Stiglitz Tells It Like It Is: Deficit Mania’s Got To Stop

Jared Bernstein

Perhaps, given my bias, I should recuse myself from the argument I’m about to make. You see, on our first date, I impressed the woman who is now my wife by convincing her conservative brother-in-law that budget deficits are not always a problem. Such is DC romance.

That was over a decade ago, but the issue remains both contentious and misunderstood. That’s why I was so interested in the recent talk given at the Economic Policy Institute by Joseph Stiglitz, Nobel Laureate economist and all around interesting guy. What’s unique about Stiglitz is not that he always rejects conventional wisdom—he doesn’t. It’s that he looks at in the context of the real world, and often finds it lacking.

Both in his talk and his writings, he seems genuinely and appropriately worried about a mania for balancing budgets. If I could summarize his message in one over-arching thought, it would be: too often, our budget debates mindlessly assume that deficit reduction is the best option, both for us and for other countries with whom we do business. This simplistic, reductionist view is leading both political parties toward a philosophy of fiscal austerity which will have very negative consequences.

The debate is far from academic. Misguided thinking about deficits has led to the two options that form the core of the fiscal debate between Democrats and Republicans: the D’s want to balance the budget by holding down spending and letting (some of) the Bush tax cuts expire, the R’s want to do so by extending the Bush tax cuts and cutting spending, big time. Make no mistake, when John McCain says in a recent speech that he wants to “save entitlements,” he means he wants to save them by shrinking them. These two options have crowded out the third: raise the revenue we need to support that which will make our economy and country stronger.

Stiglitz framed the issue in terms of two pressing problems: a short-term and a long-term one.

First, there’s the fact that the economy is currently growing about one point below its trend (with real GDP growth around 2-2.5% per year instead of 3-3.5%), a problem Stiglitz attributed mostly to the slump in housing and the loss of stimulus from this sector. In this context, taking money out of the economy by pursuing deficit reduction would do more harm than good.

You don’t hit someone when they’re down, and you don’t pursue deficit reduction when the economy is already stressing out. As Stiglitz noted, “The idea that deficit reduction leads to a strong economy was an idea that Andrew Mellon tried in the midst of the Great Depression…the effect, of course was not positive. Then came Keynesian economics.”

In the current context, this is hopefully a short-term problem and one that even some pretty hawkish folks on the deficit will be okay with. The more important question is the longer-term one: what’s the proper role of deficit spending in good times?

Here’s where reductionism—a zombie-like allegiance to balancing the budget—is your enemy. Stiglitz argued “that we should never focus just on deficits, but on broader economic concepts.” What’s the magnitude of the deficit relative to GDP (it’s now a very manageable 2%)? What are we spending it on (we’re wasting far too much of it on the war and tax cuts for the rich instead of accumulating worthwhile assets)? Are we, in the interest of balancing the budget, ignoring important investments that the private sector won’t make?

It’s on this last point where I thought Stiglitz’s message was most important, and it’s where we’re furthest off track. We have large and growing needs for investments that market forces simply won’t make.

We would be much wiser to focus on these deficits: early childhood development and education; access to higher ed for those who ought to be there but can't pull it off; our public health care system, which will absolutely need to expand in coming years as the private, employer-based system unravels; safety nets: programs like unemployment insurance and job training that can help those displaced by globalization; and, one Stiglitz emphasized, environmental policy.

Yet, even the most progressive budget alternatives, such as that of the Progressive Caucus, brag on the fact their budget gets to balance before all the others. This is a disheartening example of Bob Kuttner’s observation about deficits and Democrats: they’ve elevated a defensive tactic—hawkishness on deficits to stave off wasteful tax cuts—to a principle: balance budgets regardless of whether you’re foregoing short-term stimulus or needed investments.

Which brings us to politics.

Since when did Democrats become slavishly committed to fiscal austerity? As Kuttner explains in a recent critical piece about Bob Rubin, much of this comes from the belief that balancing the budget in the Clinton years drove the 1990s boom. When asked about this at EPI, Stiglitz explained that in his view deficit reduction had little to do with it: the boom was more of function of unique conditions in the banking sector that made borrowing cheap and financed an investment boom (that ultimately became a bubble).

Alan Blinder and Janet Yellin (both were top Clinton economists; Blinder was vice-chair at the Fed; Yellin’s there now) take the closest analytic look and are unable to pin the Clinton boom on deficit reduction. Instead, lower health care and energy costs boosted the economy, and, most importantly, productivity accelerated, facilitating both low inflation and interest rates. It was the revenue growth from these developments that balanced the budget, not the other way around.

But urban legends die hard, and Rubinomics, with its emphasis on balanced budgets, still holds sway in the top reaches of Democratic power. Word is that both Hillary Clinton and Obama are listening more closely to Bob than to Joe.

This is too bad, because more than any prominent economist, he understands the damaging limits of fiscal austerity, and the extent to which it undercuts our ability to tackle the big problems of today and tomorrow, from frayed safety nets to depleted ozone, from the war on poverty to the war in Iraq.

So move over Bob, and make room for Joe. We need him, or at least his ideas, at the table too.

