The Politics of Deficits and Debts

The frequent worry of the American right is the current state of the US debt. You hear it in just about every fiscal conversation. This makes me want to ask, "Do you think that a government has to be debt free?"

In fact, it really doesn't. A government does not face the same debt constraints as a business. In fact, all of government need to do is reduce the annual budget deficit (plus interest) below the inflation rate in order to make its debt levels sustainable.

Even the aggressive debt reduction proposed by the President's debt commission only sought to reduce the debt, over time, to less that 40% of GDP. Their plan continues to run a budget deficit for another 15 years or so. It recommends only an average annual budget cut of 461 billion dollars spread over 18 years. Obviously, considering the state of the economy, they start small and build over time.

The commission rightly points out that the real issue in solving America's debt problem is reducing the amount of money we spend on health care. That takes reforming the health care industry, not just government's role in it. Health care already accounts for 20% of government spending, which is higher than any European country with their "socialist" medical systems. To make matters worse, the rate of spending is growing fast. 

Clearly something is wrong, and we need policies to reduce this spending (while taking care of our people), or we will, in fact, go completely broke. The debt commission gets the ball rolling by recommending that a public option is included in Obama's reform of the health care system. But thanks to the way health care markets work, you can reduce the amount we spend on health care and make it more equitable at the same time. The current health bill should be a big start.

There are many other good ideas being pushed around right now on how the US's long-term deficit can be reduced. Again, start with the debt commission. This includes tax reform, military spending, increasing government efficiency and reducing spending in other discretionary programs.

And before you start screaming liberal-commie-nazi whatever, one of the co-chairs of this commission is Alan Simpson, the former Senator from Wyoming and a pretty hardcore conservative. He's not alone. Republicans actually made up half of the commission. True to form, their plan does not even recommend increases in taxes. Instead, they decrease tax rates and eliminate expenditures through a simplified system. This should result in higher tax revenues. So, it seems like there's considerable flexibility in a combination of tax increases and spending cuts to balance the budget.

While all of these proposals are important, it's important to understand the politics of the current debate. All of this debt posturing has nothing to do with deficits and everything to do with enforcing a specific vision of society on America during a time of crisis. This includes eliminating public unions even after they've agreed to take pay cuts and canceling programs for the poor to continue tax breaks for the rich. The party of "fiscal conservatism" just fought tooth and nail to make sure that rich people got additional tax cuts. They have reiterated, time and again, that they want these to be permanent. I'll believe a conservative that says he's serious about the budget the moment they stop giving millionaires handouts.

The people that actually care about the deficit (not deficit politics) already took a good stab at it through the health care reform. And who is trying to dismantle that? Why, the people that keep talking about the deficit of course. 

To make matters worse, the Republican Party spends an exorbitant amount of time on nonsense like defunding planned parenthood, attacking NPR and eliminating relatively tiny poverty programs . This is just crappy political gamesmanship. And it sucks that it happens, because while these millionaires in Washington might be doing perfectly fine, many, many people are suffering.

The long-term deficit is an issue, but I need to reiterate that now is not the time to cut government spending. Unemployment is still at 9 percent. You can't collect taxes from people without jobs, and you can't in good conscience cut their benefits when there are no jobs for them. Even worse, cutting spending at the rates originally proposed by the House GOP would cost another 700,000 jobs.

Depressed spending can lead to a downward spiral, and spending cuts now might not do any good since they'll be offset by the spending on the newly employed. Get unemployment down to 6 percent, and then start pulling back. Then there will be a tax base back in place that we can actually work with. And then we can assess program cuts and tax increases.

One last thing, if anyone out there want to play apocalypse watch, the best place to go is check 10-year US treasury rates. As rates go up, they indicate that the market is losing its confidence in the government's ability to pay off its debt (at least for the next 10 years). They are pretty damn low right now, and considerably lower than the historical average.

In other words, investors thought the Reagan administration was going to be far less likely to pay off its debts than the current one. Funny how that is, given the rhetoric surrounding Washington these days.

Now and Then

Without a doubt, recent government efforts meant to reduce the effects of the financial crisis often seem inaccessible and arcane. Much of the recent debate has focused on things like "bailouts," "backdoor loans" and "quantitative easing. While we deal with the efforts of an interventionist Fed today, we can take a lot about previous efforts during financial panics.

