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July 15, 2003

DEFICITS FOREVER....The OMB released new estimates for this year's federal budget deficit today. Here's the lead from the New York Times story:

The White House today projected a $455 billion budget deficit in the current fiscal year, by far the government's largest deficit ever and $150 billion higher than what the administration predicted just five months ago.

This is followed by a torrent of figures showing that this deficit is one of the biggest ever. However, while the fact that OMB estimates have changed so drastically in only five months might be a bit disturbing, the size of the deficit really isn't. In fact, considering the continuing flatness of the economy, a bigger deficit than expected is probably good news.

For the real news, you have to go to the Washington Post:

The federal government will pile up $1.9 trillion in new debt over the next five years and will still be running an annual deficit of $226 billion by 2008, long after White House economists assume current war costs have subsided and the economy has recovered, the Bush administration projected today.

....[The deficit] is expected to rise to $475 billion in fiscal year 2004, even without additional costs for the occupation of Iraq. The deficit is then expected to dip swiftly to $213 billion in 2007 before rising again in 2008, the last year of the White House forecast.

This is the real problem, especially since I assume that even these figures are based on the usual overoptimistic growth projections. By 2007 the economy should be booming and the government should be planning to run modest surpluses to cool things down a bit. Instead, it's deficits forever, because seemingly nobody in this administration cares a whit about anything beyond the next election.

That's the real problem. The Post got it right.

Posted by Kevin Drum at July 15, 2003 07:48 PM | TrackBack


Comments

It's even worse, though, because shortly thereafter, the baby boomers will retire.

Posted by: PaulB at July 15, 2003 08:05 PM | PERMALINK

Kevin,
I agree this is a problem. But the better way to examine this problem is as a percentage of GDP. In point of comparison, we ran deficits every year since 1970 until 1998, ranging from a low of .3% to a high of 6.0%. We ran deficits higher than the current approximately 4.5% of GDP for four consecutive years from 1983 through 1986. Yet because of the nation's economic growth, holding spending down, not in absolute terms, but as a percentage of GDP, which began in 1992, and dropped from 22.3% to 19.1% in 1998 led to a balanced budget in only 6 years.

The issue is, what spending programs are we going to start to drastically slow the growth of now? Paul B. is right, the demographic time bomb that is going to hit SS and medicare are going to exacerbate this problem. So we'd better get cracking.

Posted by: spc67 at July 15, 2003 08:23 PM | PERMALINK

My guess is that we're not going to slow the growth of either of the only two programs that matter, Social Security and Medicare. They are very popular, and I doubt that the public wants them cut.

I know that conservatives hate this, but what that means is that taxes have to go up. It's either that or eternally growing deficits. Take your pick.

Posted by: Kevin Drum at July 15, 2003 08:46 PM | PERMALINK

Of course, that's not counting the cost of letting the bait-switch tax cuts expire. Cos that's RAISING TAXES.

The boomers retiring? Don't forget 401k withdrawals are taxable.

spc67, we have a echo boom right behind this one, we have immigration, and stop fixating on programs to cut. Budget knives only cut leftward? Puhleeze.

Posted by: squiddy at July 15, 2003 08:47 PM | PERMALINK

Nope- the real news is that BUSH LIED.

You guys whipped up a frenzy over nothing, now it is going to overshadow everything, and turn out to be nothing. Enjoy.

Posted by: John Cole at July 15, 2003 08:48 PM | PERMALINK

spc67, perhaps you actually believe that the administration is interested in something approximating fiscal responsibility.

I no longer see how it's possible to believe such a thing.

The Bush Administration has had 30 months to tell us what they're going to do about government spending, and what they've done is grown it at a very rapid clip.

They truly have no interest in responsible fiscal policy - that's why they and their apologists have contorted themselves into the literally impossible logic of "deficits don't matter."

In fact, the situation is worse than the current numbers being discussed here suggests, for at least two reasons. First off, there is the problem of the AMT, which will be solved by lowering tax revenues as compared to the current projection, and there is the problem of the costs of iraq and afghanistan....

The fact is, there is undoubtedly real spending that could be cut (i'd start, for instance, with the bush agricultural policy, and i'd waste no time cutting the insane "rogue state" missile defense system and i'm sure there's plenty more), but what we need are more revenues than current policy provides.

There simply is no political support for making the kinds of cuts that eliminating the structural deficit (to call it by its correct name) would require.

As Grover Norquist has been perfectly clear about, the conservative goal is to create conditions where either our debt becomes meaningless or we cut social security, medicare, and medicaid in ways for which there is no where close to current majority support.

Bush supports this program, conciously or not, and gets no pass on fiscal responsibility. He has created a structural deficit whose resolution is extraordinarily more difficult than the last similar set of circumstances initiated by reagan's tax cut.

And at least Reagan tried to cut spending, a project that is literally beyond the Bush Administration (unless it's things like cutting military benefits or other swipes against the sorts of people who don't benefit from his tax cuts).

