2011 August 06 Saturday
Sovereign Debt Crisis About Elderly Entitlements
Robert Samuelson says "Why are we in this debt fix? It’s the elderly, stupid." Yet as he points out, cuts for the elderly remain taboo. How much longer will that taboo last?
By now, it’s obvious that we need to rewrite the social contract that, over the past half-century, has transformed the federal government’s main task into transferring income from workers to retirees. In 1960, national defense was the government’s main job; it constituted 52 percent of federal outlays. In 2011 — even with two wars — it is 20 percent and falling. Meanwhile, Social Security, Medicare, Medicaid and other retiree programs constitute roughly half of non-interest federal spending.
The approach of this crisis was easily seen in advance. But due to high commodity costs and the housing bubble the timing was sooner than mainstream debt worriers (e.g. the Concord Coalition) probably expected. The aging population problem is being exacerbated by other things going wrong in the US and other Western economies (e.g. physical limits to growth, too low a rate of innovation, and unfavorable demographic changes) and also by the rise of China and India.
Those entitlements programs mentioned by Samuelson take up over half of US federal spending before the coming doubling of the number of people over age 65. Those spending levels are before medical spending rises a projected 58% more by 2020. With massive deficit and debt already before those things happen it only makes sense that S&P downgraded US sovereign debt from AAA to AA++. (anyone want to predict when it'll hit single A?)
All that debt and unfunded entitlements would become a smaller and more manageable problem if the US economy could grow rapidly. But as Steven Pearlstein points out, since we can't get the economy growing and we've shot our wad already we now face the need to do painful restructurings, just like the PIIGS of Europe.
Unfortunately, we never reached that escape velocity and have now pretty much exhausted our policy ammunition. As a result, we are now going to have to make the rest of those painful structural adjustments — eliminating jobs, closing companies, lowering incomes, reducing government services — in the context of a stagnant economy. And its not just the United States. Similar adjustments will be required in Europe, Japan, China and much of the rest of the world as well.
Since I believe long term growth will stay below post-WWII trend for many years to come I tend to agree with those like Peter Schiff who think federal debt will spiral out of control as tax revenue growth fails to materialize. So the deficit will grow. The debt will grow even faster if the economy goes into a double dip recession.
One of the very big problems we face in this crisis is that our elites do not yet grasp the absolute size and length of it. Signs of economic faltering bring a chorus of calls for QE3 (another round of central bank quantitative easing) as if we just need to prime the pump once again. In the political realm in the fight over the federal budget each side is still trying to close the deficit on their terms without giving up much. Yet both sides of the partisan divide need to give up more than even their opponents demand. Ross Douthat says the liberals have boxed themselves into a place where they find themselves defending middle class entitlements over programs for the poor.
Here American liberalism risks becoming a victim of its own longstanding strategy’s success. Because yesterday’s liberals insisted on making universal programs the costly core of the modern welfare state, on the famous theory that “programs for the poor become poor programs,” today’s liberals find themselves defending those universal (and therefore universally-popular) programs at the expense of every other kind of government spending — including, yes, programs for the poor. It’s a classic example of putting liberal political interests ahead of liberal policy priorities.
Showing a liberal awareness of this conflict Ezra Klein comes out against cuts in discretionary non-security spending. But by citing cuts in highway maintenance as an example of false economy (small potholes are cheaper to fix than big potholes) he tries to imply the obvious falsity that most of the non-security discretionary spending has the same characteristic. He wants that spending for redistribution, not economic efficacy. He ought to say so. Many forms of discretionary spending, for example housing subsidies aren't achieving real savings or wealth generation for the taxpayer. Such subsidies are just transfer payments to the poor which subsidize dysfunction.
Both resource limitations and demographic changes are becoming big weights on economic growth. Even if we inflate away some of our debt (as Ken Rogoff, Scott Sumner and Tyler Cowen all advocate) other fundamental drags on the economy will remain. Growth is not going to save us. Even Rogoff thinks debt deleveraging after a big debt bubble takes 7 years.
If I'm right about the other weights on the economy 7 years until the resumption of normal growth is optimistic. Therefore some of the promises made to all the old folks and other feeders at the public trough can't be honored. Raising the eligibility age for Medicare and Social Security seems inevitable. Also on the list of the inevitable: big cuts in the welfare state for the poor, big cuts in defense spending, and higher taxes.
Since we can't afford our lifestyles and our current size of government we need to find ways to do more with less. I'd love to see more liberals and conservatives think harder about how to do more with less (e.g. automate education and cut the administrative fat which has built up in higher education) and also to think about what's really necessary to do in the first place (e.g. militarily babysit the Middle East?). We live in an age of sharpening limits. We need to start accepting these limits and working more smartly within them.