Apr 22, 2007 -- 04:41 PM EST

Jared Bernstein joined the Economic Policy Institute in 1992. He is the author of the new book, "All Together Now: Common Sense for a Fair Economy." His areas of research include income inequality and mobility, trends in employment and earnings, low-wage labor markets and poverty, international comparisons, and the analysis of federal and state economic policies. Between 1995 and 1996, he held the post of deputy chief economist at the U.S. Department of Labor. He is the co-author of eight editions of the book The State of Working America and has published extensively in popular and academic venues. He holds a Ph.D. in Social Welfare from Columbia University

SE Asia stocks-Markets stage biggest falls since 1997 crisis

Related
Bernanke Repeats Warnings About Federal Deficits 10:20
---
Reuters
Tue Feb 27, 2007 11:11 PM ET

 By Wee Sui Lee
 SINGAPORE, Feb 28 (Reuters) - Most Southeast Asian stocks
suffered their biggest one-day declines since Asia's 1997
financial meltdown, as investors sold off shares in a panic,
following the slump in global markets.
 Singapore's benchmark Straits Times Index <.STI> fell 5.63
percent by 0341 GMT and Malaysian shares tumbled 5.95 percent.
 The Philippine index lost 7.3 percent, while Indonesian
stocks fell 3.22 percent. Thai shares were down 1.64 percent.
 Dealers said the selloff in Southeast Asian markets
followed a near 9-percent plunge in Chinese stocks on Tuesday
 "China's the culprit. We have a lot of listed Chinese
companies, so we're dependent on China," said a dealer with a
regional brokerage in Singapore.
 Singapore-listed Chinese companies -- which make up more
than 100 of about 700 listed firms on the city-state's bourse
-- sank sharply on Wednesday.
 Shipbuilding and repair firm Cosco Corp. ,
controlled by China's top shipping firm, plunged 8.9 percent,
which reduced its market cap to below US$ 4 billion.
 Several other big-cap China plays also fell more than 7
percent, including food groups People's Food  and Pine
Agritech . More than 20 small- and midcap China plays
fell between 10 and 19 percent.
 Dealers said the Singapore market was also rattled by the
slump in U.S. stocks on Tuesday, with the Dow Jones industrial
average <.DJI> in its worst slide since the aftermath of the
Sept. 11 attacks.
 Losses in Southeast Asia's largest and most liquid bourse
were led by DBS Group , Singapore's biggest bank,
which fell 6.2 percent, and United Overseas Bank , the
country's second-largest bank, which also tumbled 6.2 percent.
 Index heavyweight Singapore Telecommunications ,
Singapore's largest listed company, was down 5.5 percent.
 Genting International  sank 11 percent after
Singapore said the Malaysian gambling firm's successful bid to
build a casino in the city-state would not automatically
qualify it for a casino licence. Sister company Star Cruises
 also slumped 14.5 percent.
 Analysts have long warned of an imminent correction in
Southeast Asian markets, many of which have recorded record or
multi-year highs in the year to date.
 "Singpore has been at an all-time high, and there's the law
of gravity -- investors are getting nervous and are locking in
profits," said Winson Fong, who manages $2 billion as chief
investment officer at SG Asset Management in Singapore.
 "For the short-term, stocks which have gone up strongly
will see sharp corrections; investors will look at underlying
fundamentals before going in," Fong said.
 But other analysts said the selldown in the Singapore
market would be temporary.
 "We anticipate the market will recover from this selloff
within the next 10-15 trading days. Leading the resumption of
the rally would be the blue-chips," said OCBC analyst Ritesh
Menon in a research note, who added that his mid-year technical
target for the index is at 3,350.
 In Kuala Lumpur, Malaysian power utility Tenaga Nasional
Bhd  led losses, sinking 5.7 percent. Malayan Banking
, the nation's biggest lender, fell 5.4 percent.
 In Jakarta, Indonesia's largest telecommunications firm PT
Telekomunikasi Indonesia  fell 3.3 percent. PT Bank
Mandiri Tbk  lost 7.4 percent.
 In Bangkok, PTT PCL , Thailand's biggest energy
firm, fell 1.9 percent. Advanced Info Service PCL ,
Thailand's top mobile phone firm, slipped 2 percent.
 In Manila, PLDT , the Philippines' largest telecoms
group, fell 8.2 percent, and Ayala Land , the country's
top property developer, lost 6.1 percent.
(Additonal reporting by Doreen Siow and Jamie Lee)

Bernanke Warns of Possible `Crisis' From Budget Gap

Bernanke appears to have forgotten about the $1.2 triilion war and the trillion dollar tax break for the rich.
---
(Update5)

By Scott Lanman and Craig Torres

Jan. 18 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said the U.S. government may face a ``fiscal crisis'' in the coming decades should it fail to deal with the rising costs of the Social Security, Medicare and Medicaid programs.

``If early and meaningful action is not taken, the U.S. economy could be seriously weakened, with future generations bearing much of the cost,'' Bernanke said today before the Senate Budget Committee hearing.

