It’s the budget, stupid

The scariest movie released last summer was not The Happening or Midnight Meat Train – it was a documentary about economics and the national debt. I.O.U.S.A. attempted to open the eyes of the American people to the country’s “ticking time bomb” of unfunded federal liabilities. As always, it seems, with budgetary and fiscal concerns, the movie’s success was somewhat limited.

And whatever success it might have had was quickly overtaken by the events of September and October – first the Lehman Brothers bankruptcy, then the freezing of credit markets, and finally the great stock market crash. In the five months following the movie’s release, the S&P 500 declined a staggering 35%, unemployment spiked, and both presidential candidates talked up the needfulness of heavy deficit spending to “jolt the economy back to life.”

Finding mainstream economists and policy-makers who believe that long-term debt issues should trump short-term economic performance is quite difficult. The consensus is to spend, spend lavishly, and to keep the government’s printing press running at full speed in order to create the money needed.

But, of course, the money isn’t so much “created” as borrowed, and such borrowing – despite the worrying silence of mainstream talking heads – will have consequences sooner or later.


Meet me in St. Louis

The January 2009 issue of The Regional Economist, a monthly publication of the Federal Reserve Bank of St. Louis, has the intrepidity to remind folks about the federal debt (HT: The Capital Spectator) in a new article titled “Deficits, Debt and Looming Disaster.” The article’s author, Michael Pakko (a researcher with the St. Louis Fed), very wisely disassociates himself from the fringe who believe that all deficits are harmful, but then reminds readers never the less:

“…when deficits are part of a fundamental structural imbalance in the long term, they signal a need for serious attention and reform. In a long-run fiscal analysis of U.S. federal government programs, this is demonstrably the case.”

As the article then explains, the US Government’s 2008 expenditures outpaced its revenues by some $638 billion (approximately the size of the federal economic stimulus package now being contemplated in Washington). Fortunately, we only had to borrow $455 billion of that figure. We raided the Social Security Trust Fund for much of the remaining $183 billion, with other trust funds and government accounts making up the difference. The point is that the deficits are much larger than those stated on-budget.

The further point is that the weakness of our revenue base is somewhat misstated if you look only at the off-budget figures. Significant changes in the distribution of Social Security inputs and outlays – such as those emanating from major demographic or employment shifts – have the ability to magnify the underlying structural problems of our deficit spending and cumulative national debt. Mr. Pakko summarizes this as follows:

“As long as the balances in the Social Security trust funds are increasing, the on-budget deficit is partly offset by off-budget surpluses. When Social Security benefit payments begin exceeding revenues—which latest estimates suggest will begin in 2017—the off-budget components will add to the overall unified budget shortfall. (It will be interesting to see if the federal government continues to report the unified budget figures when this is the case.)

“When the trust funds begin to be drawn down, the government will be faced with the need to borrow from the public in order to pay the obligations of the debt currently held in the trust funds. This will result in an increase in the debt held by the public, with no change in the total outstanding debt. In this sense, the total debt might better represent the long-term obligations of current government programs. In fact, as will be discussed later, a proper accounting of the long-term obligations of federal entitlement programs is far greater than the value of government IOUs in the Social Security trust funds.”

It is this looming shift in Social Security’s mix of income and outlays that has been at the root of my concern over the increasing federal debt. For this, I am labeled a “budget hawk,” but I don’t see what is “hawkish” about planning for a future reality that is plainly visible and rather easily known. I thought it was just good old-fashioned prudence.

That is why I have consistently advocated – even (especially!) during good times – that we should reduce spending and table debate concerning all large future entitlement programs, like nationalized healthcare insurance. The world has a way of throwing up before us unexpected obstacles and challenges: we are living through one of them right now with the implosion of Wall Street. Even the US Government experiences rainy days. How nice it would be to have some fiscal cushion when circumstance knocks us on our asses, and luckily, that is precisely what we have in the form of the Social Security Trust Fund. Unfortunately, that cushion will be gone in about a decade. You see, even if we can develop a way for Social Security to be self-sustaining over the long term, a way for the program to pay for itself despite the demographic shifts that many expect to occur within the next decade, we will still lose the roughly $100 billion that the Fund kicks in to help offset today’s deficit-spending. That’s an extra $100 billion that must be raised elsewhere or trimmed from the budget. Why wait until the bitter end to start trimming?