Posted by: howard at July 15, 2003 08:52 PM | PERMALINK

Uh, 'scuse me, but maybe one of you Californians can help me with this.

Isn't the reason Republicans want to recall your governor because he misled voters about the size of the budget deficit?

I don't suppose they feel constrained by their reasoning to be consistent in any way.

Posted by: Quaker in a Basement at July 15, 2003 09:00 PM | PERMALINK

Kevin,

I hear ya, do you think they prefer means testing those two programs? Or tax increases? If it's presented that way, what's your guess people would prefer?

Squiddy,

If you'd rephrase that in English I'd be happy to respond. I have no idea what you are talking about.

Howard,

Historically the deficits in the range we are talking about seem relatively non-problematic as long as they don't extend beyond a 7-10 year period. But I think you are generally on point. I'm ready to eliminate ag. subsidies, means test SS and Medicare for starters. Tell me what Dem will pledge to do that so I can vote for them?

Posted by: spc67 at July 15, 2003 09:21 PM | PERMALINK

spc67: Beats me. There are some practical problems with means testing that are fairly serious, although I'm not philosophically opposed. How the rest of the country feels, however, I really don't know.

(BTW, I have a feeling that means testing probably doesn't really cut all that much spending. Maybe 20% at the most?)

Posted by: Kevin Drum at July 15, 2003 09:27 PM | PERMALINK

spc67, although we are in broad agreement, no, i don't regard deficits of this size as non-problematic over a 7-10 year period. As some excellent, honest, conservative economists of the '70s realized, deficits of this scale do produce a crowding out effect in the private market for credit, thereby contributing to what I actually expect in the medium-term: stagflation.

As for what Dems support the best policy on spending - at this point, none of them, but at least some are willing to start by looking at the revenue side, as compared to the bush administration, which has no plans of any sort for this problem....

Posted by: howard at July 15, 2003 09:27 PM | PERMALINK

Howard,

I understand the crowding out theory. But it's wrong. Nominal interest rates plummeted in the 80's and are near all-time lows now. Real rates are low, though less so by all-time standards.
Plus, what the "crowding out crowd" never understood is that when corporations are making investment decisions, they are not looking at projects that no longer make sense if interest rates move 50-100 basis points. Companies are only investing in projects with at least a 15% ROI and usually substantially higher than that. There sure wasn't any shortage of credit in the 80's, and this deficit isn't old enough to have caused a credit shortage today.

I'll keep my eyes on the ideas you guys bring here, and who knows? Maybe I can be persuaded?

Posted by: spc67 at July 15, 2003 09:42 PM | PERMALINK

BTW,
I haven't the foggiest idea how we'd get to the inflation part of stagflation with Greenspan controlling the money supply.

Posted by: spc67 at July 15, 2003 09:44 PM | PERMALINK

We'll start with the stagflation.

Since you seem to be an informed citizen, you've probably noticed the movement of the 10-year bond in the last 30 days or so.

while we can't overrate bond movements in the short-term, neither should we ignore the likeliest signal: that the 10-year bond thinks that there is a possibility, thanks to the flood of fiscal stimulus, for growth to increase in the next 12-18 months.

and when it does, interest rates, for all the well-known reasons, will also increase.

i, personally, don't see any real drivers in place that would push growth, at most, beyond 3.5% for a quarter or two, max, but i think that's enough to push 10 year and longer rates up to, say, 5.

And that, my friend, is stagflation in my book, not old-school '70s stagflation, but a scenario of modest growth and modestly growing inflation, leading to little real gain and much stop-start frustration.

(As for Alan Greenspan, he couldn't be clearer: he wants companies to regain pricing power, he wants to see prices going up.)

(As for the underlying context, don't forget that it appears to be US policy to have a lower dollar, whose inflationary impact on imports should start showing up in 12-18 months.)

Now, as for the crowding out crowd being wrong, please don't put yourself in the "deficits don't matter" camp, spc67. You seem to know more than that.

Saying that higher deficits don't cause crowding out is to say that for some strange reason, supply-and-demand don't work in their normal ways when it comes to the credit markets. How can this be?

All other things being equal, higher government deficits soak up more of the available pool of capital and force the remaining demanders of credit to pay more for the dwindling remaining supply of fixed-income investors(or, all other things not being equal, pay more to attract a greater supply). At the margin, projects don't happen.

In short, all this highfalutin' talk about ROI and so on ignores market basics. In fact, investment was quite low during the Reagan years and quite high during the Clinton years (two of us can cite historic evidence, after all...).

Posted by: howard at July 15, 2003 09:57 PM | PERMALINK

There are several bombs ticking away. Some have been mentioned here, like the baby boomer demographic bulge (which is supposed to start in 2010 or something), the AMT, the elimination of the sunset clauses on the tax cuts. Each of these alone is enough to sink the fiscal ship. Together, they might be a perfect storm.