I agree with pretty much everything you write here, except your comments about QE3. Demand shortfall has been very much a feature of the recession and uncertain recovery, so we need some sort of stimulus. The cheapest stimulus is QE, so QE it is.
Yes, too much money printing will raise inflation, but that's also true of fiscal expansion! (Although, in the real world, too much fiscal expansion is generally offset by higher interest rates, with inflation being unchanged; this does not affect the general principle.)
By contrast, supply-side, structural reform is deflationary, so it makes sense to do monetary stimulus at the same time.
As a good rule of thumb, fiscal stimulus should be erased from the economic toolkit. It is a horrible kluge which doesn't do anything that monetary policy can't do, so it's only useful when the Fed is failing to do their jobs at all.
We won't have rapid growth in the economy for another reason: The demographic quality of those under 40 is less than those retiring workers that they will replace. We have more Mestizos the younger you go,and they are not a cognitively gifted group; they can't handle any of the high paying jobs an advanced economy. I say, let the old people get benefits as long as possible, at least for the next 10-20 years, because they are largely White and were once productive. And they can pass any wealth down to their White kids. This will mean the whose system eventually collapse, but why should I care? When it crashes, most of the victims will be less White and more likely to have been Obama voters.
Well, I should have been clearer: QE3 might help. Part of our problem is, as Rogoff argues, debt overhang. One of our problems on that score is that the political system is trying to prevent the number of bankruptcies needed to clear that debt overhang. Given that's the case inflation might prove useful.
But inflation has damaging side effects. Plus, it is unfair. The people who saved money get their money eaten away by inflation. So the savers reward the borrowers. Of course, the same happens when borrowers go bankrupt.
After I wrote the post a thought occurred to me: Rogoff and Carmen Reinhart talk about a 7 year deleveraging period based on previous debt bubbles. But in this debt bubble the government is taking on debt as fast as the private sector is deleveraging. Is that a net gain? Have we really begun to deleverage overall? The answer is not clear to me.
There are three deficits: One, where we spend deficit dollars into our 80 overseas military bases. Those dollars often bounce back and get turned into T bills. The other dollars are saved as reserves to protect the foreign economy against banking bear raids. If a country doesn’t have enough dollars they can be attacked. The Russian Ruble collapse, the Asian currency crises, Mexican Peso Crises, Argentina, etc. are bear raids.
Two, the trade deficit has a dollar leave our economy for every POS good that we import. Those extra dollars often return as T bills. Since dollars are taken out of the supply in this fashion, it means the dollar is driven high due to supply and demand. This makes main street more expensive that it should be.
Wall street then takes our 401K dollars and funds the movement of entire industries to China and other locales. This allows the industry to be stripped with labor arbitrage. The captains of industry and their financial partners use the delta in wages to feather their nests.
Import duties back to the U.S. remain low, because the dollar is the reserve currency of the world. Other countries sell goods to the U.S. to acquire dollars to buy oil and commodities.
The third deficit is the private sector. The housing bubble caused a balance sheet recession. After the bubble collapsed, many homeowners became underwater. People want to de-leverage rather than take on more debt. Debt deflation is when you pay usury, rather than spend on goods and services. Thus the real economy takes a hit as jobs are not produced with demand.
The private sector deficit could be fixed like this: 1) nationalize the banks, examine their balance sheets, and take a big eraser to them. Mark the homes or other assets down to the current market price. The banker doesn’t get to make future profit. Boo Hoo. The private banks created the money as a ledger entry anyway. Tell the homeowners, or the recipient of the deal, that in exchange for fixing their balance sheet we are going to change the tax structure.
2) Direct spend into industry, bypassing the banks. This allows deficit spend government dollars (vertical spend) to eventually vector into private banking debt payments. Those government dollars drive private banking balance sheets toward zero. So, it is reasonably non-inflationary, and it corrects the balance sheet problem.
(I challenge any economist to prove me wrong on this point. Vertical deficit dollars can enter the economy by direct spend, and labor will use them to buy down their credit balance sheets. When loans are paid off, the ledger entry drives down to zero, and the former vertical money disappears.)
3) When we spit out the banks and re-privatize them, make them 100% reserve. That way we never have this problem again. No more credit money is made by bankers. A banker makes his fees by matching up somebody who wants a loan with a saver who has money to loan.
