Listening to the news these days is like spending too much time around Jim Carrey at the beginning of the movie “Liar, Liar.” Mucho mendacity.
How are we being deceived (by both political parties and by just about everybody in Washington)? Oh, let me count the ways.
1)We will default on Aug. 2 unless Congress raises the debt ceiling, and such a move would be unprecedented.
A)Not to make you cynical or anything, but the Treasury magically found another week’s worth of money, and the default date is now Aug. 10.
B)The U.S. government takes in anywhere between $170 billion and $210 billion, depending on the month. The debt interest payments are about $20 billion. $20 billion is less than $170 billion. We could pay off our creditors and not default. Default should never have been mentioned by anybody. The issue is: the U.S. government does not have enough money to pay all of its current obligations unless the debt ceiling is raised. But most people already knew that.
C)The U.S. has defaulted on its debt many times in the past. During World War I, US companies refused to pay back debt to European creditors. In 1933, FDR defaulted. In 1971, Nixon defaulted on the gold standard. There were many other periods of shorter default. Don’t get me wrong: defaulting is a very bad thing and would be bad for the economy, but this claim that the U.S. has never defaulted is simply a lie, so don’t believe it. The U.S. doesn’t need to default now (see B), and will not and should not.
D)From the perspective of our biggest creditors, we are already defaulting. See, for example, the Chinese perspective (China owns about $1 trillion in debt). If you put yourself in the shoes of the Chinese, it’s easy to see why. Chinese inflation is now above 6 percent per year. One reason for this is that the US money supply keeps on growing. More money means more currency to chase the same goods. More currency means higher prices. So, if Chinese inflation is 6 percent, and the Chinese primary source of foreign investment is U.S. treasuries, this means the U.S. is already defaulting from the Chinese perspective. The yield on a 10-year bond is 2.7 percent per year. This means that the yield is half the Chinese inflation rate and lower than the U.S. inflation rate of about 4 percent. The Chinese investment in our bonds is a default because the value of the Chinese investment decreases every year rather than at least holding the value of inflation.
2)Republicans want smaller government. Oh how I wish this were true.
A)The big, bad Republican plan to cut spending is the Cut, Cap and Balance plan. The original plan asked for cuts in half of the yearly debt (at least $700 billion in cuts in 2012) and asked for capping spending at 18 percent of GDP. This is the plan that Ron Paul and Michelle Bachmann, among others, signed on to. But by the time it founds its way through the Washington meat grinder, the CCB plan was watered down to $111 billion cuts in 2012 and capping spending at 19.5 percent of GDP. This is why Ron Paul and Bachmann voted against it. It was a classic Washington bait and switch, and almost nobody is talking about it.
B)Almost no Republicans are talking about cutting military spending. Very few are talking about closing our bases overseas. Almost nobody is talking about immediately leaving Afghanistan, Iraq, Libya, etc. If they were talking about this, we could save hundreds of billions in 2012, but we aren’t. To their credit, there is a small group of Republicans actually willing to cut military spending (Ron Paul, Rand Paul, Walter Jones and a few others. Seven Republican senators voted for the Rand Paul budget plan, which does cut military spending). And also to their credit, there are many progressives willing to cut military spending. Why didn’t the Republican leadership propose a bargain of real cuts in 2012 including military spending cuts? Well, it might just be that Republicans, with a few exceptions, are not really serious about decreasing the size of government.
3)If we don’t raise the debt ceiling, the ratings agencies will downgrade the US and we will lose our AAA rating. Ok, let’s stop and think about this for a second. What is the purpose of the rating agencies? To advise potential investors on the safest and riskiest investments. The US has recently been one of the safest, partly because we have the world’s reserve currency and partly because we are a big, mostly healthy economy. So, if you are an investor, what are the things you look at? Your primary concern if you are buying government bonds is the likelihood of default. You are buying a bond for $1 million and you are promised a 2.7 percent yield over 10 years, so you want to make sure you get your 2.7 percent yield. End of story.
