The Gathering Storm
posted at 9:43 pm on September 18, 2012 by Matt Vespa
We all know that our country is facing financial catastrophe, especially if Barack Obama is elected to a second term. With $5 trillion in new debt, another downgrade in our credit rating, and the fourth consecutive trillion dollar budget deficit – it’s big government run amok. However, George P. Shultz, Michael J. Boskin, John F. Cogan, Allan H. Meltzer, and John B. Taylor of the Hoover Institute penned a rather apocalyptic column in yesterday’s edition of The Wall Street Journal exclaiming that Hamilton himself would have a near impossible task of keeping America’s full faith and credit intact if he were alive today.
Concerning Jazz Shaw’s piece this past weekend about the Fed’s QE3 program aimed at buying $40 billion dollars worth of bonds a month until labor markets improve, here’s the skinny on the cost.
To pay for quantitative easing—the purchase of government debt, mortgage-backed securities, etc.—the Fed credits banks with electronic deposits that are reserve balances at the Federal Reserve. These reserve balances have exploded to $1.5 trillion from $8 billion in September 2008.
The Fed now pays 0.25% interest on reserves it holds. So the Fed is paying the banks almost $4 billion a year. If interest rates rise to 2%, and the Federal Reserve raises the rate it pays on reserves correspondingly, the payment rises to $30 billion a year. Would Congress appropriate that kind of money to give—not lend—to banks? The Fed’s policy of keeping interest rates so low for so long means that the real rate (after accounting for inflation) is negative, thereby cutting significantly the real income of those who have saved for retirement over their lifetime.
It’s stupendously expensive and will do little to help the economy. In fact, as I wrote this past weekend, it may lead to another downgrade of our credit rating.
Concerning spending, the picture is even more bleak:
Did you know that annual spending by the federal government now exceeds the 2007 level by about $1 trillion? With a slow economy, revenues are little changed. The result is an unprecedented string of federal budget deficits, $1.4 trillion in 2009, $1.3 trillion in 2010, $1.3 trillion in 2011, and another $1.2 trillion on the way this year. The four-year increase in borrowing amounts to $55,000 per U.S. household.
The amount of debt is one thing. The burden of interest payments is another. The Treasury now has a preponderance of its debt issued in very short-term durations, to take advantage of low short-term interest rates. It must frequently refinance this debt which, when added to the current deficit, means Treasury must raise $4 trillion this year alone. So the debt burden will explode when interest rates go up.
The government has to get the money to finance its spending by taxing or borrowing. While it might be tempting to conclude that we can just tax upper-income people, did you know that the U.S. income tax system is already very progressive? The top 1% pay 37% of all income taxes and 50% pay none.
However, the president still feels we can still tax the job creating and investing class to subsidize the welfare state as it exists today, which is, as George Will said,the flawed logic of trying to jump a chasm in two bounds. As a result, “President Obama’s budget will raise the federal debt-to-GDP ratio to 80.4% in two years, about double its level at the end of 2008, and a larger percentage point increase than Greece from the end of 2008 to the beginning of this year.”
Concerning our welfare state, we’re in a $60+ trillion dollar hole in unfunded liabilities. I love my parents to death and I’m glad they’re more inclined to live to be 85, but I don’t want to pay for their prescription drugs or health care. That’s their responsibility. Just as it’s my responsibility to save to buy my own health insurance. A third of all medicare spending is spent on the last twelve months of life. As George Will has said repeatedly, the real question concerning the future of America’s fiscal health will be deciding how much money we are comfortable spending subsidizing the last two decades of Americans’ lives.
The question is cold. The answers will deliver pain. Therefore, the political class views loathes to consider bringing this into a serious policy debate. It’s anathema for the folks who make decisions due to the consequences and that’s why we will continue down this absurd track of financial negligence.
Just look at the president’s proposed budget – “the debt expands rapidly to $18.8 trillion from $10.8 trillion in 10 years. The interest costs alone will reach $743 billion a year, more than we are currently spending on Social Security, Medicare or national defense, even under the benign assumption of no inflationary increase or adverse bond-market reaction. For every one percentage point increase in interest rates above this projection, interest costs rise by more than $100 billion, more than current spending on veterans’ health and the National Institutes of Health combined.”
The “five” horseman write towards the end of their column that given what you know about our financial situation – would you want the Treasury Secretary position in the next administration? In our current state, Timothy Geithner is a “deer in the headlights.”
Their solutions aren’t anything new. They are focused on achieving “the lowest possible tax rates on the broadest base, sufficient to fund the necessary functions of government on balance over the business cycle; sound monetary policy; trade liberalization; spending control and entitlement reform; and regulatory, litigation and education reform.” All of which are suggestions that fall on deaf ears for liberals, who are still enthralled with “blaming Bush” as a winning political strategy – and an excuse to explain why we can’t act on such reforms. Lastly, it doesn’t help when our own president fails to make peace with the notion that his own neo-Keynesian disposition is empirically wrong.
If Hamilton would find this current situation almost untenable, I pray for the next Treasury Secretary who will tasked with guiding our nation away from the gathering storm.