All crises end – this is actually Larry Summers’s famous line. We avoided a Great Depression primarily because, compared with 1929-31, we have a government sector that is large relative to the economy – and which does not collapse when credit goes into freefall. What exactly did the Obama administration do in ending the crisis that a Clinton or McCain administration – or even Bush – would not have done? The most plausible answer is: Nothing.
Geithner insists, according to John Cassidy, that the Obama administration has “proposed the biggest regulatory overhaul in seventy-five years.” This is the worst conceit. The sad and unfortunate truth is quite the opposite – because Mr. Geithner and his colleagues refused to seize the moment and didn’t break the economic and political power of anyone who mattered, they have doomed us to re-run the same horrible credit loop as before. Legislation may tweak the details, but the regulation and control of systemic risk remains just as weak as before.
Johnson believes that since the "too big to fail" banks are becoming even bigger we are setting up for a far larger crisis that might exceed the capacity of the US government to handle in a crisis.
If we continue to allow banks to grow, as they have over the last 30 years – and did again through the latest boom-bailout-rescue cycle – we head towards a day when Mr. Geithner or his successor will try to save the financial system and will fail.
You might think that is a good thing and for sure it will bring on a big change in creditor attitudes and presumably much stronger regulation. But, just as in the 1930s, first we will have to dig out from under a lot of economic rubble – and we’ll lose a lot more than 8 million jobs.
In a post entitled "Way Too Big To Save" Johnson argues that in the next financial crisis we might find ourselves faced with bailing out a future Citigroup that has assets equal to 100% of the US GDP.
Let’s take that leap of faith and say we use the favorite scheme of Gerald Corrigan from Goldman Sachs – he is widely promoting conservatorship as a transition to wind-down for large complex financial institutions – and let’s say that it “works”. Presumably this would mean something like the situation with AIG since September 2008, run somewhat more effectively –perhaps without the obnoxious bonuses. But would that really lower the fiscal costs of stabilizing the economy in the face of a major financial shock? And could we afford those fiscal costs?
Maybe. But the experience in Europe is definitely not encouraging. The Irish state is in serious trouble because major banks failed and were “saved”; let’s not even talk about Iceland (where banks assets peaked around 11-13 bigger than GDP, i.e., the size of the entire economy). And Switzerland faces serious risks – with banks that had peak assets over 8 times GDP – that the international community apparently just wants to ignore (perhaps because Switzerland is not in the G20 or the even the European Union).
In the UK, one bank (RBS) had assets that were more than GDP (1.25 times, by some estimates). Ask yourself this: if Citigroup, which was around $2.5 trillion before the crisis (including the off-balance sheet commitments, let’s call that just under 20 percent of GDP) had actually been $5 trillion, would our problems now be larger or smaller? What if Citigroup – or whoever becomes our biggest bank – reaches $10 trillion or $15 trillion in today’s dollars and then fails, how would you feel about that?
What would US government policy makers do? The Federal Reserve would be tempted to inflate away the debt. We could experience 20+% inflation for a few years. Debt holders would be forced to take a very big haircut as a way to avoid an explicit national bankruptcy.
When Peak Oil hits what I would like to know: Will the resulting downturn be inflationary or deflationary? With declining tax revenues and mounting sovereign debt I expect governments to heavily pressure their central banks to expand their money supplies so as to allow inflation to cut the cost of paying interest on existing debt. A government wanting could prepare for the Peak Oil financial crisis by issuing debt with longer maturity dates. That way when monetary policy becomes inflationary and the market demands higher interest rates a government can ride along paying low interest rates on debt issued before the crisis.
Peter Boone and Simon Johnson lay out arguments for why the Greek debt crisis is not in our rear view mirror.
By the end of 2011 Greece’s debt will around 150% of GDP (the numbers here are based on the 2009 IMF Article IV assessment; we make some adjustments for the worsening economy and the restating of numbers since that time – for example, the fiscal deficit in 2009 will likely turn out to be about 8 percent, which is double what the IMF expected until recently). About 80 percent of this debt is foreign owned, and a large part of this is thought held by residents of France and Germany. Every 1 percentage point rise in interest rates means Greece needs to send an additional 1.2 percent of GDP abroad to those bondholders.
