Our National Ponzi SchemePosted: August 27, 2009
Doctor Doom, Nourielle Roubini, an economist and professor at NYU, always manages to turn an interesting phrase when making his trademark pessimistic forecasts. He’s really done it this week in Forbes.
I wrote about the Federal deficit last week and covered the major points of why we are on an unsustainable path for our taxes and spending and when that could be a problem. The Obama administration continues to revise its spending and deficit estimates upward as an act of surprise over how deep the recession has been. I’ve raised a Spock-like eyebrow over that and have been lighting candles on my alter to the wisdom beings that, hopefully, the White House will get more real. Well, nothing makes things more real than a splash of freezing water in the face while sipping the first cup of the day’s coffee. Roubini is his fully alarmed self. He basically accuses our political class of running one big Ponzi Scheme and we are the suckers.
The fiscal implications of the current policy package are particularly serious. For the time being, fiscal policy has been put at the service of survival, but the current price of survival is that net public debt is going to double as a share of GDP between 2008 and 2014. Even using the very optimistic forecasts of the Congressional Budget Office, which anticipate growth of around 4% over the next few years, the net debt burden will rise from 40% of GDP to 80%–that’s an increase in the debt stock of about $9 trillion. The interest charge alone on that increased debt will be in the region of $300 billion to $400 billion a year, which in turn may mean more borrowing to pay the interest if primary deficits are not reduced. When governments reach the point where they are borrowing to pay the interest on their borrowing they are coming dangerously close to running a sovereign Ponzi scheme.
Ponzi schemes have a way of ending unhappily. To get out of the Ponzi trap, governments will have to raise taxes, or cut spending, or monetize the debt–or most likely do some combination of all three.
Wow! If those estimates are right, just about every one with hands on the budget from the last 4 congresses to the last two Presidents should be in the jail cell next to Bernie Madoff. The information coming from the CBO is really what started ringing the death knell for health reform last spring. It should be completely obvious to any one that has followed the last stimulus package, what currently passes for ‘health care reform’, the escalation of ongoing wars, the Bush medicare pharmaceutical giveaway, bail-out bonanzas, and all those Bush tax cuts from the beginning of his term, that our fiscal policy actions need to be renamed nails in our collective coffin. We simply have to re-arrange our priorities or we will be assigned to the rubbish heap of failed empires. I can’t even image the People’s Republic (our banker) even relishes that outcome. I really, at this point, am incapable of optimism that any of this will be turned around in time. We continue to elect leaders that are either completely out of touch with reality or don’t care about it. We have VooDoo Government.
If Dick Cheney’s evil plan was to bankrupt the Federal Government, it’s working.
All three of the above options listed by Roubini are the only available options. All three, as Roubini implies, will probably be necessary. Unfortunately, we have no wiggle room on anything any more. We’re barely sitting near the trough of what is the economic downturn so we can’t afford not to continue to have direct government spending. It’s too early to raise taxes. The Chinese are getting resolute about the possibility of monetizing the debt. They simply will stop buying Treasuries and sell-off what they have. We have to prioritize what is important. We have to make incremental steps and choices.
If I had Peter Orzag’s job, there would be several things that I would do. The first would be to turn off the spigots of corporate welfare. Both the Bush Administration and the Obama Administration have their political base in corporate America. They have continually drafted legislation that enriches their cronies. As long as Congress also gets ‘theirs’, they don’t complain unless it scores points with their base. We can’t keep funneling public treasure into the likes of defense contractors, oil companies, big Pharma, the health insurance industry and what’s left of the financial industry. The agricultural supports need to go too. I say it’s about time we focus on letting them try to compete in a market rather than continually prop them up with tax dollars, price supports, and quantity restrictions. Our government doesn’t support a free market economy, it supports the creation of oligopolies, monopolies, and a bloated, ineffectual bonus class. If the Republicans were really serious about their free markets, they’d get their cronies off the public teat. If the Democrats were really serious about us little guys, they’d quit taking our money for their K Street buddies or forcing us to be the customers of their donor base. The budget process in this country is merely Kabuki theatre and more Voodoo politics.
