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US Deficit Must be Addressed

Posted by Steve Markowitz on October 23, 2012

Much of America’s attention is understandably focused on the upcoming presidential election.  However, the outcome either way, will not change the serious economic issues that America faces.  Whether either candidate chosen is willing or able to address the unsustainable deficits will determine the long-term economic vitality of the Country.

Earlier this year an important op-ed was posted in the Wall Street Journal titled, The Magnitude of the Mess We’re In.  It was penned by four notable economic experts who are fellows at the prestigious Stanford University’s Hoover Institution; George P. Shultz, Michael J. Boskin, John F. Cogan, Allan H. Meltzer and John B. Taylor.  They also served in various government policy positions in the Treasury Department, the Office of Management and Budget and the Council of Economic Advisers.  Their warning included: “The next Treasury secretary will confront problems so daunting that even Alexander Hamilton would have trouble preserving the full faith and credit of the United States”:

  • Federal government spending now exceeds the 2007 level by over $1 trillion annually.  However, during the same period government revenues remained nearly unchanged.  Since 2007 the federal budget deficits have been, $1.4 trillion in 2009, $1.3 trillion in 2010, $1.3 trillion in 2011, and another $1.2 trillion estimated for 2012.  This four-year increase alone amounts to a $55,000 for every U.S. household.
  • The raw amount of the debt is only one problem.  As with any debt interest must be paid on it.  The US Treasury holds most of the debt in short-term duration loans.  For example, during 2012 the Treasury will borrow about $4 trillion. Obviously, when interest rates go up United States’ debt burden will rise significantly.
  • While Americans believe foreign governments own much of our debt, there is another sinister issue.  America has been monetizing its debt by having the Federal Reserve purchase it.  For 2012 the Fed is purchased about three quarters of our new debt (Quantitative Easing).  With the Fed buying so much of the debt it has gained control over the economy in ways it was not intended to have.  For example, the Fed gives banks money, effectively circumventing the appropriations process that was supposed to be within the purview of the Congress.
  • The Fed’s policy of low interest rates has significantly cut into the real income of those who have saved for retirement.
  • Under President Obama, the federal debt-to-GDP ratio increased to 80%, about double its 2008 level.  This is a larger percentage increase than Greece had during the same period.  With current projections the total US debt is projected to expand to approximately $19 trillion by 2018.  In addition, the interest costs on it by that year is projected to be $740 billion.  That is more than the Country currently spends on Social Security, Medicare or national defense, and it assumes that interest cost do not increase significantly.  The authors point out that for every percentage point increase in interest rates, the debt service costs increase by approximately $100 billion.

The authors concerns are magnified if unfunded governmental liabilities including Social Security, Medicare, or Medicaid are taken into consideration.  Some estimate that this amount is in excess of $60 trillion.

Through various mechanisms the Fed has printed money.  So far these actions have not created inflation, mainly because of low product and services demand and the fact that banks are not lending money.  Ultimately the Fed’s expansion will have to be unwound.  Historically such actions have led to unintended consequences that likely will include significant amounts of inflation.

Negative consequences from the Fed’s actions already are showing themselves.  The authors point out that various markets including equities no longer respond to real economic activity.  Instead they await the next Fed action.  This has created a negative feedback loop.  When economic activity seems weak, the equity markets head downward until the Fed intervenes with its shot of heroin that then gives the markets a boost.  Not only does this give the Fed too much power, but it distorts the markets which are supposed to govern supply and demand.  While the unintended consequences of this distortion must be left the speculation, they will be significant and problematic as were the consequences of their previous interventions including the low interest rate policies of the late 1990s and early 2000’s.

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