What if Greek interest rates rise to, say, 10% – a modest premium for a country which has the highest external public debt/GDP ratio in the world, which continues (under the so-called “austerity” program) to refinance even the interest on that debt without actually paying a centime out of its own pocket, and which is struggling to establish any sustained backing from the rest of Europe? Greece would need to send at total of 12% of GDP abroad per year, once they rollover the existing stock of debt to these new rates (nearly half of Greek debt will roll over within 3 years).
This is simply impossible and unheard of for any long period of history. German reparation payments were 2.4 percent of GNP during 1925-32, and in the years immediately after 1982, the net transfer of resources from Latin America was 3.5 percent of GDP (a fifth of its export earnings). Neither of these were good experiences.
Boone and Johnson say the Greeks and other European countries have got to decide whether they are willing to pay the price to keep Greece in the Euro currency zone. Without guarantees by Germany, France, or the IMF on Greece's debt the debt interest costs will go too high and Greece will default.
But I'm less clear on how abandonment of the Euro helps. A withdrawal of Greece from the Euro zone could happen before or after a default. If Greece withdraws then its debt servicing problem remains. Greece would still have lots of outstanding debt denominated in Euros and the Greek drachma currency would drop against the Euro - making payment of existing Euro-denominated debt even harder.
What's interesting about their claims: They portray the European leaders as deceptive for pretending that the crisis is easing. They see the basic financial numbers as so bleak that the crisis looks set to escalate.
Tyler Cowen calls the article a a grim but realistic report. Paul Krugman argues that if the markets were willing to treat Greece as a very low default risk then Greece could easily afford to pay much lower interest costs on 150% GDP debt. So the question becomes: Can Greece convince the markets to treat it as a low default risk? If the markets decide Greece is a high default risk then Greece really is a high default risk.
I see another problem here: How can the Greek government maintain popular support for the austerity measures needed to prevent even higher debt accumulation if the markets decide to treat Greece as a low default risk? Absent a crisis various political factions in Greece will push for more spending for their benefit. Then the market will once again see Greece as high default risk. Interest rates demanded on new Greek debt issues will force Greece back down the path toward default.
Update: Sounds like the Eurozone countries will bail out Greece after all.
Plans for a bailout for Greece totalling €20 to €25 billion will be put to a meeting of Eurozone finance ministers on Monday.
A system of co-ordinated bilateral moves has been agreed behind the scenes by major players among the 16 countries in the single currency, led by Germany. They will step in as a last resort if Greece requests help in meeting its huge sovereign debt repayments.
The package has been formulated to work around a "no bailout" clause in EU rules, and would amount to an agreement to facilitate loan guarantees if Athens finds the price of selling its debt pushed too high by speculators.
But this doesn't kick in immediately. The goal here appears to be to discourage the markets from driving up the interest rate of new Greek debt issues.
Wolfgang Schauble, German finance minister, has a surprisingly sensible op ed in today’s Financial Times. As we suggested yesterday, first the relevant Europeans should decide if they want to keep the euro - more precisely, who stays in and who leaves the currency union – then policy must be adjusted accordingly.
Mr Schauble is obviously correct that existing economic self-policing mechanisms are badly broken; the eurozone can only survive if there are effective monitors and appropriate penalties for fiscal and financial transgression. He is also right to fear that involving the IMF in Greece would necessarily give the Fund greater rights to kibbitz on European Central Bank monetary policy. Given the fear and loathing expressed for the IMF’s “4 percent inflation solution” (or is it 6 percent?) in eurozone policy circles, you can see why this gives the Greek prime minister some bargaining power – the Germans will do whatever it takes to keep him away from the IMF in the short-term.
If the Greeks do not get bailed out and the market senses they are going to default then the EU's rules allowing free movement of capital will allow a huge flight of capital out of Greece due to fear that Euros will get converted into Drachma. If I was a Greek right now I'd be opening a bank account outside of Greece and maybe even outside of the EU. Time to get money out of the reach of a desperate government.
Kenneth Rogoff believes China's asset bubble will pop sometime in the next 10 year.
China, set to surpass Japan as the second-largest economy this year, has helped pull the world out of its deepest postwar slump. Record lending, soaring property values and accelerating economic growth prompted the government to begin retracting stimulus measures implemented during the global recession.
“Their response to the latest financial crisis clearly raised the risk that they have a debt-fueled bubble in the economy,” said Rogoff, who in 2008 predicted the failure of big American banks.