But it's worse than that, because at least 3 other huge expenditures are on the way:

Massively increased defense spending. We are going to have a substantial military presence in Iraq, Afghanistan, Korea and elsewhere for a long time. We are going to have to raise wages and benefits to keep the level of volunteer enrollment. And every new weapons platform is more expensive than the last, both in terms of implementation and maintenance costs. How much ya wanna bet the 'crusader' artillery system comes back to life again, at a cost in the billions?

The drug benefit. Even if only the stingy $60 Billion house plan passes, this thing is going to be wildy popular, and its costs are going to balloon. Plus, we're passing it right on the cusp of the demographic aging boom, and while we are experiencing an exponential increase in drug costs. This problem will be exacerbated to the degree the admin reduces the bargaining power of the government-as-drug-buyer.

The end of agricultural (and other) subsidies. It's coming, and soon. The UN and the WTO have been rumbling about this for a long while, and it's coming to a head. We don't often realize just how the US agriculture market is built around government subsidies, but this ignorance doesn't make it any less true. Between straight crop and acreage subsidies, buildings and equipment loan breaks, feed and pesticide subsidies (including the lax environmental regulations), water subsidies, tax shelters for farmers (i.e. estate tax), import tarrifs (both outright and those brought under cover of other reasons, i.e. health and safety) the US ag market is completely economically dependent on the government. If we have to remove this crutch (in whole or in part) it will, in the short run, cost us MORE, not less, because we will have to bear all the displacement costs (can't have another Grapes of Wrath scenario, now, can we?) and we will lose much of the production base to import competition. Granted, there aren't that many high paying jobs in the industry, but it is a massive sector, and it will likely be halved in economic value if we are forced to cut subsidy substantially. And we will be. Soon.

Instead of shrinking revenue streams, the admin should be gearing up for these future fiscal burdens. But, oddly enough, they're not.

I wonder if Grover knows why. . .

Posted by: epist at July 15, 2003 10:05 PM | PERMALINK

Howard,

I have a degree in economics (sounds like you may too?) and I know it says in my textbooks that the way you described it is the way it is supposed to work...but during my professional career dealing with corporate America minor changes in interest rates (1-2%, say) just didn't impact corporate decisionmaking regarding investment. Keynes' "animal spirits" carried the day instead. At some point crowding out would have to happen...but IMHO the move in interest rates would have to be substantially larger than what either of us is discussing. (The mortgage market is an exception to what I'm talking about. That's very sensitive to nominal rate changes, so I grant your point with regard to that.) Your enhanced definition of Stagflation I'll have to think about...you may have a point.

BTW, the flaw in several of the studies claiming minimal or negative investment in the 80's is that they assumed the rate of inflation for capital goods was the same as the general inflation rate. In fact it was 25% (or so) lower. As such, those studies underestimated net investment. When you adjust properly, we invested heavily in the 80's. We had to to create an incremental economy the size of Germany's.

Posted by: spc67 at July 15, 2003 10:19 PM | PERMALINK

BTW, Social Security is already means-tested to some extent: 85% of benefits paid are subject to income tax, so the government already claws back between 8.5% to, what, 30% of benefits paid depending upon the non-SS income of SS beneficiaries. For minimum benefit, low income folks like my mom, none of the SS benefit is lost, but for higher income folks the impact is to treat the SS benefit almost as ordinary incom.

Posted by: John Casey at July 16, 2003 05:49 AM | PERMALINK

spc67,

I'm glad that you've convinced yourself that deficits don't matter, but I'm willing to bet that you're not under the age of 30.
If nothing else comes out of these huge deficits but the fact that I'll have to be making interest payments on $7 trillion dollars of debt when the babyboomers retire, I still think it matters a great deal.

Geez, we're not even talking about paying down the dept anymore. We're now patting ourselves on the back for keeping the deficit under 6% percent of GDP. I think I've had enough "supply side economics" to last me a century.

Posted by: WillieStyle at July 16, 2003 06:22 AM | PERMALINK

"But the better way to examine this problem is as a percentage of GDP"--so we can spin this half-trillion dollar deficit as no new or very awful thing.

"The issue is, what spending programs are we going to start to drastically slow the growth of now?" Because we're certainly not going to forego huge taxcuts for the upper brackets.

Posted by: rea at July 16, 2003 06:24 AM | PERMALINK

Interesting debate going on in these comments. While I don't have an economics degree (and in fact am no more than a lowly undergrad who has taken a number of econ courses) I must ask:

Given the current context of overcapacity, how exactly do you expect this inflation to materialize? You have Japan in deflation, Germany ont he brink of it, and the U.S. not that far behind, from the looks of things. A large surge in real oil prices didn't manage to spark inflation, we have no where near the GDP growth necessary to utilize existing capacity and we have a continuing and self reinforcing income inequality that favors investment over consumption. From whence do you expect this inflation to materialize? Right now I see little to no reason to believe that monetary stimulus in the form of low interest rates having a substantive effect on the underconsumption problem, and I see little to support the notion of autonomous inflation trhough commodity prices.

