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THE COMING FISCAL EARTHQUAKE

And What to Do About It

A modest Proposal

By

Jay B Gaskill

Attorney at Law

 

 

At some point – sooner rather than later- many economists are predicting (among them, Alan Greenspan, whose latest warning is contained in the two pieces linked below), that the US government’s borrowing binge will hit a Wall. 

 

I describe what that Wall will look below.

 

But first, let me describe the reigning false dilemma: 

 

Some experts, still enamored by the conventional thinking that got us in the current mess, persist in arguing that running deficits (and driving up total government indebtedness to dangerous levels) is the only way we can “grow” ourselves out of this deep and persistent recession.  Therefore, in their view, we are presented with two terrible choices: 

(a)    dramatically increased taxes that will abort any economic recovery – or –

(b)   dramatically decreased federal spending that arguably will have the same depressing effect. 

 

When confronted with this apparent vice, the current administration continues to speed our collision with the Wall, while remaining unable to “jump start” a meaningful and sustained economic recovery.

 

The choice is a false one for the same reason that the “jump start” is not working.  Most federal spending has the perverse effect of diverting capital and resources into unproductive uses (however popular with the special interests they serve) that would otherwise be available to fuel a private sector recovery.[1]  Public works projects and subsidies to the unemployed, however we might want them to work, do not actually generate long term productive economic activity because the US is no longer viable as a consumption economy.  This inconvenient truth was masked as long as the US enjoyed excessive borrowing capacity.[2]

 

Three elements in the current mess need to be simultaneously grasped, to wit:

For the last half century the US:  (1) has been running a negative trade balance with the rest of the world; (2) has been running a negative fiscal balance; and (3) has gradually lost the capacity to rebound.  Put in plain English, we have bought more than we have sold, using a combination of fake and borrowed money, and we have allowed our capacity to make marketable goods and services to slip offshore.

 

The US has enjoyed the benefits of a consumption-driven economy, funded by borrowing.  As long as borrowing didn’t have to be repaid, more consumption tended to drive American productive jobs. 

 

Remember when American consumption reliably drove prosperity, when presidents told us – in time of recession to “buy more” as a sort of patriotic duty?  Those happy days are over.   This has happened because the US and most of the western economies have reached a tipping point.   The borrowing machine has broken down.  

 

Let’s stop here for a reality check.  We keep hearing about the need to “trim the “deficits”.  This is what an irresponsible manager says just before bankruptcy.  After the inevitable crash, when a supposedly viable business has been exposed as a failure, we learn that the problem all along was the looming mountain of unpaid debt itself, to which the deficits continually contributed.  Many a seemingly invulnerable economic giant has been brought down by delay and denial.  In the global economy, individual countries, yes, even ours, are increasingly subject to the Darwinian discipline that governs large corporations:  perform or die.

 

In this setting, a failure of leadership can be fatal.

 

The US multi-decade borrowing-to-prosperity phase is effectively over because the circle on which it relied is broken.  Too much of our former productive sector has been outsourced to China and other third-world, and rapidly rising second-world economies.  Too little capacity was retained.  We are no longer “borrowing from ourselves.” Now we face two stark choices: (a) dramatic economic stagnation and decline because our purchasing capacity has dried up or (b) a purposeful shift from a borrowing-sustained consumption economy to an investment-sustained production economy.

 

Permit me one more aside:  Another “solution” has already been tried in Latin America with disastrous results.  Some governments have artificially inflated their money supply - via vast increases in fiat money.  The results were vast increases in prices, destabilizing inflation that toppled governments and brought in dictators.  HINT:  Post WWI Weimar Germany tried this and ended up with Adolph Hitler. 

 

We don’t want to go there. 

 

So if we wait until we actually hit the fiscal Wall, only the first choice may be available, leaving us with the prospect of decades of stagnation, permanently high unemployment and the final erosion of our very capacity to restart a sick economy.

 

 

BLOOMBERG

 

“Former Federal Reserve Chairman Alan Greenspan said the U.S. may soon face higher borrowing costs on its swelling debt and called for a “tectonic shift” in fiscal policy to contain borrowing.”

 

http://preview.bloomberg.com/news/2010-06-18/greenspan-says-u-s-nearing-limits-on-borrowing-capacity-restraint-needed.html

 

 

The Wall Street Journal

By Alan Greenspan

 

“An urgency to rein in budget deficits seems to be gaining some traction among American lawmakers. If so, it is none too soon. Perceptions of a large U.S. borrowing capacity are misleading.”

 

http://online.wsj.com/article/SB10001424052748704198004575310962247772540.html?KEYWORDS=greenspan

 

 

WHAT WILL THE WALL LOOK LIKE IN THE YEAR WE HIT IT?

 

At present, almost all of the “stimulus” spending and about 20% of every federal dollar is borrowed.  In practice that means that the everyday operations of the federal government require that the borrowing continue.  When that becomes impracticable because the lending markets lose confidence in the US economy, lenders (particularly foreign lenders) will no longer be willing to subsidize our government’s spending on any terms that will support the current budgets.  That’s when the politically driven economies hit the WALL.

 

The resulting crash will resemble the credit freeze that followed the collapse of overleveraged real estate assets.  But we used borrowed money to bail ourselves out of the real estate-driven bank crash.  If and when our government’s fiscal scheme crashes, there will be no bailout.  Hundreds of thousands of federal employees will be furloughed, benefit checks will be slashed - eventually fiat money will be printed, then ordinary commodity prices will double and more. 