Second, we can’t afford to be the world’s policeman and super nanny. Why is Barrack Obama building yet another military base in yet another country? This time it’s Colombia. Is pissing off Hugo Chávez really that important?
South American leaders are due to square off tomorrow over a plan to increase US access to military bases in Colombia, a deal that has damaged Barack Obama’s attempt to mend relations with the region.
A diplomatic firestorm has been ignited, with a summit in Argentina pitting Colombia – which has sought closer co-operation with Washington – against its neighbours who fear the US presence will threaten leftist governments.
Venezuela‘s president, Hugo Chávez, has led the denunciations, claiming US imperialist aggression was blowing “winds of war”. He has vowed to buy extra Russian tanks to defend his socialist revolution and told his cabinet to prepare for ruptured relations with Bogotá.
Colombia responded with a formal complaint to the Organisation of American States, a pan-regional body, accusing Chávez of “expansionism” and meddling in its internal affairs.
The row has left Bogotá isolated, however. Bolivia and Ecuador’s socialist leaders have condemned the bases plan and even the more centrist governments of Argentina, Brazil and Chile have expressed unease.
This comes as Obama (and just about no other country including the NATO ones with said responsibilities) escalates the war in Afghanistan. I’m personally tired of funding and manning bases all over the world and wars all over the world that are half-assed attempts at expanding our influence by enriching defense contractors. Some one needs to tell the rest of the world to step up, because we’re going to step down. Let us take the diplomatic high ground for a change and let them play in the mud and blood. We need to pick our battles much more wisely and fund them even more carefully. We’ve created and we sustain VooDoo wars.
Third, the minute the recovery is firmly established, we need to get rid of the Bush tax debacle. We can no longer encourage any more Republicans that don’t understand that Reaganomics was a failed hypothesis. It is failed Reaganomics that has brought us to this point. We can no longer play 1 + 1 = 3 any more because of a bunch of ideologues. You cannot increase government spending and decrease taxes and expect to balance the budget. Also, budget deficits matter at some point. Reaganomics needs to be buried in the graveyard of failed social experiments. Why do we keeping breathing life into VooDoo economics?
Read what Nourielle Roubini says is going to happen when this third one does eventually happen. It’s complete gloom and doom.
Consider that by the end of 2010 most of the tax cuts legislated by the Bush administration in 2001 and 2003 are due to expire. This means that there will be a sharp tax hike, including income taxes, capital gains taxes and taxes on dividends and estates. This hike–equivalent to around 1.5% to 2% of GDP–is already factored in to future calculations of government indebtedness. So if by next year the recovery proves as anemic as I expect, and if unemployment is around 10.5%-11%, as I also expect, then the pressure for another stimulus round early in 2010 will be strong.
A rough calculation goes like this: Stimulus money to keep the lid on rising unemployment is likely to be around $200 billion. Add to that the likely temporary partial extension of the Bush tax cuts and funding of the current administration’s plans for universal health care (an additional bill of around $1.5 trillion over 10 years) and you get deficits close to12% of GDP.
This amounts to a fiscal train wreck.
This still takes us back to points one and two. No one in the executive or legislative branch ever shows the leadership to cut the money to their interests, no matter what is at stake in the country. No politician wants to be the one to raise taxes either. Yet, this simply cannot continue. Roubini sees the role of the Fed as the enabler to this fiscal train wreck once again.
Bond issuance will remain enormous, and it will mean that the Fed will almost certainly have to monetize a proportion of the debt by buying even more government or government-backed securities.
A combination of higher official indebtedness and monetization has the potential to yield the worst of all worlds, pushing up long-term rates and generating increased inflation expectations before a convincing return to growth takes hold. An early return to higher long-term rates will crowd out private demand, as lending rates on mortgages and personal and corporate loans rise too. It is unlikely that actual inflation will emerge this year or even next, but inflation expectations as reflected in long-term interest rates could well be rising later in 2010. This would represent a serious threat to economic recovery, which is predicated on the idea that the actual borrowing rates that individuals and businesses pay will remain low for an extended period.
Yet the alternative–the early withdrawal of the stimulus drug that governments have been dispensing so freely–is even more serious.