Posted by: Lorenzo at July 16, 2003 08:03 AM | PERMALINK

The real problem, if you dig into the OMB numbers, is "technical adjustments", which means changes in the assumptions they make about revenue. The single largest factor seems to be the changing composition of tax revenues. The internet bubble caused tax revenues to increase for several years at far above trend. Those "bubble increases" more than account for the entire Clinton surplus. They're a result of inflated capital gains from stock prices (capital gains revenues are off 80% since the peak, according to one report I saw), and people being pushed into higher tax brackets by large one-time events such as bonus payments and stock options. Since spending actually increased beyond the long-term historial revenue trend, the result is a return to persistent deficits. The tax cuts seem to account for less than half of the long term change, even after you strip out the OMB's pollyanna estimates about the tax cuts stimulating growth.

Posted by: Jane Galt at July 16, 2003 08:13 AM | PERMALINK

Williestyle,

Well, as usual you got it wrong. I said deficits of this kind for 7-10 years (with the 80's as a specific example) have had no demonstrable effect on corporate investing. I actually concede that at some point deficits do cause problems, I even cited examples! Have you any examples to counter mine? I'd be happy to consider them. By the way, the patting myself on the back is also wrong, I said we had a demographic timebomb on our hands and we'd better get cracking on addressing this issue. Try rereading my posts.

Rea,
No, I'm not trying to spin anything. But you can see why a $455bln deficit in an $11 trillion economy is a different thing than a $455bln deficit in a $1 trillion economy or a $100 trillion economy can't you? Analyzing as a percentage of GDP is a more precise method of economic comparison, the same as holding dollars constant to eliminate the effects of inflation.

I'm guilty of your second point of not foregoing tax cuts. I would gladly do so if we would restructure the budget and begin cutiing spending as well. You willing to fundamentally alter social spending in return?

Lorenzo,
My degree is only a lowly BA as well. May I say your professors are doing right by you. I haven't the foggiest idea how to address the overcapacity issue you are identifying.

Posted by: spc67 at July 16, 2003 09:15 AM | PERMALINK

Williestyle,
Well, as usual you got it wrong. I said deficits of this kind for 7-10 years (with the 80's as a specific example) have had no demonstrable effect on corporate investing.

"As usual"? Getting a little snippy are we?

I actually concede that at some point deficits do cause problems

Then proceed to pontificate about why we are not yet at such a point. A position that is frankly ludicrous to anyone under 30.

You said:
"Historically the deficits in the range we are talking about seem relatively non-problematic as long as they don't extend beyond a 7-10 year period."

Well deficits that last less than 7-10 years but do increase the national debt by over $1 trillion dollars are a pretty fucking problematic, in my humble, non-economics-degree-having opinion.

So amidst all the economic gymnasitics, try to remember that every dollar of deficit is 2 dollars that aren't going to paying down the national debt that exploded the last time we had deficits with "no demonstrable effect on corporate investing".

Posted by: WillieStyle at July 16, 2003 09:52 AM | PERMALINK

I applogize for the profanity above.
My post came out a lot more caustic (and much less jovial0 than I had intended.

Posted by: WillieStyle at July 16, 2003 10:15 AM | PERMALINK

Williestyle,

Yes, got a little snippy. BTW, I'm in my thirties.Please get a copy of the Budget, it's on line, Google Federal budget 2003. Go to the historical tables section for all the data/tables you need. Here's the 80's in a nutshell. Declining interest rates, 17 million jobs created, real gov't receipts rise 74.6%, GDP growth averages 3.5% for 8 years, stock market triples, defecits commonly proportionately larger than our current one.

The argument for defecits causing problems rests primarily on two things: (simplifying tremendously)
1) Government borrowing crowding out private investment, that is interest rates rise and company's choose not to invest because the cost of borrowing makes projects not economically viable. Interest rates today are near historic lows, so this is clearly not happening.

2) The interest burden on the Gov. gets so high that in order not to default, it chooses to introduce inflation into the economy, thereby decreasing the real value of the debt it owes, making it easier to repay. Where's the inflation?

So now the burden is on you to explain why my views are "ludicrous," and why my solution, slowing the growth of gov't spending, which worked in balancing the budget in the 90's isn't a good approach here.

If you are really concerned about fiscal problems, go read the Concorde Coalition's stuff on how SS, Medicare and Medicade are currently $27 trillion in the hole on a present value basis.

BTW, what you call "gymnastics" goes by another name, analysis.

Posted by: spc67 at July 16, 2003 10:20 AM | PERMALINK

Williestyle,

I too will try to control my snippiness:)

Posted by: spc67 at July 16, 2003 10:23 AM | PERMALINK

The interest burden on the Gov. gets so high that in order not to default, it chooses to introduce inflation into the economy, thereby decreasing the real value of the debt it owes, making it easier to repay. Where's the inflation?

Here's where we differ.
Even if increased debt burden doesn't tempt the govt. to inflate away the debt "bannanna republic style", the mere fact that the govt. has to pay extra in interest payments on the debt is an evil in and of itself.
For every dollar of debt, the govt. ends up paying back about $1.03 or $1.04. That extra 3 or 4 cents, which typically goes to China or Japan, might as well be used as kindling for all the good it does us.