So, Greek bonds have to pay 20 percent (or so) because investors know there is a decent chance they won’t get paid back.
Now let’s say you are thinking of investing in a company, let’s call it “Millennial Star.” Let’s say this company, because of mismanagement by past owners, had a huge amount of debt. But the company actually has a plan to pay off the debt and become profitable, and when you look at the plan you are convinced. Yes, M* will pay off its debt and be profitable in 2013. Now, let’s say you look at another company, let’s call it “Communist Mormons.” The company has a huge debt and is going around to hundreds of banks asking for loans and has no plan to ever pay off the debt but says it will continue spending to help “the poor.”
In which company are you more likely to invest, the company that has a plan to return to profitability and lower its debt or the company that does not have a plan? Well, the answer may not be obvious to all people reading this because in fact there are a number of Communist Mormons out there, but the answer is obvious to the rating agencies and real investors: you invest in M*.
The exact same principle applies to sovereign debt. Investors want a return on their investment. They want to see a plan for profitability and decreasing debt. So, if the US raises the debt ceiling without dealing with debt, what will happen? Well, the ratings agencies will lower our rating. And this is exactly what all of the major ratings agencies have said.
The tipping point is debt at about 90 percent of GDP. This is when alarm bells start going off at the ratings agencies. Our total GDP is about $14 trillion, and our debt is $14.5 trillion. So, our debt to GDP ratio is over 100 percent. This is the reason Egan Jones and other ratings agencies have already lowered our rating. The debt ceiling is irrelevant (as it should be). The issue is: how healthy is the U.S. debt situation, and the answer is very unhealthy indeed.
My experience with many readers is that they tend to stick their heads in the sand and ignore inconvenient facts that don’t fit their world view. So, in the vain hope of reaching some of these readers, I would like to refer them to a Planet Money discussion on debt, which indeed confirms the fact that a debt to GDP ratio over 90 percent is a very, very bad thing and much more important than whether the debt ceiling is raised or not. Planet Money is run by NPR and has been very balanced on this subject, and is not some right-wing propaganda outfit.
I could go on and on about this subject, but this has gone long as it is. Let’s see if I can answer any questions in the comments.
“Human sacrifice, dogs and cats living together… mass hysteria!” – Peter Venckman
Personally, I’m all for slashing the federal government. I think that if Washington DC can’t get their act together and do some real cutting, nature will take over and do it for us. There is a tendency for someone or something to eventually press the “reset” button. You can only pass the button down so far before it automatically goes off by itself. Just ask the Soviet Union and Communist Bloc….
Just don’t cut my entitlements. Or future entitlements. Like Medicare. Social Security. Welfare. Military benefits. Heck, don’t touch any entitlements. But make sure you slash government spending while you are at it!
What bugs me, is all of these people saying, “We’re cutting spending over 10, 20…whatever number of years”. Well that sounds nice and all, but how do you hold future Congresses to your promises today? You don’t, and you can’t. Just make cuts now. Cut a few cabinet departments and their associated agencies and costs and let’s see where that gets us.
Rame and Joyce, both excellent points. I was going to get into those areas of deceit, but I was running out of space. 🙂
Nicely done, Geoff. The federal budget is a massive shell game. The promises of deep cuts from the right and the hystronics from the left should both be ignored.
This is a good post, Geoff. Thanks. This whole topic is so discouraging. I do think the ceiling should be raised and a real plan should then be worked out to balance the budget and cut spending for the long term. That has to be coupled with reversing the Bush tax cuts and returning from these useless foreign wars.
It’s tempting to believe that the Democrats and Republicans are actually on different sides of this “debate,” but the reality is that this is more like WWE than Mr. Smith Goes to Washington. Everything’s staged for the benefit of the MSNBC/CNN/NPR/Fox News crowd, who fall every time to the idea that “their team” is in a life-or-death struggle against an evil opponent. Rome isn’t even burning, but the circus goes on.
There will be no default.