Liaquat Ahamed's Lords of Finance, the story of the key central bankers during the interwar period, obviously deals with these issues extensively. Two stand out: efforts to stem the banking panic (today's TARP and bailouts) and the decision to abandon the gold standard (similar to today's lax monetary policy at the Fed). The latter was the most important pieces of monetary policy in the first half of the Twentieth Century. There were many efforts to mitigate the effects of the depression in the US, but none were as effective. As Ahmad writes, monetary easing was "one step that succeeded beyond anyone's wildest expectations in getting the economy moving again."

Efforts to stem the banking crisis were also eerily similar to the Fed's response to the collapse of Bear, Lehman and the rest of the American financial system. How did it happen back then? Roosevelt had four brilliant young economic advisers during his first term: Dean Acheson, undersecretary of the Treasury, James Warburg, Roosevelt's direct adviser on economics, Lewis Douglas, the budget director, and George L. Harrison, the head of the New York Fed. These men were instrumental in the first maneuvers that Roosevelt conducted to save America's banking system, which was on the verge of collapse. Something like 7000 banks failed between 1931 and 1933, the New York Fed ran out of gold reserves supporting the system (it lost $350 million dollars on March 3, 1932), and almost half of the currency in circulation was withdrawn from banks. In a span of eight days, they stopped this cascading disaster right in its tracks. Hoover had been trying to do it for three years already.

I'll let Ahamed take it from here:

Every one of Roosevelt's advisers, including Harrison, believed that having stabilized the banking system, they could rely on the traditional levers - expanding credit, undertaking open market operations - to get the economy moving again. Most important, none of them could see any reason for breaking with gold.

note: This means abandoning the gold standard and devaluing America's currency. This would create inflationary pressure in the US, as foreigners could buy American goods at a lower price - in their currency - and Americans would have a harder time importing goods. This increase in demand for American currency leads to inflation, which is a good thing when a country has high unemployment and depressed aggregate demand.

Pitted against this array of economic expertise was one man - the president himself. Roosevelt did not even pretend to grasp fully the subtleties of international finance; but unlike Churchill, he refused to allow himself to be in the let bit intimidated by the subject's technicalities - when told by one of his advisers that something was impossible, his response was "Poppycock!" Instead, he approached the subject with a sort of casual insouciance that his economic advisers found unnerving but which nevertheless allowed him to cut through the complications and go to the heart of the matter.

His simplistic view was that since the Depression had been associated with falling prices, recovery could only come about when prices began going the other way. His advisers patiently tried to explain to him that he had the causality backward – that rising prices would be the result of recovery, not its cause. They were themselves only half right. For in an economy where everything is connected, there is often no clear distinction between cause and effect. True, in the initial stages of the Depression the collapse in economic activity had driven prices downward. But once in motion, falling prices created their own dynamic. By raising the real cost of borrowing, they had discouraged investment and thus caused economic activity to weaken further. Effect became cause and cause became effect. Roosevelt would have been unable to articulate all the linkages very clearly. But he had an intuitive understanding that the key was to reverse the process of deflation and kept insisting that the solution to the Depression was to get prices moving upward.

Roosevelt ended up adopting a policy on gold similar to the research of George Warren, a Cornell economics professor who was an expert on farming. And the actual mechanism for accomplishing this was through a farming bill, with an amendment that most people overlooked. It was a reckless and foolish decision that appalled most of the people working for him and caused outrage among the world’s financial experts. But, as Russell Leffingwell, a Morgan partner, wrote to Roosevelt, “your action in going off gold saved the country from complete collapse.”

Days after Roosevelt's decision, the Dow jumped 15 percent, one of the highest increases in its history. During the following three months, wholesale prices jumped by 45 percent and stock prices doubled. With prices rising, the real cost of borrowing money plummeted. New orders for heavy machinery soared by 100 percent, auto sales doubled, and overall industrial production shot up 50 percent.

This is exactly what should have happened if the stimulus had any real teeth. We are where we are because of a true lack of guts. Roosevelt may have been insane for doing what he did, but his hard-headedness and iron cajones prove why he is a true American hero.