So now the burden is on you to explain why my views are "ludicrous," and why my solution, slowing the growth of gov't spending, which worked in balancing the budget in the 90's isn't a good approach here.

It wasn't just slowing the growth of government spending that led to balancing the budget in the 90's. The deficit reduction act of 1993 (which raised taxes and which not one Republican voted for) was also instrumental in returning the nation to fiscal sanity.

My position is essentialy that your belief that Reagan erra deficits were benign is ludicrous because it ignores the dramatic effect they had on total national debt.
Furthermore, as long as you and others maintain notion of benign "short-term" deficits, there will never be enough political preasure brought to bear on this administration all but ensuring that our deficits do not remain "short-term".

Posted by: WillieStyle at July 16, 2003 10:41 AM | PERMALINK

Williestyle,

The tax plan of 1993 incresed federal revenue from 17.6% of GDP to 19.9% in 1998. An increase of 2.3 percentage points. Federal spending fell from 22.2 % to 19.1% a drop of 3.1 percentage points. So spending control was the more significant factor. But the tax increase clearly played a major role.

Total national debt today is about 65% of GDP, far below the high (WWII) is 121% and in the range where it lay through both the fifties and 90's. It's clearly within historical bands, and needs to be understood that way.

But you are flat out wrong in assesing my motivations. I desperately want a balanced budget, I think it should only be out of balance in wartime (for the reasons you cite about spending choices needing to be made). I also want a vibrant economy. Running around like chickens squawking while having no data to provide guidelines or potential answers is counter productive.

Now, do you want my answers? (not in order of priority, and my offer is a package, take it or leave it, no picking away).
1)Eliminate ag. subsidies
2)Forego latest tax cut
3)Begin means testing SS and Medicare so that it really is only a safety net (implement over 25 years so we don't change the rules on the elderly now)
4)Eliminate non-essential gov't programs, NEA etc.
5)Sell Amtrak, no buyers? Close it.
6)Pass an amendment to constitution requiring a balanced budget and that federal debt not exceed 50% of GDP unless Congress has declared war
7)Pass an amendment to the constitution requiring that the Fed gov't to limit receipts to 15-20% of GDP (exact number negotiable)
That should get us on the right track.

I've foregone my tax cut...what will you forego to solve the problem.

Posted by: spc67 at July 16, 2003 11:06 AM | PERMALINK

Willie,

I'm outta here for a while, check back later.

Posted by: spc67 at July 16, 2003 11:13 AM | PERMALINK

Boy, live your life for a few hours and all kinds of things get said.

spc67: I don't have the time right now to dig around, but if you have a link supporting your position that there wasn't a very large delta between private investment in the '90s and the '80s, i'd like to see it. The gap was much larger than 25% (if i'm recalling correctly, it's more like 3x or 4x, though i wouldn't swear to it).

more broadly, i'm with you about "animal spirits" and all, but that doesn't really prove quite what you think it does. Yes, in real life, supply and demand don't create perfectly smooth curves, and individual decision-making can conflict with what a "pure" analysis would suggest.

but that doesn't make the basic realities of supply and demand go away.

Part of why it doesn't is that not all investment decisions are made by big companies populated by hotshot mba's running complex economic models. They're also made by the person who runs a laundromat and is deciding whether to buy the building next door to expand, by the person running the corner store deciding whether to add refrigeration units in order to sell frozen food, by the person who wants to open a jewelry store to sell the craftwork of his or her friends.

The supply of capital is not infinite, and increased demand by the government by definition makes a difference for someone, somewhere at the margin.

Finally, i redirect your attention to the behavior of the 10-year bond. Real interest rates are not low right now as it is, and no one is investing (corporations are refinancing, but that's a different matter), so there isn't sufficient demand, yet, to see crowding out. But I believe that sooner or later the economy will show signs of growth thanks to the enormous fiscal stimulus being flooded into the market, and that's when we'll see crowding out begin.

WillieStyle: i introduced the threat of inflation to this discussion, and what i'll say to your question is exactly what does capacity utilization have to do with inflation? To cite an extreme example that I am not predicting, if the price of oil shot up to $90/barrel this afternoon, we'd see the inflationary impact in America rapidly, even without any change in capacity utilization.

As for the broader question, the aggregate inflation stats mask two differing trend lines. What i'll call commodities are showing no inflation; what i'll call services are showing modest inflation.

As the fiscal stimulus creates demand, and as the lower dollar ripples through into import prices, and as Alan Greenspan hopes to see pricing power restored to corporations, i confidently expect to see modestly growing inflation result, regardless of the level of capacity utilization.

Jane Galt: Capital gains simply aren't a big enough part of the economy to have the impact you are implying. I don't have it handy right now (damn computer problem ate some stuff), but i put together a bunch of stuff recently because a conservative friend was saying that the Clinton surpluses were a result of two factors: capital gains tax increases and an end of the Cold War peace dividend.