Fourth, we need an independent arbitrator of fiscal policy priorities and budgeting above the CBO. With polarized politics taking precedent over the good of the country, I have no idea where this can come from unless a group of us economics and financial folk do it independently. Brilliant economists of all stripes need to sit down and find a consensus for fiscal priorities that reflects the political spectrum and the good of the country because it is damned evident to me our political class can’t do it. This is because both parties are functionaries of ideologues and interest groups. They are held captive by the ignorant and they act on it without reservation.
You cannot hear the frustrations of ordinary people over the winger nuts and the winger nuts are enabled by a corporate media that profits by putting ideological misinformants and miscreants on the airwaves. As Lexington of The Economist says in a piece last week, we are in the grips of folks who are more driven by conspiracy theories than reality on the ground. How can you get a national dialogue when even the political leaders join in by calling us all names? And there is the press, fanning the flames of the wrong discontent for profit and fun! We have HooDoo political discourse covered by a VooDoo press corps.
Belief in conspiracy theories can be comforting. If everything that goes wrong is the fault of a secret cabal, that relieves you of the tedious necessity of trying to understand how a complex world really works. And you can feel smug that you are smart enough to “see through” the official version of events. But widespread paranoia has drawbacks. For a start, it makes calm, rational debate rather tricky. How can you discuss the trade-offs of health-care reform, for example, with someone who thinks the government is plotting to kill grandma? It does not help, either, that politicians on both sides are willing to fan the flames. Sarah Palin calls Mr Obama’s health-care proposals “evil”. Harry Reid, the Senate majority leader, calls the protesters who loudly oppose them “evil-mongers”. Nancy Pelosi, the speaker of the House of Representatives, calls them “un-American”.
Our civilization has lost its civility. Roubini does sees wiggle in his own version of wiggle room. Can we resolve to wiggle around together despite the underlying current of Voodoo Reality?
So policymakers are between a rock and a hard place. Stop spending now and risk renewed recession and deeper deflation (stag-deflation). Keep spending now and risk renewed recession amid rising inflation expectations (stagflation).
Yet there is a space between the rock and the hard place. It is not a big space, but it is there.
His solution is for government to manage perceptions. Fed Chair Bernanke has been successful at doing this for monetary policy. Can POTUS Obama or his SOT or his Chief Economic adviser be counted on to do the same?
Governments will have to manage perceptions. Today investors remain willing to bankroll federal spending without any clear or firm indication of how the fiscal crisis–and it is a crisis of extraordinary proportions–is going to be dealt with. That won’t last. Clear indications will soon be needed as to how and when public finances will be repaired. That doesn’t have to be accomplished soon–but it does have to be communicated soon.
Monetary policy can most likely remain looser for longer (in the developed economies at least)–as long as there is a clear commitment to fiscal consolidation. But a credible fiscal commitment to medium-term fiscal sustainability is vital, because that is what will open up the very narrow window that is the exit route from our current and unsustainable spend-and-borrow economy.
Despite all the trouble of the Great Depression, FDR was a master of calming every one’s fears. He also had the Brain Trust out finding out all the possible options and coming back with clear data and even clearer heads. We have Obama, Geithner, and Summers, although the last administration Economist out defending the stimulus was Christine Roemer. Right now, the only person in the administration polling as credible is Hillary Clinton. Obama’s been losing the message and losing ground. This cannot continue.
So my final recommendation is based on Roubini’s and it’s one you’ve heard me talk about before. Much of what goes on in markets is due to those “animistic spirits”. It’s the same craziness that is driving political discourse these days. It’s perception, raw emotion, and in some cases VooDoo political hypotheses. All this VooDoo stuff needs to be undone. There needs to be a sense that some one in charge of fiscal decisions is articulate, well-meaning, and acting for the good of all of the country. The voters thought it was Obama. Nine months later, more and more people know that it’s not. There’s a vacuum of economic gravitas in the White House. I mean, who do you know that takes Timmy-in-the-Wall-Again Geithner, La-La Summers, Baghad Charlie Gibbs or even Barrack Obama serious on economic issues? Yeah, I hear the crickets too …
This cannot continue.