I happen to be reading and highly recommend This Time is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff. It is about the financial bubbles over centuries and the recurring pattern of claims that the bubbles weren't really bubbles because "this time is different". Nope, just another bubble.
For rapidly growing China the collapse of an asset bubble does not mean an economic contraction. Instead of growing at 9-10% per year growth will just slow down to 2-3% for about 18 months. China's long term prospects are very bright.
A collapse would depress output gains to 2 to 3 percent, a “very painful” period which would persist for about a year and a half, Rogoff said. The slowdown won’t lead to a Japan- like “lost decade,” he added. In a speech earlier yesterday, he said China will do “very well this century.”
Now that a big financial bubble has popped with widespread damage to financial institutions Rogoff sees worse troubles for other countries in the form of sovereign defaults.
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.”
Europe is getting all the attention in terms of sovereign default risk with the PIIGS (Portugal, Iceland, Ireland, Greece, and Spain) getting the bulk of the attention. But other Eastern European countries as well as countries in Central and South America and Asia certainly must pose some risk. I'd like to know what the top sovereign default risks are globally.
Rogoff thinks the US might face a crisis similar to Greece's within 50 years.
GHARIB: What is the scary part?
ROGOFF: The scary part is we look at what's happening in Greece and we look at what's happening in the budget of our country. We wonder, you know, if within five years we might be having similar problems tightening our belts.
I expect America's coming sovereign debt crisis will follow California's pattern. Years of political gridlock over whether to cut spending or increase taxes will escalate for a few more years. Then a huge increase in sovereign debt costs will cause an acute crisis that forces huge cuts in the US federal budget across most categories of spending. Even entitlements will cease to be sacred. At the federal level tax increases will play a larger part of the solution. But the US government is clearly overextended and cutbacks will come in military spending, old age entitlements, medical spending for the poor, and assorted pork projects.
If the US sovereign debt crisis hits around the time world oil production starts declining then the spending cuts will have to be savage in scope as each year tax revenues plunge even if tax levels are increased.
Rogoff thinks it unlikely Greece will avoid a default in the long run.
GHARIB: What do you think is the timetable? I know it's hard to gauge. What is the timetable to resolve a crisis of this magnitude? Are we talking about months or years?
ROGOFF: Years. This is a drama in many acts. Probably they'll bring in the International Monetary Fund and then have to bring them in again. This tends to take a long time to play out. There will be ups and downs, but I think it's going to be very difficult for Greece to avoid a default in the long run.
GHARIB: So explain this to people who are listening in on this conversation. Is this really a Wall Street issue or is this a Main Street problem?
ROGOFF: Oh, this is a Main Street problem. I mean, we are in a very delicate global recovery. Unemployment is still very high. We don't want the economy to get shaken up. I mean, best guess is this is worse for Europe than the United States, but you don't want your biggest trading partner stumbling just as you're in a fragile recovery.
An excellent article in the New York Times about prospects for a Greece bail-out from Euro zone countries highlights some of the politics of whether Greece will get an EU bail-out or an IMF bail-out.
Germany is reluctant to sanction any bailout knowing that, as the euro zone’s biggest economy, it will bear the brunt of the cost. But France and Germany also believe that any recourse by Greece to the International Monetary Fund would damage the prestige of the euro, highlighting its inability to sort out internal problems.
Moreover, France’s president, Nicolas Sarkozy is said to be particularly reluctant to see a rescue orchestrated by the monetary fund, which is led by Dominique Strauss-Kahn, a Frenchman and a potential rival in the next presidential elections.
The political leaders in Germany need to show Germans that the Greeks are imposing a lot of suffering on themselves in order to justify to the German public a bail-out using German money. Will the Greeks raise their retirement age to German levels? Will they do more cuts in public sector wages and more tax increases? What's within the realm of the politically possible in Greece?
German chancellor Angela Merkel really does not want to bail out the spendthrift Greeks. But fear of a larger debt crisis that would engulf the PIGS (Portugal, Italy, Greece, Spain) and possibly some eastern European countries like Estonia or Latvia have caused Germany to reconsider. Still at the moment all we've gotten is a big joint statement saying basically that Greece needs to be helped.
George Papandreou told Le Monde that it was important that the eurozone countries acted together to address the crisis. Papandreou said he expected fellow European leaders to support his efforts to cut Greece's debt, which is expected to hit 120% of GDP this year.