In short, and again, don't hold me to the precise number, the peak of capital gains under Clinton was something like $120B. While an 80% drop from that is nothing to sneeze it, it does not come close to accounting for the deficits.

(BTW, if you're interested, the answer on defense spending is that, in constant dollars, Clinton spent more on defense than the average Cold War defense expenditure, and only modestly less on defense than the peak of the Reagan defense buildup. My conservative friend conceded that he had been wrong.)

Posted by: howard at July 16, 2003 11:50 AM | PERMALINK

Total national debt today is about 65% of GDP, far below the high (WWII) is 121% and in the range where it lay through both the fifties and 90's. It's clearly within historical bands, and needs to be understood that way.
[Emphasis Added]

All that means is that we've had the problem for fifty years and failed to solve it. Not that it isn't significant. Also, only looking at the national debt as a percentage of GDP is disingenuous because global capital markets do not grow with U.S. gross domestic product. The absolute (inflation adjusted) increase in the national debt has been significant to say the least.

As to solutions:
1)Eliminate ag. subsidies

Absolutely. Sadly the President doesn't agree with either of us. Here's to hoping for a Democrat with backbone.

2)Forego latest tax cut

Well obviously.

3)Begin means testing SS and Medicare so that it really is only a safety net (implement over 25 years so we don't change the rules on the elderly now)

Something has to be done about SS. A while back I suggested a funky scheme of investing in securities markets. Frankly, I'd rather raise the retirement age than means test, but I agree something must be done.

4)Eliminate non-essential gov't programs, NEA etc.

Good luck defining non-essential.
What's the NEA's budget? Does it approach Steel Subsidies and such?
If it does then pare it down.

5)Sell Amtrak, no buyers? Close it.

Meh.

As to 6 and 7, constitutional amendments for economic policy are genraly really bad ideas (Just look at Germany). We need the flexibility to occasionaly run deficits (during recessions for instance) but the discipline to only do so when we absolutely must.
Besides, there isn't going to be another constitutional ammendment in our lifetimes.

Posted by: WillieStyle at July 16, 2003 12:27 PM | PERMALINK

Howard:

I was one of the people raising questions about inflation, so I'd like to flesh out some of what you mentioned.

i introduced the threat of inflation to this discussion, and what i'll say to your question is exactly what does capacity utilization have to do with inflation? To cite an extreme example that I am not predicting, if the price of oil shot up to $90/barrel this afternoon, we'd see the inflationary impact in America rapidly, even without any change in capacity utilization.

Are you seriously asking what capacity utilization has to do with inflation? I mean, as a rhetorical point to emphasize the idea that real price of oil has been one of the *major* drivers of inflation for the last thirty years, I can undertstand, but to dismiss it entirely seems odd. In a situation of capicity underutilization rising demand can be met with increased utilization rather than price increases. Pretty standard macro theory as I was taught it.

Of course, being an economic heretic, I'd hardly disagree with your point about the price of oil. Considering the real price of oil has been one of the major *leading* indicators of inflation since the 1960's, I'd entirely agree that a change in the real price of oil can have substantive effects on inflation regardless of GDP growth or capacity utilization, however, as the recent trip to $40/barrel territory demonstrated, a quite significant increase in the price of oil would be necessary to generate inflationary pressures of a magnitude sufficient to push the U.S. economy into stagflation (though I would argue that stagflation is exactly what a lot of major players close to the Bush administration want.)

Essentially I'm saying I don't see the mechanism to create this inflation right now.


As for the broader question, the aggregate inflation stats mask two differing trend lines. What i'll call commodities are showing no inflation; what i'll call services are showing modest inflation.

As the fiscal stimulus creates demand, and as the lower dollar ripples through into import prices, and as Alan Greenspan hopes to see pricing power restored to corporations, i confidently expect to see modestly growing inflation result, regardless of the level of capacity utilization.

I would definitely have to question this assumption. I mentioned capacity utilization not only for the standard macro-economic reasons but also as a reason I believe monetary policy will be inefective in restoring pricing power. Cuts in the interest rate act primarily on business investment, home-buying, and car buying. Most consumers do not take bank loans to fuel normal consumer demand for goods other than homes, cars, etc. (as far as I know, anyway) and businesses borrow money to invest, do they not. So tell me, in a context of unused capacity, why exactly would businesses invest heavily in *more capacity*? There isn't much of a point in expanding what you can produce if you aren't using all of your existing capacity to produce, is there? Furthermore, if these businesses *did* significantly increase investment, wouldn't that simply exaserbate the existing over-capacity problem and in fact *reduce* pricing power?

Posted by: Lorenzo at July 16, 2003 12:58 PM | PERMALINK

Williestyle,

Sorry it took so long.

I agree the growth in the absolute number of the federal Debt is significant. It's just a less complete way to look at it than as a % of GDP. Your point about global capital markets is correct, but clearly that has had no impact to date and hence can be discounted.

