Thursday, August 04, 2011

This Debt Deal 'Solution' is a Problem

The debt deal agreed to by Congress allegedly "reduces" budget deficits by at least $2.1 trillion in the next 10 years.

However, the deficit for just this fiscal year alone is projected to be $1.5 trillion, or about 71% of the size of the cuts that will take place over the next decade. And the Congressional Budget Office (CBO) projects $7 trillion in deficits over the same period.

The math simply does not add up. Reducing $7 trillion in projected deficits by $2.1 million will still leave the nation with $4.9 trillion in deficits over the next decade.

Clearly, bigger cuts were needed and the U.S. credit rating will most surely take a hit as a result.

Just weeks ago, Standard & Poors warned there was a 50-50 chance it would downgrade U.S. debt. S&P said that $4 trillion in cuts was the minimum to avoid a ratings downgrade.

This deal didn't even come close.

Though Moody's kept the U.S.'s AAA rating in place for now, it assigned a negative outlook for U.S. debt. That's not a long term vote of confidence.

Remarkably, the debt deal does not raise any new revenues, which would have helped to offset these long term deficits.

Last year, federal spending amounted to nearly 24% of GDP. However, federal revenues fell to 14.8% of GDP, the lowest intake relative to GDP in 60 years. Without question, the U.S. has both a spending problem and a revenue problem.

When Obama realized that the GOP wouldn't budge on his proposal to raise taxes on corporations and the wealthy, he pursued an option he was sure Republicans would embrace.

Like the Bush Administration before it, the Obama Administration called for much needed tax reform, including the closure of numerous loopholes used by corporations and the super rich, meaning millionaires and billionaires.

However, despite their open disdain for the nation's byzantine tax code, the GOP balked at Obama's proposal.

So, instead of solving the revenue crisis by making Wall Street pay their fair share, ending the Bush-era tax cuts for the wealthy, and closing corporate loopholes that let Bank of America pay no income taxes for the past three years, Congress passed a bill that will increase the debt by at least $7 trillion over the next decade.

For what it's worth, a tax increase and additional revenues are little more than a year away. On December 31, 2012, the Bush-era income-tax breaks for the wealthiest Americans — those households earning over $250,000 a year — will expire.

The new revenues will help, but they are not a panacea.

Due to Congress' high stakes game of debt-default chicken, the cost of borrowing is virtually certain to rise. And since the debt will continue to rise by trillions of dollars despite the agreement, that will also put upward pressure on Washington's borrowing costs.

Due to historically low rates, the government is paying less to service its debt than during the 1980s, 1990s and most of the last decade.

According to the latest figures, interest on the debt will cost roughly $250 billion for fiscal 2011. That’s about 1.6% of American output, which is lower than at any point since the 1970s – except for 2003 through 2005, when it was closer to 1.4%.

Under Ronald Reagan, the first George Bush, and Bill Clinton, payments on federal debt often got above 3% of GDP. Under Bush the second, payments were about where they are now.

In other words, these remarkably low rates have allowed the government to engage in deficit spending at very affordable costs. That cannot go on forever, and it will change soon enough.

The cost of servicing our debt will eventually reach unmanageable proportions and keep the government from addressing domestic issues, such as infrastructure, research and development, and higher education — things that could keep America competitive in the 21st Century.

Higher interest rates would add to the deficit and cause a slowdown in economic activity. That would reduce revenues, which would also add to the deficit. Such an outcome would create a vicious cycle that would be difficult to escape.

This debt agreement can only be viewed as a lost opportunity. It will make $900 billion in immediate cuts and create a special panel of lawmakers to find an additional $1.5 trillion of deficit cuts through reforms of entitlement spending and the tax code.

However, the bipartisan Simpson/Bowles Commission already issued its recommendations just seven months ago, and they were largely ignored. Another commission is nothing more than a red herring allowing Congress to avoid making tough choices, as it has for decades.

Unfortunately, the U.S. finds itself in a predicament with no good options. The current spending and borrowing levels are unsustainable. However, budget cuts will create a drag on the economy and reduce the nation's GDP.

Private-sector GDP is roughly where it was in 1998. The economy has only grown because a substantial portion of GDP the last few years was the result of government debt.

Even before these cuts have been initiated, the economy has already been limping along for three consecutive quarters, in the midst of a so-called "recovery."

Barclays has cut its forecast for U.S. economic growth this year from 2.5% to 1.7%. That's a razor-thin expansion and would essentially constitute economic stagnation. GDP needs to be 2.5% just to keep up with the number of new workers entering the work force.

However, that kind of growth is not happening and the trends are negative. Fourth-quarter GDP was revised down to 2.3 percent from 3.1 percent. First-quarter GDP was revised down to just 0.4 percent from the previously reported 1.9 percent. And the initial second quarter GDP projection is just 1.3 percent.

This economy is on very wobbly legs. Consequently, you can expect the unemployment rate to rise. That will continue to increase government expenditures while reducing revenues. It's the same bad combination the nation has been dealing with for three years now.

This pathetic debt deal amounts to half measures at a time when the U.S. needed something more substantial and significant. Aggressive measures were needed, but Congress punted as usual.

Perhaps we're already too far down the hole, but the politicians didn't even meaningfully try. The sad reality is that there are no good solutions. In fact, there may be no solutions at all.

If it hasn't already reached the point of no return, America is on a short road to insolvency. Revenues have been far too low for far too long, and expenditures have been far too high for far too long. Two wars and a prescription drug bill were put on the government credit card. It's now time to pay up.

Though the looming spending cuts aren't nearly deep or broad enough, America will soon learn just how punitive they will feel.

We now know that the Great Recession was even worse than originally presumed.

The drop in GDP during the recession from the fourth quarter of 2007 to the second quarter of 2009 was 5.1%, worse than initially projected. That marks the deepest recession since World War II.

The unfortunate truth is that we are still in a very perilous position and the worst may not yet be behind us.

1 comment:

  1. Anonymous3:23 PM

    A band-aid on a bullet wound.