Britain, though, had already ruled out contributing to any rescue. The chancellor, Alistair Darling, said there was no plan to use UK taxpayers' money to support Greece. "The other members of the euro group want to monitor and manage the situation very carefully, they may have fresh proposals to make," Darling said.
If Greece is the canary in the coal mine then we are descending the mine shaft.
"In a way, the Greek case signals that we are in a new phase of the global financial crisis where the forefront issue becomes fiscal sustain-ability rather than exiting the recession," Pier Carlos Padoan, chief economist at the OECD said in an interview with Reuters yesterday.
Based on projections from the International Monetary Fund, the average ratio of G20 government debt-to-GDP will reach 118% by 2014. The United States, the group's biggest member, will see its debt exceed 100% of GDP in two years' time. Its federal deficit already adds up to 10% of GDP.
Imagine what happens to US debt costs when 10 year Treasury bond interest rates go over 7%. The US government would need to pay the equivalent of over 7% of GDP just on interest costs. That'd run about $1 trillion per year. Welcome to the approaching era of high taxes and low levels of government services.
As the US sovereign debt grows the US government runs the risk of an acute crisis where suddenly the market dries up for new Treasury notes.
We are going to experience declining living standards due to accumulating government debt, the need to stop running trade deficits, a worsening demographic picture with an aging and dumbing down population, and Peak Oil.
LONDON -- Governments in Athens, Madrid and Lisbon struggled on Friday to quell fears of a looming debt crisis in Europe that is pummeling the euro and rippling across global markets, as authorities vowed to impose fiscal austerity and plug their yawning budget deficits. The problem, however, is that investors don't appear to believe them.
On the one hand the French and German governments do not want a Greek loan default and probably will intervene to prevent it. On the other hand, they are reluctant to intervene and take pressure off the Greek government to cut spending and/or increase taxes. So we get to watch a game of chicken between Greece, France. Germany, and bond investors. Who will blink first?
What, me worry? Why are the markets getting worked up when Greece should be able to avoid bankruptcy for several months yet?
Senior officials at the major rating agencies on Friday played down the risk of an immediate debt crisis, saying even nations such as Greece have enough reserves to put off for months a day of financial reckoning.
Greece shows Americans our future.
With debt piling up to 113% of the economy, investors fear Greece won't pay its debts, in the form of government bonds — or will need a lifeline from other EU countries to meet its 54 billion euro ($74 billion) borrowing needs this year.
In spite of a long distinguished history of economic mismanagement continuing to this day Italy has failed to get the markets to take its rickety finances as seriously as those of Greece and Portugal. It seems unfair somehow. What do the Italians need to do to get attention?
Economy Minister Giulio Tremonti likes to remind Italy that it has "the third highest public debt in the world without having the world's third biggest economy".
Portugal, Italy, Greece, and Spain are now referred to in some financial circles as PIGS. The PIGS financial crisis. But not all analysts see their fates as so tightly bound together. What about contagion? Goldman Sachs says Greece stands above all others in financial recklessness. Ireland, Spain, Portugal, and Italy do not warrant the same degree of attention.
Ireland has made a “solid start” to consolidating its finances, Spain’s plans are “realistic and credible,” Portugal’s 2010 budget is “a beginning,” and Italy has “stronger balance sheets,” Nielsen said.
Spain has relatively low debt, but high unemployment and weak banks, and after the bursting of the housing bubble it can no longer rely on construction and inflated asset prices to propel growth.
These aspects, together with the larger size of the Spanish economy, had led Nouriel Roubini, a professor at New York University, to suggest this week that Spain is a bigger threat to the euro zone than Greece.
Writing in the New York Times Gretchen Morgenson assures us there's no way a financial contagion will spread off-planet. Your investments in asteroid mining operations and private sector Mars penal colonies are safe.
YOU know we’re in trouble when we’re told that the economic problems in Greece, Portugal and Spain, the most indebted countries in the euro zone, are likely to remain safely contained in those nations.
After all, we heard the same nonsense in 2007 from United States financial leaders talking about the subprime mortgage mess. Both Ben S. Bernanke, the chairman of the Federal Reserve Board, and Henry M. Paulson Jr., then the Treasury secretary, rolled out to reassure concerned investors that troubles in mortgage land wouldn’t permeate the rest of the economy.