His comments may help frame a debate leading up to President George W. Bush's Feb. 5 budget, in which he will unveil a plan to balance the budget by 2012. Bernanke, unlike his predecessor Alan Greenspan, refused to endorse a strategy to narrow the shortfall.

While official projections may show a stable or narrower budget deficit over the next few years, ``unfortunately, we are experiencing what seems likely to be the calm before the storm,'' Bernanke said in his first hearing on Capitol Hill since Democrats won control of Congress from the Republicans in November's elections.

Bernanke, 53, didn't discuss the current state of U.S. monetary policy or economic conditions in his remarks. He will testify on the economic outlook before Senate and House of Representatives committees on Feb. 14-15.

Under Congressional Budget Office projections, the ratio of federal debt held by the public to gross domestic product may rise from about 37 percent now to about 100 percent in 2030 and ``grow exponentially after that,'' Bernanke said. ``Ultimately, this expansion of debt would spark a fiscal crisis, which could be addressed only by very sharp spending cuts or tax increases, or both,'' Bernanke said in the testimony.

Bush Budget Proposal

Bush, who nominated Bernanke in 2005 to succeed Greenspan as Fed chairman, plans on Feb. 5 to release a $2.9 trillion budget proposal that he said would put the budget on a path to balance in five years.

Treasury Secretary Henry Paulson said on Jan. 4 that ``given the fact that revenues are coming in and revenues are strong, it looks like we're going to be able to balance,'' in an interview with PBS.

Bernanke said the economic growth spurring revenue today won't resolve the budget's long-term challenges.

``Economic growth alone is unlikely to solve the nation's impending fiscal problems,'' Bernanke said. ``Economic growth leads to higher wages and profits and thus increases tax receipts, but higher wages also imply increased Social Security benefits, as those benefits are tied to wages.''

Democrats' Stance

Democrats favor letting many of Bush's tax cuts expire when they terminate in coming years, arguing that more revenue is needed to cover the looming surge in spending tied to the aging population. On Jan. 5, the House of Representatives approved rules that make it more difficult for lawmakers to cut taxes or increase some government spending, changes that Democrats said would help restore fiscal discipline in Washington.

The White House Office of Management and Budget projected in July that the budget deficit would be $339 billion this fiscal year, up from $248 billion last year. The OMB estimated that the deficit would narrow to $188 billion in 2008. Bush entered office in 2001 with a budget surplus of $127 billion.

Bernanke cautioned that supporters of low taxes must ensure that spending is ``kept low as well,'' while backers of ``more- generous benefits payments'' must recognize that higher taxes may have ``adverse'' consequences for the economy.

Tax Rates

``Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient to achieve and appropriate balance of spending and revenues in the long run,'' Bernanke said. He added that the ``general'' view is that tax cuts ``don't pay for themselves.''

Bernanke also said that increased government saving would help narrow the record U.S. current-account deficit, the broadest measure of trade.

What would help Congress, Bernanke said, is to monitor government spending relative to GDP ``or a similar indicator.'' In addition, Congress should pay ``close attention to measures of the long-term solvency of entitlement programs, such as long- horizon present values of unfunded liabilities for Social Security and Medicare,'' Bernanke said.

Bernanke previously used an Oct. 4 speech to warn of the ``major impact'' that the aging U.S. population will have on the federal budget.

Without changes to current law, combined spending on Social Security and Medicare will rise from 7 percent of U.S. gross domestic product today to almost 13 percent by 2030, Bernanke said.

Such increases will force the country to choose from policy changes including higher taxes, spending cuts, a bigger budget deficit, ``or some combination thereof,'' Bernanke told the Washington Economic Club in October.

Yellen on Budget

Other Fed policy makers share Bernanke's stance that the government must deal with the situation in some way. Yesterday, San Francisco Fed President Janet Yellen, who like Bernanke has served as chairman of the White House Council of Economic Advisers, said the longer-term budget picture ``frightens me.''

``We'll be looking at budget deficits that will make us wish for the level that we have now,'' Yellen said in response to an audience question yesterday after a speech in Arizona. ``Some changes will need to be made on the spending side, the entitlement programs, or taxes, or both.''

The Senate budget panel last heard testimony from a Fed chairman in April 2005, when Greenspan said record fiscal deficits threatened the U.S. economy, and urged lawmakers to cut spending and work toward a balanced budget.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net ; Craig Torres in Washington at ctorres3@bloomberg.net .

Last Updated: January 18, 2007 11:20 EST

How US is deferring war costs

from the January 16, 2007 edition

As war spending on Iraq and Afghanistan nears the levels for Vietnam and Korea, concern is rising over the 'borrow now, pay later' approach.

Staff writer of The Christian Science Monitor

NEW YORK

To pay for World War II, Americans bought savings bonds and put extra notches in their belts. President Harry Truman raised taxes and cut nonmilitary spending to pay for the Korean conflict. During Vietnam, the US raised taxes but still watched deficits soar.

But to pay for the ongoing wars in Iraq and Afghanistan, the US has used its credit card, counting on the Chinese and other foreign buyers of its debt to pay the bills.