That is also why I get so very short-tempered with folks who suggest that, now that we’re deep in trouble, we have to choose the lesser of two evils and allow for larger deficits. A typical rhetorical approach is that of James Picerno at The Capital Spectator (and mind you, I generally enjoy reading Mr. Picerno’s stuff):

“Yes, there’s a strong case for arguing that what this country needs (again) is a good $800 billion (stimulus) cigar. This writer and many others have warned frequently over the past several months that as troubling as a spending spree is at this point, the alternative—deflation—is worse. Unfortunately, the only way to prevent deflation at this point is to shovel money into the economy, as we’ve discussed. We’d prefer another choice, but engineering a different scenario required different policies in years past. But having let the fiscal burden grow, we’re now between the rock and the hard place with the deflationary winds blowing directly in our collective faces. Simply put, this is no time to balance the budget.”

Apparently, there is no good time to balance the budget. At some point budgetary rectitude cannot simply be a hoped-for quality. It seems that, in recessions, deficits are needed to spur growth and aid job creation, but in healthy cycles, it seems we always dream up some ‘dividend’ to pay ourselves to wipe away potential surpluses – the Peace Dividend, the Internet Dividend, the Home-Ownership Dividend. But, of course, these weren’t ‘dividends’ at all. They were a form of leveraged borrowing no better and no worse than what Wall Street did over the past decade. The result: we have turned Social Security into a kind of large, intergenerational Ponzi scheme, worthy of Bernard L. Madoff, where promises will be, by necessity, broken at some indeterminate date in the future because of our inability to fund them.

But in the meantime, the cognoscenti seem content to kick the can, once again, further down the street, buoyed by their belief that imminent apocalypse awaits if we decline Mr. Obama’s stimulus package.

Saying so, of course, makes me a crank. Or an ideologue. The proposed stimulus plan has become a litmus test of sorts among the chattering class – rejecting it suggests that one is too “ideologically rigid” to participate fruitfully in the discussion. Take, for example, Nate Silver’s advice over at FiveThirtyEight.com:

“Basically, I would resist the temptation on either side to see the stimulus in too overtly ideological terms. The ordinary rules are suspended during a severe recession: what matters is – emperically [sic], theoretically – What Works. Instead, I would encourage everyone to cut down on their consumption of political blogs for the next few weeks and instead read more of Brad DeLong and Greg Mankiw and Paul Krugman and Tyler Cohen. Those are the sorts of people I’m interested in listening to on this; all others must bring data.”

I have nothing against the economists Mr. Silver defers to, but at the end of the day, fiscal rectitude depends so very little on data and more so on ethics. For example, the implicit premise of today’s deficit spending is that our happiness, today, is more important than that of our children and grandchildren. Our financial and policy-making flexibility, today, is more important than that of future generations. Now, when stated so bluntly – and, some would say, shrilly – no right-thinking person would suppose that such selfishness lies at the heart of today’s fiscal policy. After all, parents love their children. Then why do we opt, time and again, to leave them a fiscal train wreck?


Welcome to the irrational marketplace

Yesterday, I referred smilingly to Michael Lewis’s and David Einhorn’s weekend essay in The New York Times that recounted the now well-known actors and actions that, directly or indirectly, precipitated the current financial crisis. I was somewhat surprised by the less-than-appreciative response the article received in some quarters. For instance, David Zaring, writing over at The Conglomerate, thought the essay was “anecdotey and pat,” preferring to believe that “the crisis is complex, and that responding to it takes more than knee-jerk reactions, and, especially, more than moralizing over how dunderheaded the other guys are.”

I suppose I took away something altogether different from Lewis and Einhorn. I didn’t so much read the essay as offering a panacea to the financial world, but rather, an attempt to sketch out the psychology behind our failures, which I think is perfectly captured with one sentence: “The fixable problem isn’t the greed of the few but the misaligned interests of the many.” And as I quoted yesterday, the key passage is this:

“Our financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest.”

In my estimation, Lewis and Einhorn here strike upon the heart of the matter. I reprise it here because I think the same dynamic is present throughout the body politic and relates directly to why, against our own self-interest and that of our children and grandchildren, we continue to spend money we don’t have. Now, I understand if you – upon reading the passage above or this essay entire – are left somewhat perplexed by my endless fascination with what seems to be a rather facile point. After all, you don’t need a slide rule to understand “the tyranny of the short term,” as Lewis and Einhorn would have it. But just as Wall Street no longer has “any serious pressure” to “consider its enlightened self-interest,” it would seem that the American people likewise have lost any stomach for self-discipline vis-à-vis fiscal matters. We will continue to defer the pain necessary to market economics until pain is the only portion available to us.