As we all now know, mortgage woes were contained — to planet Earth. And so it may be with overleveraged nations in Europe.
Morgenson makes a number of good points about the failures of US policy makers in handling mortgages. I agree with her. The US government doesn't want to own up to the scale of the needed debt liquidation.
Okay, I know the little boy cried wolf lots of times over the years and the wolf never came. But, hey, isn't there a later point in the story where the wolf finally shows up? The US government is yet another dubious borrower.
"Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected, the federal financial picture as presented in [President Obama's Feb. 1 budget] will at some point put pressure on the AAA-government bond rating," Moody's said in a report Tuesday.
The debt trajectory isn't sustainable.
"The debt trajectory is clearly continuously upward if further measures are not implemented," Mr. Hess said.
I do not want to live thru hyperinflation or a depression. But we seem on course for some kind of economic disaster.
For the next 10 years the US Congressional Budget Office expects 2014 to be the best year with a $475 billion deficit. CBO expects the deficit to grow worse after 2020.
For the shorter-term, the CBO sees deficits of $980 billion in FY'11, $650 billion in FY'12, $539 billion in FY'13, and $475 billion in FY'14 and $480 billion in FY'15.
Looking further forward, the CBO sees deficits of $521 billion in FY'16, $525 billion in FY'17, $542 billion in FY'18, $649 billion in FY'19, and $687 billion in FY'20.
You might think that surely the US government won't let total government debt reach 100+% of the GDP. But I would have thought 10 years ago that the current debt and deficit levels would be politically impossible. Yet here we are with Obama and Congress trying to create massive new spending on health care on top of the Medicare drug benefit that George W. Bush and Congress put into place on an already financially rickety medical program.
If your retirement planning for the 2020s or 2030s includes government funding of a large part of your retirement and almost all your health care costs then think again. Expect higher taxes even in your retirement and means testing of more benefits. Also expect higher age requirements for retirement. You will work longer and pay more taxes.
A Congressional source told Reuters that the White House expects a new record one year deficit for 2010. $1.6 trillion in the red. Is that cool or what? I love it when humans strive to achieve what has never been done before.
Bill Gross of Pimco in his February 2010 column has a ring of fire around a group of industrialzed nations headed for sovereign debt crises. The United States is in that circle and will likely reach the important 90% of GDP sovereign debt threshold that is proposed by another book that I (and apparently Gross) am currently reading: This Time is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff. The book is a look at the history of sovereign financial crises. Reinhart and Rogoff built up a database of history of financial crises over many countries and 800 years. To my knowledge this is the first time a quantitative analysis on this scale has been done for sovereign debt and banking crises. The book is therefore able to offer unique insights into the frequency and triggers for financial crises.
Since the United States had such a financial crisis in 2008 and since its leadership shows no signs of developing an appreciation that we are skating on thin ice I expect we will experience a bigger financial crisis in the next 10 years or so. If the patterns Reinhart and Rogoff found are applicable to the US (and I see no reason to justify exceptionalism - look at 2008 for evidence of our fallibility) then our economic recovery will be slow for several years. Our big debt increase is no surprise to Reinhart and Rogoff:
On average, government debt rises by 86 percent during the three years following a banking crisis. These indirect fiscal consequences are thus an order of magnitude larger than the usual costs of bank bailouts.
Anyone who says "this time is different" is deluded.
Our immersion in the details of crises that have arisen over the past eight centuries and in the data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that "this time is different". That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy.
The book looks at inflation crises, currency crashes, currency debasement (when currencies used real metals and were debased with cheaper metals), the bursting of asset price bubbles, external debt crises, and domestic debt crises. The US has had the asset price bubble. Now it is moving on toward a debt crisis. At best US debt will weigh down the economy so that growth is slow. At worst, a bigger economic contraction could be heading our way.
Ireland and some southern European countries that are members of the Euro currency zone have run up too much public debt and some of them continue to run up sovereign debt at an alarming rate (just like the United States and Japan). A New York Times story suggests the moment of crisis could happen when economic recovery causes a sharp rise in interest rates. Suddenly sovereign governments that are already paying 1%-2.5% more than Germany on new debt will find their spread over German debt puts their cost of new bonds beyond their reach.
The true test for the world’s largest common currency zone, analysts say, will be whether it can withstand the economic, political and social strains once the European Central Bank begins to raise interest rates in response to economic improvements in Germany, France and other Northern European countries.