Now, as President Bush is promising to boost the number of troops in Iraq, there is increased scrutiny over how the US is going to pay for it all.

The US is spending about $10 billion a month on Iraq and Afghanistan. By the end of this year, the total funds appropriated will be nearly $600 billion – approaching the amount spent on the Vietnam or Korean wars, when adjusted for inflation.

However, the actual impact of the war on the economy is different than in the past, largely because the US economy is so much bigger now. During World War II, some analysts calculate that the US spent as much as 30 percent of its gross domestic product (GDP) on the war effort. The Korean War, at its spending peak in 1953, represented 14 percent of GDP; Vietnam was about 9 percent. The current war, however, is less than 1 percent of America's annual $13 trillion GDP.

Payment due: in the future

The US can certainly afford the war, says budget analyst Stan Collender, a managing director of Qorvis Communications in Washington. But the spending is taking resources from other areas, he notes. Because the US is borrowing to finance the war, the cost will be borne by future generations. "And it's still going to be one of the most expensive wars we have ever fought," he says.

Unlike in previous major wars, the United States has cut taxes at the same time it has increased military spending. "It's fair to say all of the money spent on the war has been borrowed," says Richard Kogan, a senior fellow at the Center on Budget and Policy Priorities, a think tank in Washington. "But eventually everything has to be paid for."

Congressional questioning

Congress hopes to hold hearings on the financial implications of the war before the president releases his budget proposal for fiscal year 2008 on Feb. 5. Democrats, now in the majority, plan to ask a wide range of questions, from the future costs of the war to how those costs should be budgeted.

"We won't balance the budget in one year. The best we can expect is five years," says Rep. John Spratt (D) of South Carolina, the new chairman of the House Budget Committee, in a phone interview. "But we need to know: What is the bar we need to reach?"

Estimating the budget deficit has become more difficult in recent years because the White House has funded much of the war through emergency supplemental bills, which are not included in the federal budget. According to a Congressional Research Service report, it is a practice that other administrations have employed since the Korean War. This year, the White House is expected to ask for another $100 billion in supplemental war funds, but Representative Spratt says he would like to get the war back on the budget since it can be argued the war is no longer an emergency.

"Calling it an emergency means the spending does not get the scrutiny," he adds, because then the spending is reviewed by only one committee – House Appropriations. In addition, he says, emergency spending is exempt from caps on discretionary spending. This has prompted the military to include in the bill items that are not directly related to the war. Making the spending a part of the budget would end the practice of some members placing pet projects on a bill that must be passed, he says.

A war-by-war cost comparison

Numbers are fuzzy on how much has been spent so far on the global war on terror. According to the House Appropriations Committee, some $471 billion has been committed so far. Spratt says it's closer to $507 billion. By the end of this year, on a cash basis, the wars in Iraq and Afghanistan will be closing in on the costs of the Vietnam War ($650 billion in today's dollars) and the Korean War ($691 billion).

Some analysts believe the cost of the war is much higher than Congress estimates. In a study last January and updated in October, Harvard Prof. Linda Bilmes and Columbia Prof. Joseph Stiglitz estimated the budgetary and economic cost of the war at $2 trillion.

Ms. Bilmes, in a phone interview, says Congress looks only at its cash outlays, not at the war's future costs. For example, she says, an estimated 42,000 light trucks are in use in Iraq. Although it costs something to run them, the major cost will be replacing them. "That's not factored into the cost of the war," she says.

The same is true of the cost of taking care of injured veterans in the future. "After our study came out, what surprised us is that the VFW, the Vietnam Vets, and others said, 'Thanks for shining the spotlight on this issue, but your numbers are too low,' " Bilmes says. After working with the vets, she concluded that the future costs of caring for the wounded were much higher than she had estimated.

Just the cash costs alone have mushroomed over the past two years, says Steve Kosiak, an analyst at the Center for Strategic and Budgetary Assessments, a think tank in Washington. He estimates that Congress has appropriated nearly $300 billion during that period. "Perhaps some of the additional cost is for repairing the equipment," he says. "But it's fair to say it's partly a mystery why it's up so much."

Polls show people are concerned about the war, says Dennis Jacobe, chief economist at the Gallup Organization in Washington. But, he adds, "they are not concerned about the cost."

This is partly because of the way the war is funded through the supplemental budget process, Mr. Jacobe says. But it's also because the war has not disrupted the economy the same way past wars have. "It's really had no significant impact except for the deficit spending," he says.

By Ron Scherer

America's Red Ink

Sunday, December 24, 2006; B06

The largest employer in the world announced on Dec. 15 that it lost about $450 billion in fiscal 2006. Its auditor found that its financial statements were unreliable and that its controls were inadequate for the 10th straight year. On top of that, the entity's total liabilities and unfunded commitments rose to about $50 trillion, up from $20 trillion in just six years.

If this announcement related to a private company, the news would have been on the front page of major newspapers. Unfortunately, such was not the case -- even though the entity is the U.S. government.

To put the figures in perspective, $50 trillion is $440,000 per American household and is more than nine times as much as the median household income.

