Hushbeck on Question 2: The Budget

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Link to question #2.

The 21st century has been marked by economic bubbles. It began with the collapse of the Internet bubble starting in the late spring of 2000 when venture capitalists pulled their money from many fledging internet companies.  This sent shock waves throughout the economy during the summer and fall of that year as many big name companies collapsed, throwing the economy into recession.

With the resulting decline of the stock market, people were looking for a safer place to invest.  Over the previous decade the federal government had been demanding that lenders offer more avoidable home loans. These new loans made housing seemingly a great place to invest.

As money moved into housing a second bubble developed, the housing bubble. By 2007 it too was collapsing. When this was combined with a depression era account rule, reinstated in November 2007, it caused the economic crisis that rippled through 2008 and into 2009 when the resulting recession ended.

But if the recession ended in the spring of 2009, why are things so bad now, four years later?  The reason is that we are in yet another bubble. But unlike the Internet and Housing bubbles, this bubble is in government.

Washington D.C. is a boomtown, in which even the highly priced housing market in the surrounding areas are doing fine. But the growing government is stifling an already struggling private sector with taxes and new regulation. This only increases the need for government services, which causes government to grow even more, further stifling the private sector.  This is a classic bubble.

Herbert Stein famously said, “that which cannot go on forever, won’t.”  The simple fact is that the federal government cannot go on forever borrowing 42 cents out of every dollar it spends.  To be sure, this is not a problem that started with Obama. The roots go back decades.  But it is true that Obama has taken the problem to new levels never before reached.

While people complain about the seemingly never ending crisis after crisis in Washington over fiscal cliffs, continuing resolutions, and debt limits, the first step in fixing this is well known:  Get a budget then stick to it.   But Obama for the 3 straight year just missed another deadline.  But at least he does finish his budget eventually, even if he is constantly late.  The Democrats in the Senate have not produced a budget in nearly four years, even though required to do so by law.

But the real problem that is driving all of this is that government has made so many promises, that it is impossible for them to keep them all. This is why the politicians keep “kicking the can down the road.”

We focus on the deficit, i.e., how much money we will need to borrow this year to make ends meet, about $1 trillion; or the debt, how much money we have already borrowed and need to pay back, about $17 trillion. This is over 5 times the yearly budget and more than the total Gross National Product of the country.  This put us very close to the territory of Greece and other economic basket cases out there.

Both of these are huge problems, but they pale in comparison to the unfunded liabilities, i.e., the promises that politicians have made, but have not bothers to pay for.  This is about a staggering $90 trillion.   It is no wonder politicians do not want to deal with this, for it means coming clean and admitting that there is just no way we and keep the promises they made. We simply will never be able to pay for it.

As Stein said, “that which cannot go on forever, won’t.”  At some point this bubble will end. We can either change course to get our finances under control or it will, like all other bubbles, reach a point where it collapses. Exactly how this will happen cannot be predicted, we could see massive inflation in which our money become basically worthless (Note the 100 trillion dollar bill from Zimbabwe which is worth about $5). We could see a depression so deep that the last four year will seem like “the good times.”  It will probably be some combination, but it will not be pretty.

Already we cannot find enough lenders to loan us the money we need to pay our bills each year. As a result the Federal Reserve has been effectively buying it by just printing money such that over the last few years we have tripled the money supply. If it was not for the economy being so bad, we would have already seen inflation, and in fact, we may be beginning to see it now.

There are only three ways to deal with this.  One approach would be to encourage inflation.  Cut the value of a dollar in half, and you effectively cut the amount we owe in half.  This may be what is behind the increase in the money supply, though even if this were the case, I doubt, given the harmful effects of inflation, that any would openly admit it. This approach is deceptive in that the early stages of inflation look like economic growth and seem positive.   But in the long run this is a horrible option.

A second approach would be to increase taxes. The problem here can be seen in a study by Christian Romer, former Chair of Obama’s Council of Economic Advisers, which showed that a tax rate above 33% brings in less, not more, money. I know those on the left often questions this, but it has numerous historical examples that have demonstrated it to be true. Given that just federal taxes on the upper income earners, those who pay the vast majority of the taxes, already exceed this, higher taxes will not work.  While lower income earners are still below the 33% level, raising taxes on them is hardly likely in the current “tax the rich” environment.

That leaves cutting spending. This is not as onerous as it may at first seem.  Studies cited by George Guilder in his book Wealth and Poverty, demonstrate that countries that have chosen this approach generate so much economic growth, that within a few years they actually have more money to spend than countries that tried to tax their way out of their financial problems.

Ideally, the best approach would be to focus the government, both tax system and regulation, towards economic growth, while cutting spending.  However, in the current political climate that is not going to happen.  Even if it did by some miracle, I believe our current problems are so severe that we can no longer avoid significant pain, we can only minimize it.  Which given the inclination of politicians, means that the government bubble will be like all other bubbles, we will avoid the warning signs until it is too late, and economic realities take over.