At that point, the laggards on the union’s fringe — Portugal, Ireland, Italy, Greece and Spain (the so-called Piigs) — will face even tougher choices to cope with what looks like several more years of stagnant economies, high unemployment and gaping budget deficits.
The higher their rates go the more the market will doubt their ability to pay and hence the market will demand even higher rates. Greece seems the likeliest candidate for such a crisis.
At that point a few choices become possible:
- Germany lends Greece a large sum of money. The Germans would find this a repugnant solution. It would enable the Greek government to keep running up more debt besides.
- Greece exits the Euro zone and borrows money from its own central bank in its reintroduced drachma currency. Then inflation makes the bonds worth less. Problem with this approach: Greece still needs to pay off large Euro bonds and an exit from the Euro would require it to use declining drachma to buy expensive Euros to pay interest and principal.
- The Greek government defaults.
- The Greek government increases VAT and other taxes to levels that drive out many of its most productive. Short term revenue boost but stagnation and crisis later.
- The Greek government must do massive lay-offs of government works and slashing of welfare state benefits.
Note that These options are not all mutually exclusive.
Whenever global oil exports start declining year after year sovereign defaults and/or high inflation will happen. If the Germans insist on a stable Euro then southern European countries will default on their debts. Outside of Europe some countries will pursue expansionary monetary policies in response to economic contraction caused by declining supplies of oil. Those countries will experience high inflation that will cut back on debt in inflation-adjusted terms.
What I would like to know: Which countries will experience inflation and which will experience deflation in response to declining world oil production?
Jeffrey Rogers Hummel, an economist at San Jose State U in Silicon Valley, says eventual US federal default on sovereign debt seems likely.
What about increasing the proceeds from explicit taxes? Examine Graph 1, which depicts both federal outlays and receipts as a percent of GDP from 1940 to 2008. Two things stand out. First is the striking behavior of federal tax revenue since the Korean War. Displaying less volatility than expenditures, it has bumped up against 20 percent of GDP for well over half a century. That is quite an astonishing statistic when you think about all the changes in the tax code over the intervening years. Tax rates go up, tax rates go down, and the total bite out of the economy remains relatively constant. This suggests that 20 percent is some kind of structural-political limit for federal taxes in the United States. It also means that variations in the deficit resulted mainly from changes in spending rather than from changes in taxes. The second fact that stands out in the graph is that federal tax revenue at the height of World War II never quite reached 24 percent of GDP. That represents the all-time high in U.S. history, should even the 20-percent-of-GDP post-war barrier prove breachable.2
The point about historical tax revenue as a percentage of GDP seems persuasive. How many Americans are going to support cutting their own effective buying power by 20% to pay for US federal entitlements programs in the 2020s and 2030s? On the other hand, the people who want to get stuff from the government and the people who want them to get stuff from the government are substantial factions as well (with some considerable overlap with the people who do not want to be taxed).
Currently I see Obama doing something that is the mirror image of what Reagan tried to do. Reagan tried to cut taxes to starve government and cut its size. Obama is trying to so increase spending that taxes have to rise to support the spending programs. Once the spending programs get established they develop powerful constituencies to defend them. If Obama can enact more new spending programs he increases the odds of a call for a tax increase as the needed fiscal response.
But the problem is that government is already on an unsustainable course with growth in entitlements spending before considering new Obama entitlements such as medical insurance funded by government.
Compare these percentages with that of President Barack Obama's first budget, which is slated to come in at above 28 percent of GDP. Although this spending surge is supposed to be significantly reversed when the recession is over, the administration's own estimates have federal outlays never falling below 22 percent of GDP. And that is before the Social Security and Medicare increases really kick in. In its latest long-term budget scenarios, the Congressional Budget Office (CBO), not known for undue pessimism, projects that total federal spending will rise over the next 75 years to as much as 35 percent of GDP, not counting any interest on the accumulating debt, which critically varies with how fast tax revenues rise. However, the CBO's highest projection for tax revenue over the same span reaches a mere 26 percent of GDP. Notice how even that "optimistic" projection assumes that Americans will put up with, on a regular peacetime basis, a higher level of federal taxation than they briefly endured during the widely perceived national emergency of the Second World War. Moreover, once you add in the interest on the growing debt because of the persistent deficits, federal expenditures in 2083, according to the CBO, could range anywhere between 44 and 75 percent of GDP.3
I see about 4 possible resolutions of the coming financial crisis:
- US government default. This seems like the lowest probability outcome.