I'm not going to respond to your point by point since it was an all or nothing proposal. You passed, fine.(What's "meh"?).

I look forward to your insights on how to close the gap. So far I've seen complaints, no solutions. Ball's in your court. :)

Howard,

The inflation rate for capital goods was 25% lower than the inflation rate for the general economy. That led to an underestimation of investing in the 80's. I wasn't comparing the absolute level of investing.

Your point on the impact of small changes in interest rates due to gov't borrowings is as anecdotal as mine. My experience with corporations is a 15% plus threshold unimpacted by small changes in rates, my experience with small businesses is a much higher return threshold, and much less analysis and therefore even MORE predicated on animal spirits.
We simply have different anecdotes and disagree.

As for the ten year, let's see what it looks like in six months before we read too much into it. What's your idea for a balnced budget?

Posted by: spc67 at July 16, 2003 01:18 PM | PERMALINK

Lorenzo: yes, i was being bold in my remarks. Inflation can increase or decrease independent of any change in capacity utilization, so I was being dismissive of the idea that low levels of capacity utilization can, in and of themselves, mean that we won't see inflation increase.

As demand increases, it is entirely possible for two things to occur simultaneously: prices can rise and capacity utilization can increase. There's nothing in standard macroeconomic theory that suggests otherwise.

Now, might i be wrong? absolutely - maybe we won't see a modestly increasing rate of inflation. but it won't be because capacity utilization is too low to support inflation.

spc67: you and i aren't that far apart on economic analysis, but there is clearly one point where we differ significantly: we aren't just talking anecdotally about how investment decisions are made. If you don't believe in impact at the margin, then you don't believe in a major element of macroeconomic theory.

Personally, i think that's a loser's game. In a free market in which tens of thousands of individual decisions are made daily, the idea that some of those decisions, at the margin point, aren't affected by a change in interest rates, despite the level of animal spirits, simply makes no sense.

(To drop to the purely anecdotal, i've dealt with big-time investment bankers, and i've run small businesses, and i've never - and i mean that literally, as in not once - seen someone say "I don't care whether interest rates are 10% higher than this model is projecting." I've seen people say "this deal is so good that we have plenty of margin of error," and i've seen people say "this deal is too iffy even if optimistic assumptions pan out," but i've never seen anyone say "i don't care what interest rates are."

Remember, as Ben Graham told us long ago, in the short-run, the market is a voting machine; in the long run, it's a weighing machine.

So yes, animal spirits can affect short-run decision-making and people can and will - especially when gripped with "animal spirits" and/or "greed" - make wrong-headed decisions (otherwise, how did we end up with so much more backbone capacity than we currently need?), but not because they shrug off alogether the impact of interest rates in their investment analysis. End of the purely anecdotal.)

How would i balance the budget? Well there are major programs (such as agricultural subsidies and missile defense system and others) that i would certainly eliminate, but fundamentally, i'd take the same approach as Clinton and Rubin did: i'd combine cutting spending with a rollback of some of the Bush tax cuts. In particular, i would start by restoring the inheritance tax above $5M, and i would bump marginal rates at the top back to the clinton-rubin levels....

Posted by: howard at July 16, 2003 01:38 PM | PERMALINK

It's not just capital gains -- it's all the associated revenues with teh bubble. Huge investment banking bonues, taxed at fat 39% rates. Stock options which delivered a big chunk of money taxed at much higher effective rates than the owners paid on their regular income.

Those options and bonuses had the effect, for many people, of taking income that otherwise would have been spread out over many years and cramming it into one taxable year. This pushed them into a much higher tax bracket than they ordinarily would ever have paid. That artificially boosted taxes -- but it also borrowed tax revenues from the future.

Hey, don't believe me -- the CBO has the figures. There are many contirbuting factors, including the tax cuts and the war on terror. But what the figures will show is that if the Democrats want to run on a platform of fiscal responsibility, and they want to put out good numbers, they can' t merely claw back Bush's tax cuts -- they'll need to propose either a net increase in taxation, or unpopular spending cuts.

Remember, we're talking about a budget deficit of 4% of GDP. Capital gains don't have to be a big chunk of the economy to make that type of difference -- and at the peak of the boom, they were growing faster than GDP, which is an extremely rare historical anomaly.

Posted by: Jane Galt at July 16, 2003 01:48 PM | PERMALINK

Jane, i'm not afraid of higher taxes, and your underlying point may well be valid.

But you're going to have to do some more work (i'll even settle for a CBO link that shows this) before any of us accept that investment banking bonuses, for instance, were, in aggregate, massively lower in 2002 than they were in 1999.

As for stock options not being capital gains - well, maybe never having been a beneficiary of stock options, i'm missing something here, but i'm of the impression that any rational person (and i'll admit up front that there were irrational people who didn't do this) who saw his or her options vest in the money, exercised those options and sold the stock, which is a capital gain.

have i misunderstood something?