 

But...within a few weeks or months of the FIRST WALL EVENT, those measures will be obviously insufficient. 

 

Look at the Greek riots.  We can expect worse, especially in certain urban centers.  Enacting rational fiscal and economics policies in such a crisis will be almost impossible.

 

The heart of Alan Greenspan’s warning is that the day of fiscal reckoning can take place much sooner and more dramatically than out current leaders expect. He cites the Geek example as a forerunner of what the US faces.

 

BUT IS THERE A WAY OUT?

 

Yes there is, but at present no political leader has emerged with the combination of hard-nosed realism and resolute optimism to set the course, let alone to actually lead the country to adopt it.  Here are seven elements.

 

  1. We need to return to the federal spending patterns of the 1950’s, with a tax structure that generates slightly more revenue than the federal government spends.  That surplus needs to be consistently applied to sovereign debt reduction, with particular emphasis on retiring debt held by foreign lenders.
  2. We need to comprehensively reduce the political load on commerce, aggressively cutting through that tangle of multi level permissions, delayed approvals, licenses, regulations, taxes and fees that burden any business startup or ongoing commercial enterprise.
  3. The overall tax burden, especially as it affects private productive endeavors at all levels, must remain slightly lower than it is at present.
  4. The revised business and commercial regulatory regime needs to be radically simplified and reconfigured to concentrate on public safety, financial accountability and responsibility.  All else – given the dire circumstances – constitute frills.
  5. Doors need to be opened wide to any and all foreign private investment and skilled labor, provided they are directed at producing and sustaining American-based production and profits.  Our own capital and labor needs to be similarly unburdened.
  6. These and the related implementing measures need to be comprehensive, effective and sustained for at least a fifteen year path, such that entrepreneurs and investors will have the necessary confidence to, once again, invest in the American economic engine.
  7. All temptations to prematurely bleed the capitalists, harvest the golden geese, or re-impose the crippling political and economic load on commerce that have accumulated over the last four decades must be resisted.  The US economy must be treated like the gravely ill patient that it is.  The vampires must be held at bay.

 

These common-sense ideas seem radical only because they are – or will be - a sudden response to the ruinous wreckage left by the radical hollowing out of the US economy over several decades.  In any form, including their most modest iterations, these proposals will be derided and opposed as retro-utopian, or as a return to “raw, untamed capitalism” or worse. 

 

Because these charges will be true, at least in part, there is little incentive to propose half measures.  Of course, in the real world, a degree of incrementalism is inevitable in practice.  Se we must propose boldly, while working tirelessly and realistically. 

 

There is no time to lose. 

 

In a perfect world there will be conservative and liberal versions of those core ideas, much as the anti-communist American left and right reached a general foreign policy consensus during most of the Cold War.  But it is not yet a perfect world, and the emergence of a fruitful dialogue between renaissance conservatives and constitutional liberals (my terms) cannot take place until new leadership emerges on both sides.

 

In today’s New York Times, columnist Russ Douthat discusses the left’s growing disenchantment with our new president, “The Agony of the Liberals” – LINK:

http://www.nytimes.com/2010/06/21/opinion/21douthat-1.html?ref=todayspaper.

After an agonizing analysis, he gets to the real problem at the end of the piece – “It’s not that he hasn’t done a great deal for liberals during his 18 months in office. It’s that liberalism itself may be running out of time.” 

 

But liberalism and conservatism are in an eternal dance in which the former attempts to erase boundaries and the latter seeks to defend them.  Liberalism, in this universal sense, is not dead, but its current, irresponsible, business-hostile form would benefit from euthanasia.  Just as the liberals need a “left-ectomy”, the conservatives need a shot of creative inspiration.  And US political leaders need to get real.

 

The heavy needed lifting will only grow with time.  Really, can the US productive capacity be restored by Twitter and Google?  Will the rest of the world willingly buy that which it can readily steal or copy?

 

The critics of a common-sense recovery will be many and noisesome.  But the resulting restoration of the great American productive commercial engine, the accompanying high employment and sustained prosperity will be a sufficient answer.

 

Can bureaucrats direct our way out of this?  One of the many lessons of the current crisis is the “creative innovation epiphany”.    This is the insight that the next “new, new” thing is always generated by risk takers, not bureaucrats, and is rarely predicted by the maven of conventional wisdom.  This is why my seven element list did not include any “product-specific” prescriptions.  Commerce 101 tells us what we need to know here.  Innovation responds to, stimulates and anticipates demand.  This is why we need free markets and risk takers.  And this is why government’s obligation is to maintain the playing field, then get out of the way.

 

Are we Americans up to the challenge yet? To paraphrase Hillel the Elder: “If I am not for restoring my country’s freedom and prosperity, who will be for those things? And if not now, when?’   

 

JBG

 

 

 

 


[2] The conventional political wisdom has been based on a careless reading of Keynesian economics, the theory that counter-cyclical deficits produce spending that ALWAYS can “tame” the business cycle.  This core notion has been expanded to a ludicrous extreme - in effect endorsing the silly idea that deficit spending can fix any economic dysfunction.  The facile use of Keynes’ theories by undisciplined governments breaks down at very large scales, especially when governments abuse the seeming spending-borrowing license - Keynes actually proposed having governments run surpluses to compensate for the deficits. These issues are exacerbated by the turbulences inherent in a global economy.  See http://mises.org/daily/1099 and http://bostonreview.net/BR35.3/kirshner.php .