4) Since fiscal policy and monetary policy are flip sides of the same coin, then it has to be understood that the tax code needs changing. We start taxing the rent value of land in accordance with Georgist principles. Labor looses the income tax, which immediately drops the cost of employing somebody by 30%. Government revenue remains the same with no loss in the standard of living, and we are off to the races. (Homeowners agreed to the tax change when they accepted the haircut of their home loan.)
The rent value tax will keep homeowners from refinancing and starting another price spiral bubble on homes. That money that formerly vectored as usury to bankers is now captured as taxes. In this way, it is free income that we currently do not capture.
The third deficit, the private economy is now fixed. The other two deficits are tougher nuts to crack, but they can be fixed too.
Sometimes I feel like an alien on this planet. The problems are pretty simple to fix, it is just a matter of doing them.
If anybody wants to take my ideas and run with them, go for it. Ronald Reagan once said you can get a lot done if you don’t care who gets the credit.
If Democrats actually prefer slashing welfare over middle class entitlements - an electoral calculation, certainly - it may actually be the rare case where Democratic policy is in sync with the national interest. Ejecting people from public assistance puts more people into the job market, and forces out immigrants, legal or otherwise; it would discourage immigrants from even coming, in fact. It would be a chance to actually reverse the current decline in human capital. We can't get to that point quickly enough.
With all the talk of how difficult it would be to balance the budget, it's easy to miss how large some of our budget items are. We spend over $600 billion annually on defense. We give Israel $3 billion/year, Egypt $2 billion, and Africa (PEPFAR# over $6 billion. Unemployment checks now run >$100 billion annually, and food stamps and other "nutritional programs", with 45.8 million recipients averaging $1,600 per recipient per year, cost us over $70 billion annually. There is still plenty of low-hanging budget balancing fruit. It won't get us to $1.2 trillion, let alone solve the coming social security debacle, but it's still a start.
"Many forms of discretionary spending, for example housing subsidies aren't achieving real savings or wealth generation for the taxpayer. Such subsidies are just transfer payments to the poor which subsidize dysfunction."
I wouldn't call it dysfunction, exactly, but I have an old high school "friend" #i.e., Facebook friend#, who actually worries about getting too much overtime at work because it will disqualify her from maintaining her housing subsidy. She's a perfectly decent if misguided human being, who's being incentivized to do the wrong thing by the geniuses in our government. What's more, given the massive housing surplus we now have there is absolutely no reason we should be *paying* to subsidize low housing costs. Housing subsidy money ultimately subsidizes real estate investors, as well as rich liberals in vacation towns #e.g., Aspen, Jackson Hole, etc.# where the help can't otherwise afford to live.
Randall, the problem right now is that inflation is, if anything, too low. The Fed doesn't even care about their 'unofficial' 2.0% target. The current situation is very much unfair to borrowers, because interest rates are artificially higher than they should be and credit has dried up.
REN, I agree with what you say here, except the "direct spend money into the economy" bit. Because it's functionally identical to QE, except that the govt would have to manage the money supply, and that's very problematic. There's a reason the Fed is an independent agency. (It's only formally a "private bank", and cutting its ties to the banking system would be a good idea.)
I forgot to mention that full reserve banking is also a dumb idea. It would impose large costs on bank depositors for no appreciable benefit. (Savings accounts and CDs would disappear, and banks would be forced to charge fees on demand deposits.) But banks do need to be tightly regulated, given their reliance on govt support.
REN must be an MBA. Nobody else could construct a complete edifice for economic recovery without even talking about physical resources, especially oil.
Any move to address the trade deficit has to include oil imports. Getting most of the 12-MPG pickups and fifth-wheel toy-haulers off the roads and replaced with Cruze Ecos and Priuses and Fusion hybrids would do a lot. The reduced petroleum demand would not just hit imports directly, it would also reduce demand for corn ethanol and free more corn for export.
If the Democrats agree (with lots of kicking and screaming) to cut entitlements to the poor (Medicaid, food stamps, subsidized housing, welfare, etc.), education and health care, I wonder if they will start to change how they feel about immigration, especially the illegal kind? Hard to see how they can support allowing more (mostly poor) foreigners to enter this country when we're cutting back support for those already here.
Engineer-Poet, yes I agree that we only monetize the extraction and distribution value of oil. It's actual value is not captured, so it is underpriced. That's a whole nother story, and it gets complicated for short blog entrys. By the way, I'm not a MBA, I'm a full on autodidact. Most of what I know is self taught. Thomas Jefferson had thousands of books in his library, so a self learning tradition is a well worn part of history; it is just in modern times we have become (wrongly) obsessed with letters. I find people who are educated in our government schools, often lack the ability to think outside of the box. Please don't conflate me with MBA's or Phd's, I consider it an insult.