Yes, the bubble was big, but i don't see how it borrowed tax revenues from future years. If in year 1 i have a big bonus and in year 2 i have no bonus, why do you think that instead i could have had 1/2 of the same bonus in year 1 and 1/2 of the same bonus in year 2?

Posted by: howard at July 16, 2003 01:59 PM | PERMALINK

We're not going to have a booming economy.

When Alan Greenspan speaks he is ALWAYS wrong! So, it's pretty easy to guess what's gonna happen instead. Lots of places around the world will be destabilized.

Especially if we can get the price of oil down. (High supports help despots who steal their countries blind. Try Venesuela. But you can punch in other names, too.) So many currencies won't be worth anything. Of course, those are the building blocks of opportunity. After the fall, those who have will buy cheap.

So far, nothing's cheap.

Yup, on raising the age for social security, but for one problem. Even white men, today, over 50, can't get hired. Women, post menapausal, ditto. And, women with young kids earn marginal incomes. Because kids really do wrap up your time.

Once upon a time AMerica's greatest strength, because it was so isolated from Europe, it had to make do, here. And, we became accomplished at saving everything. Using everything. Just like you'd see in China, today.

Maybe, the prize will go to people who are frugal. And, know how to save. (And, the goverments don't tax these savings away.)

An odd thing happened in Japan, where the death tax is 50% of assets. I didn't know what the hell happened when that famous Van Gogh "Sunflowers" painting went for $115-million. Till someone explained it as 'tax strategy.' The very wealthy, by holding assets in the bank, that the bank lends the money out for, can 'save' in real time, and real bucks $115-million. A debt. Not taxable. And, a priceless work of art (only one in the world, folks), that actually goes up in value. Beyond just retaining assets.

And, that's it. The poor will get poorer. The middle class will get sucker punched ... and those who understand financing will die and keep all the gold in their families. (Where the power to crown kings will be placed.)

You got any other ideas?

Posted by: Carol Herman at July 16, 2003 03:15 PM | PERMALINK

I agree the growth in the absolute number of the federal Debt is significant. It's just a less complete way to look at it than as a % of GDP. Your point about global capital markets is correct, but clearly that has had no impact to date and hence can be discounted.
[Emphasis Added]

I don't know about that. There are theories being floated by men much richer (and hence much smarter) than I am that claim that the reason we haven't felt the pinch of global capital markets in the past is that for decades the Dollar has been unchallenged as the global currency. If you're Japan or China (or someother country with a large rate of national savings) you're going to want to invest in dollar-denominated assets. But now with the Euro on the scene there might be a new option for low risk Asian central banks. That could spell trouble for US bond markets.

As for solutions to our deficit problems:
1) End subisidies now. Not just agricultural subsidies but nonsense like steel tarriffs.

2) Don't pass a prescription drug benefit this year. In fact, don't pass one until we've figured out how to lower prescription drug costs in general. But that's a whole other discussion.

3)Repeal tax cuts.

4)Close corporte tax loopholes. Especially keep companies that incorporate in the Bahamas (or someother tax haven) from getting government contracts.

5) Freeze the current round of next generation programs at the pentagon. Focus on boosting enlistment numbers (particularly for peacekeeping forces like MPs) and rapid deployment stuff like C-130s. Skip a generation of fancy stuff like the Raptor and the Crusader and focus on adapting our armed forces to fight the sort of wars we'll be facing for the next 10 years.

6) Scrap all that missle defence crap and send the whole project back to the drawing board.

7) Break OPEC by investing (both militarily and economicaly) in West Africa. This one's more of a longish term suggestion.

8) Really go after supplemental appropriations (Rober Byrd, that means you). Raise the political cost of such shinanegans by giving both the senate majority and minority leaders the ability to call for an open line item vote on any bill.

Not sure how much of a dent all of that would make but it's a start.

P.S.
"Meh" is an exlamation denoting indifference.

Posted by: WillieStyle at July 16, 2003 06:58 PM | PERMALINK

Howard,

I said minor differences in interest rates. Not 10% for crying out loud. My career was as an investment banker, and I never had an executive tell me, if this bond deal goes off 50bp higher than rates are today, we're no going to build the new factory/buy the competitor/have the stock buyback. 10% is an order of magnitude difference.

Williestyle,

First, thanks for the definitional help.
My claim was "to date" you said "could spell trouble" that's the future, so not sure we have disagreement except on probabilities.

I think your suggestions re: the budget, while wholly inadequate to balance it, would indeed be a fine start. Especially in that they would set a precedent for moving in the right direction. I'm not willing to do anything to reverse military funding until the danger from terror is less than i think it is today.

I think we've killed this horse folks. Thanks for your thoughts, you've given me much to consider.

Posted by: spc67 at July 16, 2003 08:26 PM | PERMALINK

spc67, for the record, by 10% difference, i mean relative, not absolute. Of course there's a huge difference between 5 + 15, but i'm talking about the difference between 5 and 5.5.

Posted by: howard at July 17, 2003 07:24 AM | PERMALINK

Howard,

Sorry for the misreading.

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