The only way elected officials will be able to make the tough choices necessary to put our nation on a more prudent and sustainable long-term fiscal path is if opinion leaders state the facts and speak the truth to the American people.

The Government Accountability Office is working with the Concord Coalition, the Brookings Institution, the Heritage Foundation and others to help educate the public about the facts in a professional, nonpartisan way. We hope the media and other opinion leaders do their part to save the future for our children and grandchildren.

DAVID M. WALKER

Comptroller General of the United States

Government Accountability Office

Washington

Krugman -- Flat-Out WRONG

Dec 22, 2006

By Bonddad
bonddad@prodigy.net

Today's Paul Krugman writes an essay in the NY Times arguing that the Democrats should not try and fix the deficit. While is argument is clear and cogent, it is also 100% wrong. Below I will explain why.

Here is a link to the editorial

Now that the Democrats have regained some power, they have to decide what to do. One of the biggest questions is whether the party should return to Rubinomics — the doctrine, associated with former Treasury Secretary Robert Rubin, that placed a very high priority on reducing the budget deficit.

The answer, I believe, is no. Mr. Rubin was one of the ablest Treasury secretaries in American history. But it’s now clear that while Rubinomics made sense in terms of pure economics, it failed to take account of the ugly realities of contemporary American politics.

And the lesson of the last six years is that the Democrats shouldn’t spend political capital trying to bring the deficit down. They should refrain from actions that make the deficit worse. But given a choice between cutting the deficit and spending more on good things like health care reform, they should choose the spending.

....

But the realities of American politics ensured that it was all for naught. The second President Bush quickly squandered the surplus on tax cuts that heavily favored the wealthy, then plunged the budget deep into deficit by cutting taxes on dividends and capital gains even as he took the country into a disastrous war. And you can even argue that Mr. Rubin’s surplus was a bad thing, because it greased the rails for Mr. Bush’s irresponsibility.

As Brad DeLong, a Berkeley economist who served in the Clinton administration, recently wrote on his influential blog: "Rubin and us spearcarriers moved heaven and earth to restore fiscal balance to the American government in order to raise the rate of economic growth. But what we turned out to have done, in the end, was to enable George W. Bush

.....

With the benefit of hindsight, it’s clear that conservatives who claimed to care about deficits when Democrats were in power never meant it. Let’s not forget how Alan Greenspan, who posed as the high priest of fiscal rectitude as long as Bill Clinton was in the White House, became an apologist for tax cuts — even in the face of budget deficits — once a Republican took up residence.

I understand what Krugman is saying -- by actually balancing the budget the Democrats would allow another Bush to come in and screw things up.

While I am sympathetic to that argument from a political perspective, I am completely opposed to it from a policy perspective for several reasons.

1.) The dollar is approaching multi-year years. While there are several reasons for this, the lack of fiscal discipline in Washington is one reason. Restoring fiscal discipline to Washington will help to bolster the dollar. Here is a recent chart of the dollar to illustrate what I am talking about.

2.) According to the Bureau of Public Debt, the US has issued over $550 billion dollars of net new debt each year for the last 4 years. The debt/GDP ratio now stands at over 60% of GDP. Simply maintaining that pace under a "do not harm" governing strategy will increase the burden on future generations. In addition, if we don't start addressing this issue now, it could spiral out of control and get to the point where it addresses us.

3.) It would increase the market's confidence. Corporations have a ton of cash on their balance sheet right now. However, they aren't spending it. That leads to the question of why? One of the reasons is the uncertainty to the current economic situation. Businesses look to the Federal government and see a mess. They know that eventually someone will have to clean it up. And that means tax increases and spending cuts. As a result, businesses are shoring up their balance sheets for that possibility. Balancing the budget will free up these balance sheets for more domestic investment.

4.) The end of crowding out. In line with 2 and 3 above, the net new issuance of debt means there is over $550 billion in money invested in government bonds that could be invested in the domestic economy. The US economy desperately needs this money.

Update [2006-12-22 9:37:19 by bonddad]:: I wrote the preceding in a fit of pique, so I left a few things out.

5.) Krugman wrote that Dems should spend on things like health care, etc... That's a good idea. But -- where is the money for that going to come from? Thanks to Bush's policies we are in debt. There ain't any money there.

6.) As the chart below indicates, the US is more and more obligated to foreign holders of US debt. Some of this is the result of the trade deficit. However, thanks to the budget deficit, the US is floating lots of debt as well.

7.) The entire US system is currently based on a "rentier" system. Because the US floats all this debt, it has to create a tax system that promotes debt. Hence -- the need to cut capital gains taxes and income taxes on upper-income individuals. After these taxes get cut, the US is more able to promote the "borrow and squander" theory of budgeting. Until we dry up the supply of debt, politicians will be more likely to promote the current system.

While I respect Krugman's intellect and ability, here he is simply wrong.

For market and quick hit economic commentary, go to the Bonddad Blog

Democrats and the Deficit: PAUL KRUGMAN

THE COMPLETE ARTICLE
The New York Times

OP-ED COLUMNIST
Democrats and the Deficit
By PAUL KRUGMAN
Published: December 22, 2006

Given a choice between cutting the deficit and spending more on good things like health care reform, Democrats in Congress should choose the spending.