I suspect I'm going to have to create my own website, so I can lay a proper foundation. That way people can understand what I'm trying to convey. I don't have a lot of time though with being a laboring schmuck and continuous reading.
I'm not trying to diminish the importance of oil and its easy energy content. I know it is important, and is becoming an increasing problem. But, if our economic structure is tilted wrongly, we cannot price and allocate resources properly. Yes, oil is not valued properly, and real wealth (not money) is a direct function of energy conversion. Sorry, in future I will try and figure out a way to preface with some "given" assumptions. If you are interested in oil, and its miss-use, you should be equally interested in economics. I suspect Randall is beginning to understand the linkage between these subjects as well.
By the way, nobody has challenged my basic premise. The idea that we can speed up "deleveraging" in the way I propose has not been mentioned previously in the media, or by any economist. Am I the only one in America that sees this fix? It is a serious proposal that cannot be flippantly ignored. It gets frustrating to hear all the noise and fury in our media, when most of it is just noise and ignorant fury - not rational problem solving.
With regards to 100% reserve banking being a dumb idea, then almost all of the great economists in 1938 must have been dumb. If not for the intervention of WW2, we probably would have implemented the program. For WW2 we spent at 3/8 of 1% direct into industry, which "deleveraged" the previous great depression balance sheet. Prior to that we had to threaten the bankers with another Greenback issuance.
When the tanks and airplanes were lost, it was cheap money. We ended up with good infrastructure and not much debt. QE2 is not the same as direct spending. QE2 money was spent directly into banks. This is a big giant difference that needs to be understood. When vertical government money goes into the private banking system, it is seen as exogenous to the system. The banker puts the extra money on the overnight market, because it is seen as extra reserves. That drives the interest rate DOWN. The low rates create a speculative boom in commodities, and causes a carry trade. QE2 is mis-allocation of resources, and cannot be remotely compared to direct spend. The FED through open market operations then tries to control a rate window by buying up the excess reserves with repos and reverse repos. That is why we never have bond failures, the money is already in the economy. Sorry, don't blame the messenger, I didn't create our crazy system.
People just need some sort of stable token to trade their output. The notion that money needs to come into being based on debt is a lie. History has already refuted this lie many times. 100% reserve has no counterparties and insurance and other gimmicks to make it stable, it is inherently stable by its nature. It is not CREDIT money, a liar that should not stand in for money.
I'll be saying goodbye to you guys for awhile. I won't have time to make comments again in the near future. I appreciate the people here; everybody is intelligent and thoughtful.
One couldn't erase that much debt in banks without a taxpayer bail-out of the banks. Why should I, a non-mortgage holder, fund the erasure of hundreds of billions of dollars owed by tens of millions of mortgage-holder?
Also, the US government is already going into debt as fast as the private sector is deleveraging. Bank losses on mortgages would become federal government losses on mortgages in your scheme. Those losses would be funded with more Treasury bill sales. Turning mortgage debt into Treasury debt is supposed to help the economy?
Ken Rogoff advocates some inflation to deflate the value of debts. I'm going to try to minimize the amount of my assets that are held in cash because I expect eventually the Fed is going to take his advice.
I agree with E-P about the primacy of oil. If massive bankruptcy or other measures were used to reduce debt levels the economy would still be constrained by the price of oil and other commodities. We have hit real limits to growth that reform of our monetary system won't fix.
The battle over much of federal spending cuts fall on the middle class elderly versus the younger poor is one of the biggest battles over the next 10 years. I can't tell how this is going to turn out.
The needed cuts are much larger than even the Tea Party envisions because the Tea Party still imagines we can return to our normal post-WWII growth rate. I really believe that is not possible absent some huge technological innovations in energy.
BTW, VW is not happy about the new CAFE standards:
"Passenger cars would be required to achieve five percent annual improvements, and light trucks 3.5 percent annual improvements. The largest trucks carry almost no burden for the 2017-2020 timeframe, and are granted numerous ways to mathematically meet targets in the outlying years without significant real-world gains.”
While VW is unhappy that trucks getting off lightly I do not expect light trucks to be as large a fraction of the total market in 2025 as they are today. Gasoline prices will be much higher. So more people will opt for the 50+ mpg sedans.
These problems are not actually all that complicated, from a mathematical standpoint. Raise the retirement age - the age of eligibility for Social Security and Medicare - for everyone, specifically including government workers. Raise it in increments until it reaches 73, then index it to the national average life expectancy.