- Huge tax revenue increase. Only one way to do that: Stiff European-style Value Added Tax (VAT) that raises prices 10-20-30%. Goods and services become as expense as we see in Europe. We get a permanent large European-style welfare state but with a worse outcome. I see the people who support this as enemies.
- Inflation. This might happen thru the back door as a response to a financial crisis even bigger than what we saw last fall. The Federal Reserve's attempt to stop a panic will lead to an even bigger monetary injection than we've seen in the last year.
- Massive cuts in entitlements programs. California's fiscal crisis provides a demonstration.
If and when the US dollar ceases to be the world's reserve currency a sharp transition caused by large scale flight from the dollar could cause skyrocketing interest rates and a downturn that causes one or more of the above resolutions. We might get some combination of the latter 3 possibilities in a series of crises with different levels of contribution from each item.
The biggest mistake the Democrats are making is to assume economic growth will fund their dreams. I see demographic problems slowing economic growth as a lower skilled work force grows up to replace the smarter Baby Boomers. Also, Peak Oil is coming at most 11 years from now and possibly much sooner. Economist James Hamilton has explained in his paper Causes and Consequences of the Oil Shock of 2007-08 how oil price run-ups cause recessions. Well, our current recession is basically a rehearsal for worse recessions to come in the 2010s as a result of high oil prices. The money isn't going to be there to make the government spending scenarios above remotely possible.
As people get poorer due to Peak Oil and demographic problems they will become more opposed to taxes on what remains of their take-home income. So I'm expecting some really severe cuts in entitlements. Expect to work longer. Expect more entitlements for old folks to become needs tested. Save now because you are going to need the money in years to come.
David M. Walker, former Comptroller General of the U.S., argues that the current financial crisis is small potatoes compared to the coming unfunded entitlements US financial crisis.
At the dawn of the 21st century the U.S. had $5.7 trillion in total debt. As we approach the end of George W. Bush's presidency only eight years later, that sum has nearly doubled, thanks to war costs, tax cuts, spending increases, expanded entitlement programs, and now a welter of government bailouts and rescues.
This year was particularly bad. The federal budget deficit for fiscal 2008 hit $455 billion, up from $162 billion last year. That figure does not include the cost of the Emergency Economic Stabilization Act of 2008, which has an initial pricetag in the hundreds of billions of dollars. In fairness, some of that money presumably will come back to the Treasury, since the new rescue-related sums will be used to acquire preferred stock, mortgages, and other assets that someday could be sold at a profit.
Yet any such calculations are penny ante compared with the fiscal disaster that is bearing down on America.
The US old age entitlements are underfunded.
The U.S. Government Accountability Office (GAO), noting that the federal balance sheet does not reflect the government's huge unfunded promises in our nation's social-insurance programs, estimated last year that the unfunded obligations for Medicare and Social Security alone totaled almost $41 trillion. That sum, equivalent to $352,000 per U.S. household, is the present-value shortfall between the growing cost of entitlements and the dedicated revenues intended to pay for them over the next 75 years.
Do not plan on retiring at age 65. Here's why:
Today we are headed toward debt levels that far exceed the all-time record as a percentage of our economy. In fact, by 2040 we are projected to see debt as a percentage of our economy that is double the record set at the end of World War II. Based on GAO data, balancing the budget in 2040 could require us to cut federal spending by 60% or raise overall federal tax burdens to twice today's levels.
My guess is that the problem is much bigger than Walker expects. Calculations of the size of the unfunded liability are based on assumptions about future economic growth. These assumptions seem excessively optimistic for a couple of reasons. First off, Peak Oil is coming. That's going to cut into per capita GDP and cause the US economy to shrink for several years. Second, the aging of the US population is not the only large demographic crisis we face. Poorly performing Hispanic immigrants will cause declining per capita income in California The economy in Texas will become more like the Third World as well. The lagging groups will not get better with time. So declining per capita GDPs seem inevitable - at least until either artificial intelligence or genetic engineering overwhelm this trend. The libertarian view of immigration is deeply flawed. This means that the leftist welfare state and the libertarian dreams for a smaller government will both take big hits. So will your living standard. Plan and work accordingly.