Now that the Democrats have regained some power, they have to decide what to do. One of the biggest questions is whether the party should return to Rubinomics — the doctrine, associated with former Treasury Secretary Robert Rubin, that placed a very high priority on reducing the budget deficit.

The answer, I believe, is no. Mr. Rubin was one of the ablest Treasury secretaries in American history. But it’s now clear that while Rubinomics made sense in terms of pure economics, it failed to take account of the ugly realities of contemporary American politics.

And the lesson of the last six years is that the Democrats shouldn’t spend political capital trying to bring the deficit down. They should refrain from actions that make the deficit worse. But given a choice between cutting the deficit and spending more on good things like health care reform, they should choose the spending.

In a saner political environment, the economic logic behind Rubinomics would have been compelling. Basic fiscal principles tell us that the government should run budget deficits only when it faces unusually high expenses, mainly during wartime. In other periods it should try to run a surplus, paying down its debt.

Since the 1990s were an era of peace, prosperity and favorable demographics (the baby boomers were still in the work force, not collecting Social Security and Medicare), it should have been a good time to put the federal budget in the black. And under Mr. Rubin, the huge deficits of the Reagan-Bush years were transformed into an impressive surplus.

But the realities of American politics ensured that it was all for naught. The second President Bush quickly squandered the surplus on tax cuts that heavily favored the wealthy, then plunged the budget deep into deficit by cutting taxes on dividends and capital gains even as he took the country into a disastrous war. And you can even argue that Mr. Rubin’s surplus was a bad thing, because it greased the rails for Mr. Bush’s irresponsibility.

MORE: http://tinyurl.com/y2wk76

Feds' Creative Accounting

Posted on Fri, Dec. 15, 2006
Report: Federal deficit would be higher MARTIN CRUTSINGER Associated Press WASHINGTON - The federal deficit for 2006 would have been 81 percent higher than the $247.7 billion that was reported two months ago if the government had to use the same accounting methods as private companies. That was the finding Friday when the administratio n released a 166-page "Financial Report of the United States Government" for the 2006 budget year that ended on Sept. 30. The report, released by the Treasury Department and the president's Office of Management and Budget, found that under the accrual method of accounting, the deficit for 2006 would have totaled $449.5 billion, not the widely reported $247.7 billion incurred under the cash system of accounting. Under the accrual method, expenses are recorded when they are incurred rather than when they are paid. That tends to raise costs for liabilities such as pensions and health insurance. Ten years ago, Congress ordered the government to start issuing annual reports using the accrual method of accounting in an effort to show the finances in a way that was comparable with the private sector. In this year's report, as in every one that has been issued, Congress' auditing arm, the Government Accountability Office, said that it could not sign off on the books because of problems in the reporting. Comptroller General David M. Walker, the head of GAO, said in a letter included in the report that 53 percent of the government's total assets were included in agencies that could not be audited properly. These problems included what Walker described as "serious financial management problems at the Department of Defense," repeating criticism previous reports have made about the Pentagon's bookkeeping. The report, citing information from the trustees of the Social Security and Medicare programs, said that the shortfall in funding those two programs would total $44 trillion over the next 75 years. "This report shows we are making progress getting our fiscal house in order in the near term," White House Budget Director Rob Portman said in a statement. "But it also puts in stark terms the necessity of addressing the rapid increase in entitlement spending over time." ON THE NET Financial report: http://www.fms.treas.gov

The U.S. is Insolvent

Dec 18, 2006

Many of us have known for a while that the U.S. is running out of time on its debt clock, but now the Treasury Department has confirmed it, via a report it snuck out last Friday. Enter Dr. Chris Martenson, with this week's must-read blog post: "The United States is Insolvent":

The US is insolvent. There is simply no way for our national bills to be paid under current levels of taxation and promised benefits. Our federal deficits alone now total more than 400% of GDP.

That is the conclusion of a recent Treasury/OMB report entitled Financial Report of the United States Government that was quietly slipped out on a Friday, deep in the holiday season, with little fanfare. Sometimes I wonder why the Treasury Department doesn’t just pay somebody to come in at 4:30 am Christmas morning to release the report....

But, hey, I understand. A report is this bad requires all the muffling it can get.

Follow me (and the Treasury Dept) below the jump to Meineke, 'cause we're going to need a huge-ass muffler.

David Walker, Comptroller of the US, followed up the report with an accompanying statement, saying:

"...the U.S. government's total reported liabilities... continue to grow and now total approximately $50 trillion, representing approximately four times the Nation’s total output (GDP) in fiscal year 2006, up from about $20 trillion, or two times GDP in fiscal year 2000.

...it seems clear that the nation's current fiscal path is unsustainable and that tough choices by the President and the Congress are necessary in order to address the nation's large and growing long-term fiscal imbalance."

What!?! Say that again??! $50 Trillion in liabilities. Wow, and I've been worried about my mortgage and credit card debt. This is SERIOUS debt. Martenson again:

...the official debt stands at $8.507 trillion or 65% of (nominal) GDP but when we add in our "off balance sheet" items the national debt stands at $53 trillion or 403% of GDP.