Of course from a political standpoint this is all very difficult, but that's a question of will. It takes no great intelligence to address these problems.
CAFE doesn't create any incentive to reduce oil consumption, especially in the near term when we need it. It was the wrong idea then, and it's the wrong idea now. What we really need is $5/gallon gasoline (and more), and laws which give right of way to NEVs and scooters on more roads. The added gas taxes can be refunded through a deductible on social security.
Giving incentives for scooters would be a big help. People who can't afford a new car can afford a scooter, and if people can leave their cars at home 50% of the time they'd save lots of fuel. I wouldn't be surprised if a scooter or NEV and a car-sharing service is cheaper and more convenient for many people than owning an ICEV for lots of people already.
What CAFE does is makes it easier for those who want to cut their personal oil bill. Granted, some of the masses will still make wrong choices. But CAFE increases the quality of the choices available.
Also, I expect $5 per gallon gasoline on the next oil price spike. QE3 will get California at least to $4.5 and maybe even to $5 in the most expensive areas. Then QE4 will get the whole United States up to $4.50. Then QE5 will get us to $5. So we don't have long to wait.
Got any guesses on when global oil production goes into decline? When do we leave the plateau? 2015?
We've been through this before. CAFE makes it easier, while the cheap-fuel policy makes it less and less attractive to do so. People resent sacrificing performance and a commanding view when those who do not don't pay a price. Never underestimate the power of feelings of unfairness (or worse, being on the losing end of a power trip).
CAFE also fails to address other means of cutting fuel requirements, such as shorter commutes and telecommuting. These are easy things to do over time, but the incentives have to be there. If driving mileage stays cheap, it won't happen.
OECD oil consumption is already falling, but not fast enough. World oil production isn't the issue; for the OECD, it's net oil exports. Consumption by oil exporters is going up rapidly, leaving less for importers. We will run down the consumption curve either by increasing GDP/barrel fast enough to keep up (preferably faster), or losing GDP.
So tell me if this is your argument in a nutshell: people will make such bad decisions on their own that they'll choose cars (and places to live) that cause them to spend too much on gasoline so that the economy shrinks more than Peak Oil makes necessary. Therefore we really need a high gasoline tax in advance of Peak Oil in order to minimize the economic impact of Peak Oil.
Do I get you correctly? If so, we have no hope since the public won't accept higher gasoline taxes even if those taxes are for their own good.
Okay, I have a few points in defense of CAFE by itself: I think with such radical high CAFE standards people will drive more efficient cars as a result. Also, they won't increase their miles driven per year much because people already have commutes close to as high as they'll tolerate. Plus, Peak Oil will cause higher oil prices that will do (albeit later) some of the price increases that you want to get thru taxes.
What worries me is the drop of oil prices back below $80 today. Maybe we can't maintain oil prices high enough to cause people to shift away from oil.
people will make such bad decisions on their own that they'll choose cars (and places to live) that cause them to spend too much on gasoline so that the economy shrinks more than Peak Oil makes necessary.
I thought that was already proven. People assume historical fuel prices, a return to "normal" even during spikes, and fail to plan for contingencies such that their non-energy disposable income shrinks much too far to avoid economic contraction in conditions such as the present.
Therefore we really need a high gasoline tax in advance of Peak Oil in order to minimize the economic impact of Peak Oil.
No. Peak oil is in the past, to list just one error in that sentence. We need a high gasoline tax to get the public to make plans with future conditions in mind, not past conditions which will never be seen again. When people sink money into durable goods such as vehicles, they need to be planning for at least the next ten years.
we have no hope since the public won't accept higher gasoline taxes even if those taxes are for their own good.
Nobody has tried to sell those taxes as anti-OPEC measures before. I'd like to see someone try. Ross Perot had a chance to get such unconventional ideas into the public eye, but I haven't seen anyone since who had both the press coverage and independence from special interests.
I have a few points in defense of CAFE by itself: I think with such radical high CAFE standards people will drive more efficient cars as a result. Also, they won't increase their miles driven per year much because people already have commutes close to as high as they'll tolerate.
The problem is that CAFE+cheap fuel means public sentiment pushes automakers to do end-runs around CAFE (as the truck loophole did the last time). Our history proves that the only way to discourage fuel consumption is to do it directly.
What worries me is the drop of oil prices back below $80 today.
Which encourages people to think of low prices as "normal" again, even if they are 50% higher than the last low point of the ratchet.
Policy is the only way to overcome this conceptual error.