Posted by: Bruce Allen | September 11, 2008

Balancing Federal and Trade Deficits: Not Likely

Let’s check the laundry list of issues confronting the US economy:

o    a soft domestic economy, virtually flat, with inflation and unemployment both on the rise;

o    foreign trade deficits in the area of $700 billion a year;

o    federal deficits on the order of $400 billion a year and most def on their way up;

o    never mind the implied deficits in the “off-the-book” stuff, i.e., Social Security and Medicare;

o    global growth in the demand for natural resources, from oil to water;

o    crumbling global infrastructures everywhere but downtown Dubai City.

The mild form of stagflation currently in place in the United States is an example of an economy that is out of equilibrium.  (See Rock–Ben Bernanke–Hard Place)  There are scores of reasons as to how it got here, but it’s here.  Most of the reasons are political.

A Little Ideology, Please

Back in the mid-20th century, domestic political economics used to be pretty straightforward. Republicans were committed to fiscal balance, and would cut back on social programs in order to maintain order.  “Tax and Spend” Democrats would raise taxes in order to fund social programs.  The stereotypes took shape–the clear-eyed, dispassionate, conservative Republican versus the softheaded bleeding-heart liberal Democrat.

We Americans have an almost insatiable desire to be and to have the best of everything, from our cars and homes to our military. We like stuff “tricked out.” Things tend to become expensive quickly, but, hey, that’s how we roll.  We make a lot of money, and we buy nice stuff.  During the last half of the 20th century, this approach flourished in the U.S. military, prodded by Ronald ReaganReagan spent the Soviets into the dirt, and put it all on a large American MasterCard. Now, it seems we are doing the same thing to ourselves.

Republican administrations have ruled for 20 of the past 28 years.  Federal deficits have skyrocketed during this period because Republicans have chosen to reduce income taxes and print government debt to finance all of these incredibly necessary programs.  In 2008, we are spending $10 billion a month just in Iraq, for a worthy cause I’m sure, but an absolute drain on the federal treasury.  George Bush took an economy that was generating $300 billion surpluses and turned it into one trending toward $500 billion deficits.  Both Obama and McCain seem capable of taking it to a trillion.

All of these bonds are piling up in warehouses overseas.  The fall in the value of the dollar since 2003 has made our currency and our economy vulnerable to assault in overseas markets.  The countries that hold U.S. government bonds and bills have watched the value of their dollar investments decline for five years, yet they continue to accumulate more dollars, by way of foreign trade and government bonds.  They are accumulating leverage.  It’s like what big companies do, when they sacrifice margin to gain market share.  Plus, American companies and real estate are cheap these days.  Everything’s on sale.

When Does The Fed Run Out Of Bullets?

Our growing national discomforts are symptoms of the fact that throughout history, powerful nations that become debtor nations become captive nations, and in most cases the quality of people’s lives decline.  The cost of money, hence the cost of living, in these situations continues to rise, until people are paying mob rates. Miss a payment and they send someone to break your legs.  With the bailout of Fannie and Freddie now on the books, the US federal deficit/liability/exposure now hovers around $15 trillion.

The chronic trade deficit is recessionary–it exports growth and imports inflation. Chronic, massive Federal deficits, however, should stimulate growth, yet the economy is moribund. Some of this is reduced spending by consumers, due in part to the negative wealth effect of falling home values.  Credit card balances are rising steadily.  The trade deficit and the Federal deficit seem to offset one another, when in fact their stagflationary effects on the economy are additive.

There’s No Free Lunch

How does the next administration go about reducing the amount of debt it sells each year, and instead move to begin paying off bonds and reduce the deficit and attendant leverage from overseas banks and governments?   By controlling spending?  Not likely!  By devising revenue-neutral programs that will encourage sustainable consumer behavior and encourage the development of alternative energy sources.  And by generating more tax revenue from high income individuals for whom the marginal utility of income is not as high as it is for the poor.  Very Keynesian.

Here’s a glance at a purely conceptual approximation of what it will take to fix Social Security.  The age at which people receive full benefits will continue to go up, in step with the increasing longevity of the population.  They will eventually raise or remove the cap on income/earnings, so that earners will pay SS tax on every dollar their earn. (If they make $500,000 a year, I feel sorry for them.)  And they will devise a means-testing formula, a combination of assets and income such that above a certain level you don’t receive a check.  No more sunbonnets for racehorses.  Then, sit back and hope people start having more babies.

Will The Last Keynesian Leaving The Building Please Turn Out The Lights

In a nutshell, the United States needs fiscal and monetary policies that will move the economy back toward equilibrium.  The major symptoms of the current macroeconomic disequilibrium are the foreign account deficit, the annual federal deficit, and the actual/implied increase in the national debt due to growing unfunded entitlement obligations.  Picture these planks in either candidate’s platform:

o    A commitment to balancing the federal budget during his first term.

o    A commitment to halving the foreign trade deficit during his first term.  And getting it to zero during a second term.  And doing it with sustainable green technologies.

o    A commitment to making Social Security actuarially sound in his first term.

o    A commitment to universal health coverage for all American citizens during his first term.

o    A commitment to spend less on the military and more on domestic infrastructure.

Such a platform would amount to political suicide for any candidate willing to offer it.  The implications, the “ways and means” it would take to approach such radical goals, the political costs, all would be enormous.  Social Security reform itself is known as the 3rd rail of American politics.  While Americans like the sound of fiscal prudence, we still want our lives tricked out.  And don’t raise our taxes.

It is an unhealthy economy that is not stimulated by a $400 billion federal deficit. It is an unhealthy political landscape that will not even allow discussing its repair.

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