Now that’s horrifying.

OK, so what does all this really mean? We'll just print more money, right? Once again, Dr. Martenson sums it the consequences:

1. There is no way to "grow out of this problem". What really jumps out is that the US financial position has deteriorated by over $22 trillion in only 4 years and $4.5 trillion in the last 12 months. The problem did not "get better" as a result of the excellent economic growth over the past 3 years but rather got worse and is apparently accelerating to the downside.

2. The future will be defined by lowered standards of living. ...the insolvency of the US will minimally require some combination of lowered entitlement payouts and higher taxes. Both of those represent less money in the taxpayer's pockets and, last time I checked, less money meant a lower standard of living.

3. Every government facing this position has opted to "print its way out of trouble". That's an historical fact and our country shows no indications, unfortunately, of possessing the unique brand of political courage required to take a different route. In the simplest terms this means you & I will face a future of uncomfortably high inflation, possibly hyperinflation if the US dollar loses its reserve currency status somewhere along the way.

Oops. There goes my idea.

In all seriousness, I feel there will be no bigger issue going into the 2008 campaign; we need to start the debate now and help push our legislators (on both sides) to:

a) recognize there is even a problem.
b) recognize the problem is potentially immense.
c) begin brainstorming viable solutions and approaches.

Maybe we can start right here. Ideas???

P.S. - Again, read the whole article, it's eye-opening:

The United States is Insolvent

--By Ike Arumba

Soft Landing So Far; Housing Recession Still Looms: Bonddad

Dec 18,2006

By Bonddad, bonddad@prodigy.net

Right now, the US economy appears to be moving into a soft landing. GDP growth is slowing but not turning negative. The unemployment rate is still technically good. The official BLS measure of inflation has declined the last several months -- although the alternate Cleveland Fed median CPI is still showing higher levels. Basically, Fed Chairman Bernanke has a lot to be pleased about. However, there are three economic wild cards that threaten the soft landing. These are oil, the dollar and housing.

Of these three wild cards, housing still causes the most concern.

Let’s review the general economic background. According to the Bureau of Economic Analysis, US GDP increased 5.6% in the first quarter, 2.6% in the second quarter and 2.2% in the third quarter. The BEA revised third quarter GDP up from 1.8% to 2.2%. However, the three quarter trend is clear: growth is slowing.

Housing is in a slump. The Federal Reserve made the following comment in its FOMC statement on December 12:

Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market. Although recent indicators have been mixed, the economy seems likely to expand at a moderate pace on balance over coming quarters.

Housing will most likely continue to be a drag on GDP growth going forward. The chart below is from the blog Calculated Risk and shows the percentage of housing to GDP. The graph shows that housing has a long way to go before it returns to historically normal levels:

The employment picture is statistically solid:

Nonfarm payroll employment rose by 132,000 in November, and the unemployment rate was essentially unchanged at 4.5 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Job gains continued in several service-providing industries, including professional and business services, food services, and health care. Employment declined in construction and manufacturing.

The US continues to lose manufacturing jobs. More importantly, construction sector employment topped out at the beginning of this year and is starting to turn downward.

Hourly wages have actually increased through November of this year. So far, hourly wages increased from $16.40 in January to $16.91 in November for an increase of 3.1%. Over the same period, the BLS’ inflation index increased from 198.3 to 201.5 for an increase of 1.61% making wage gains 1.49%. This is the first year of this expansion when wages have increased faster than inflation. So this is good news, but it will take a bit of time for 80% of the population to start making money beyond inflation. However that may prove difficult in a 2.2% GDP growth rate environment. I should add that using the Cleveland Federal Reserve’s median CPI calculation, inflation would still be rising faster than wages.

Finally there is inflation. The overall level of inflation isn’t as relevant as what the Fed thinks about the overall level of inflation. The Fed stated its position on inflation in the last FOMC statement:

Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Short version – the Fed is still concerned about inflation. They still think a slowing economy will do the Fed’s job, but their statement gives them enough wiggle-room to raise rates if they need to. The Fed has been saying this for the last few months.

So using the above metrics we see the US is in a low-unemployment situation. Wages are either increasing slightly or are still stagnant depending on which inflation measure is used. Inflation is still too high according to the Fed, but they are willing to sit on the sidelines to let the economy slow inflation’s growth. But growth is slowing and the housing market is slumping. So the US economy is technically in OK to good shape, but certainly not something to write home about.

There are three wild cards going forward which place the "soft-landing" scenario in doubt.

The dollar

Below is a weekly chart for the dollar, going back a few years:

The dollar had been trading in an upward slanting range for most of the year. However, it broke through support in late November/early December. This indicates a downward change in the trend.

There are several reasons for this drop. The first is the interest rate differential between Europe and the US. The European Central Bank has increased rates while the US has maintained interest rates. This process has closed the interest rate gap between the US and the EU, taking away the carry-trade (borrowing in the US and lending in Europe) between the continents. In addition, European growth is picking up while the US is slowing down. This makes the euro a more attractive investment relative to the US.

