayek, only $36.7 billion of the stimulus has been spent.  Take President Clinton's budget director Alice Rivlin's advice and divide the stimulus into immediate stimulus measures and long term transformative spending.  Take more time examining the transformative spending.  Most if it can be cut.  Rivlin's advice is not draconian as it would preserve much of the stimulus, but acknowledges weaknesses of fiscal policy: it crowds out private investment lowering long term economic growth, is slow to evolve, and almost always results in wasteful spending.  
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Red Ink Outlining His Carbon Footprint

(HT Drudge) President Obama kept a promise of a night on the town to his wife this weekend, apparently on the American taxpayers' dime.  Charles Hurt and Stefanie Cohen describe the promise and the date ("Obama Keeps His Big Apple Pledge," New York Post, May 31, 2009).

"I am taking my wife to New York City because I promised her during the campaign that I would take her to a Broadway show after it was all finished," the president said yesterday after touching down at JFK for an intimate night on the town.

By the way, did anybody calculate the Obama's carbon footprint for the night?

Taxpayers footed the bill for the big night on the town, which included a total of at least $24,000 for the three aircraft used to ferry the Obamas, aides and reporters to New York and back. Dinner costs and orchestra seat tickets -- at $96.50 apiece -- were paid by the Obamas.Obama's jet, a Gulfstream 500, served as a more modest Air Force One for the day in place of the customary presidential Boeing 747.

The White House declined to say how much the trip was costing taxpayers.

Is a night on the town worse than a weekend at the Crawford ranch?  Of course not, but a little modesty by a president ready to micro manage our lives would be nice.  A president preparing a cap and trade program to curtail our carbon footprint could easily be tracked from Washington to Broadway by following his.  A president who lectured American consumers and business for their profligacy spending painted the town red using only a drop in an ocean of red ink from his own deficit.  I found the night on Broadway, tone deaf.
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Obama Administration Concerned About Deficit?

Treasury Secretary Timothy Geithner is in China to reassure them that the Obama administration will work hard to close the budget deficit.  Rebecca Christie, "Geithner Tells China U.S. Will Tackle Budget Deficit (Update2)," (Bloomberg, June 1, 2009) describes the trip.

Treasury Secretary Timothy Geithner told China that the U.S. wants to shrink its budget gap as soon as an economic recovery takes hold, reassuring the nation that is the biggest holder of U.S. government debt.

The U.S. goal is a deficit of “roughly 3 percent” of gross domestic product from a projected 12.9 percent this year, Geithner reaffirmed today in a speech in Beijing...

The U.S. will need to phase out the tax cuts and bank rescue programs set up to help the economy recover from a deep recession, Geithner said. Spending cuts also will be needed, along with health care reform and new budget constraints like pay-as-you-go rules.

I have a hard time believing that the Obama administration has come to grips with the size of the deficit or that the deficit is deemed a major problem.  In the third paragraph that I quoted, Geithner refers to health care reform as a method of reducing the deficit.  A good, short Washington Post article, "Health Reform's Savings Myth," May 31, 2009, lists several reasons why it will do just the opposite (HT Mankiw).  I quote just one.

"Health-care reform is entitlement reform" has become a mantra of the Obama administration. The idea is that Congress can add a massive health-care program this year -- covering the uninsured -- and use the same measures that pay for the health reform to fix the broader budget problems. If that sounds too good to be true, there's a reason.

...It's true that Congress doesn't much like all-pain-and-no-gain policies. But the administration's proposal, even before Congress gets to work, is to spend $100 billion more on coverage while finding cost-saving measures worth only about a third as much. Another third would be paid for by tax increases. The last third, so far, isn't paid for at all. That's three times as much sweetener as medicine, in other words -- and Congress will be tempted to jettison some of the savings and all of the tax increases.

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We Are Out of Money Now

From the Drudge Report, "We're Out of Money," May 24, 2009.

In a sobering holiday interview with C-SPAN, President Obama boldly told Americans: "We are out of money."

C-SPAN host Steve Scully broke from a meek Washington press corps with probing questions for the new president.

SCULLY: You know the numbers, $1.7 trillion debt, a national deficit of $11 trillion. At what point do we run out of money?

OBAMA: Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we've made on health care so far. This is a consequence of the crisis that we've seen and in fact our failure to make some good decisions on health care over the last several decades.

In one short paragraph, President Obama pronounces that the government is broke, ducks blame and passes the the buck to elected officials over the last several decades.  Does anyone smell a tax increase to fund medical care reform?

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Cut Spending, Increase Taxes, Or Do Nothing?

Robert Schmidt reports on concerns expressed by Treasury Secretary Timothy Geithner ("Geithner Vows to Cut U.S. Deficit on Rating Concern (Update2)," Bloomberg, May 22, 2009).

Treasury Secretary Timothy Geithner committed to cutting the budget deficit as concern about deteriorating U.S. creditworthiness deepened, and ascribed a sell-off in Treasuries to prospects for an economic recovery.

“It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term,” Geithner said in an interview with Bloomberg Television yesterday. He added that the target is reducing the gap to about 3 percent of gross domestic product, from a projected 12.9 percent this year.

The dollar extended declines today after Treasuries and American stocks slumped on concern the U.S. government’s debt rating may at some point be lowered. Bill Gross, the co-chief investment officer of Pacific Investment Management Co., said the U.S. “eventually” will lose its AAA grade.

To close the deficit, our elected officials can cut spending or increase taxes.  Of course, they can also do nothing and let the large deficits fester.  Which course will they follow? 

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A Less Rosy Budget Projection

Roger Runningen and Hans Nichols of Bloomberg ("Obama Says U.S. Long-Term Debt Load ‘Unsustainable’ (Update2)," May 14, 2009) report that,

President Barack Obama, calling current deficit spending “unsustainable,” warned of skyrocketing interest rates for consumers if the U.S. continues to finance government by borrowing from other countries.

Earlier this week, the Obama administration revised its own budget estimates and raised the projected deficit for this year to a record $1.84 trillion, up 5 percent from the February estimate. The revision for the 2010 fiscal year estimated the deficit at $1.26 trillion, up 7.4 percent from the February figure. The White House Office of Management and Budget also projected next year’s budget will end up at $3.59 trillion, compared with the $3.55 trillion it estimated previously.

Two weeks ago, the president proposed $17 billion in budget cuts, with plans to eliminate or reduce 121 federal programs. Republicans ridiculed the amount, saying that it represented one-half of 1 percent of the entire budget. They noted that Obama is seeking an $81 billion increase in other spending.

Constrained by the recession, President Obama must balance the cost of his ambitious reorganization of government priorities with tax revenues on the one hand with the difficulty in cutting existing programs on the other.  As noted in an earlier post, legislators of both parties oppose the proposed $17 billion in budget cuts.  Apparently, all spending is sacred. 
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