In addition, the US trade deficit is again getting press time. Below is a chart of the overall US trade deficit from the St. Louis Federal Reserve.

Although the deficit has narrowed over the last few months it is still on track to set another record this year. Paulsen’s visit to China may have opened the door going forward, but the US does not have any solid actions from China regarding the deficit as of yet. In addition, a large portion of the trade deficit’s recent increase is based on oil. As long as the US remains an oil dependent country we will have a trade deficit. So, while the deficit may narrow in the coming years, don’t expect any miracles.

The chart below from the St. Louis Reserve indicates that foreign holdings of debt have greatly increased the last four years.

As more foreigner central banks take on more US dollar obligations, the possibility of a shift away from the dollar to other currencies (most notably the euro) increases. The quiet shift away from the dollar to the euro has already started. The South Korean, Japanese and Chinese governments have slowed their purchase of US debt, Russia has announced they will diversify their currency holdings into the euro, and OPEC has shifted 2% of their assets in the euro over the dollar.

The downtrend is in place. It will probably take a fundamental shift in world sentiment towards the dollar, the US trade deficit or the US economy to change the dollar’s direction.

What does a weakening dollar mean going forward? It creates two inter-related problems. First, a cheaper currency means imported goods increase in price. This increases the possibility of importing inflation. This leads to the second problem – hemming-in interest rate policy. Several economists have predicted the Fed will lower interest rates sometime in 2007. However if import prices increase to a high enough level the Fed won’t be able to lower interest rates to stimulate the economy if it slows down.

Oil

Below is a weekly chart for oil, going back a few years.

Oil has come down from it’s yearly high in about September. One of the quiet market forces leading to this decline was Goldman Sachs re-weighting a major commodity index. They changed gas’ weighting from 7.3% to 2.5%. Whenever a market index changes a component’s weighting mutual funds, index funds and other investment managers who track the index must also re-weight their respective portfolios. This resulted in a net selling of oil futures.

However, there are other fundamental reasons for oil’s drop which primarily center around the US’ slowing economic growth. The US is the world’s largest oil consumer. When the US economy slows, overall oil demand slows (This may have been a reason for Goldman lowering oil’s importance in its index). A drop in US demand will have a negative impact on oil’s price. However, India’s and China’s growing economies provide a floor for oil prices, which the market currently pegs right around $60/bbl.

In addition, OPEC has announced two production cuts. The first went into effect about a month ago and the second is scheduled to go into effect in February. This provides additional support for oil’s price. OPEC’s members have a habit of breaking production cuts because there is no formal enforcement mechanism within the OPEC cartel. So we will have to wait and see how effective this cut in production actually is.

Finally with regard to oil, the world economy is only one geopolitical event away from an oil price spike. With the US Iraq policy in a state of flux this risk increases.

Housing

Housing has been slowing for the last six months or so. There are three inter-related problems with housing that do not bode well for the future. A slowing rate of purchases is the first problem. According to the latest Census data on new home sales, the year-over-year (YOY) sales rate has declined 25% from an annual pace of 1.3 million homes to 1 million homes. According to the National Association of Realtors, the YOY sales rate of existing homes has decreased 11.5%. The second problem is an increasing inventory level. The total inventory of new homes available for sales has increased 13.8% from October October 2005 levels, from 490,000 units to 558,000 units in October 2006. The slowing rate of purchases has increased the number of months of available inventory from 4.5 months to 7 months from October 2005 to October 2006. Existing home inventory has increased from 2.868 million units in October 2005 to 3.854 million units in October 2006 – an increase of 34%. Meanwhile, the slowing rate of existing home purchases has increased the months available for sale to 7.4. Finally, there is the issue of total household debt outstanding, which has greatly accelerated during this expansion. The chart below shows the rapid escalation in household debt for the duration of this expansion.

No soft-landing housing person has been able to answer the following question: "How much more debt can the US consumer put on his respective balance sheet?" The US consumer is already massively in debt and most people already have houses, leading to the question of "who will actually buy this inventory?"

To sum up we have the following. The current economic environment plays out the soft landing scenario. However, there are three economic wildcards that will take time to play out: the dollar’s overall value, oil and the domestic housing market. Housing is still the number one concern. There's a ton of inventory on the market and buyers are already massively in debt.

A downturn in either one of these three could tip the US into a recession. So while the soft-landing camp has plenty to cheer about right now, raising a toast is very premature.

For an update on the market and current economic events, go to the bonddad blog

The Spoils of Defeat

November 24, 2006
Editorial

The departing Republican majority in Congress is about to leave the nation a memorial to its own shameful history as the grand enabler of record debt and deficits. G.O.P. leaders are preparing to walk away from their most basic constitutional responsibility — passing a budget. Instead of finishing work on government spending bills needed for the next year, they’re reported to be planning nothing more than a cut-and-paste, short-term continuing resolution. That will allow them to run out early from their lame-duck session, leaving the mess to the incoming Democrats in January.

More:

http://www.nytimes.com/2006/11/24/opinion/24fri2.html?hp=&pagewanted=print