And the hystrionics from the right and promises of cuts from the left?? Ignore those, too.
Agree that the Planet Money discussion of the debt is terrific and informative. They also note that the US, with about 100% debt:GDP is lower than the nations that are really making the markets nervous (Greece, for instance). Yes, 90% is the tipping point the podcast points out, but it’s not like pants are on fire at 100%.
From the OP: “The issue is: the U.S. government does not have enough money to pay all of its current obligations unless the debt ceiling is raised.” That is the issue.
Your analysis of bond holders’ wanting profits — they also want their principal protected. They want more than just the 2.7% payment.
You use the term profitable when comparing the government to M* and Communist Mormons. But we don’t expect the government to be profitable. We do want its budget to be (generally, over time) balanced, and its debt to be reduced.
Good comments everybody. Thanks. Ben, I agree with the WWE comparison. I tend to think of this debate as the captain and the first mate arguing over who gets to be the boss of the Titanic after it hit the iceberg. While they argue, the bosun reports that there aren’t enough life boats. Oops. So, obviously what should have happened is that A)the Titanic should have been designed differently and B)there should be enough lifeboats. In our case, we need to drastically change our ideas of what government should do so that we don’t have to go through these debates every year.
Paul, #7, it is true that we don’t want or expect the government to be profitable. But we should expect the government to be near a balanced budget. Canada has a debt to GDP ratio of about 30 percent. That is still too high in my opinion, but that’s where we have been in the past. So, I was trying to explain the psychology of the person buying bonds, and that was the reason for the comparison between a company and the government. Would you rather buy bonds in the U.S. with a debt-to-GDP ratio of 100 percent or Canada with 30 percent? Which one is more likely to pay the yield and return your principle (good point)? The answer seems obvious to me. And this is one reason the Canadian dollar has been doing very well against the U.S. dollar lately.
To me, it all seems rather like trying to get a higher credit card limit to buy food.
There are only two ways out, and all the bickering in the world isn’t going to change it. And call me a skeptic, but I doubt raising the debt ceiling is going to do anything but prolong the inevitable.
SR, yes, and make the inevitable worse when it comes. A $14 trillion debt in a $14 trillion economy is one thing. A $20 trillion debt in a $16 trillion economy (where we may be in a few years) is quite another.
Obviously we need some sort of strategy for making Social Security/Medicare/Medicaid sustainable. But in addition to that, I’m in favor of a 15% across the board cut in the budget to every government agency (including defense budget as you mentioned). Everyone can cut back by 15%. Almost every business in the country has made cuts that deep or deeper by cutting waste and improving efficiency. Make it hit republican and democrat pet-departments alike so that everyone feels the pain equally. Sadly there is 0% chance of this.
Jacob, good point. 15 percent would be a nice start. 43 percent to balance the budget would be better. 🙂
If you look at future budgets, entitlements is where all the growth is. So, you cannot come even close to balancing the budget without taking on entitlements. Here is my proposal:
1)Raise the Social Security age to 72 over the next 30 years.
2)Means test Social Security.
3)Block grant Medicare to the states.
4)Means test Medicare.
5)Block grant Medicaid to the states.
6)Change our foreign policy so we can cut military spending in half within a few years. Right now we spend about $1 trillion. That should be $500 billion by 2014.
7)Close down the departments of Education, HHS, Commerce, Agriculture and Homeland Security. Massive cuts in all other departments.
There are only two presidential candidates who are talking about these ideas: Gary Johnson and Ron Paul.
There are only two presidential candidates who are talking about these ideas: Gary Johnson and Ron Paul.
Who are two presidential candidates who will never sniff a win, Alex?
I am looking forward to learning about the plan of the Gods of the Copybook Headings Party. I hear its going to be super-practical and easy to implement.
Geoff B (sorry — I don’t get numbers of comments on my browser) — you are right — 30% debt is better than 100%. But the world (for now) still trades in US dollars.
“In our case, we need to drastically change our ideas of what government should do so that we don’t have to go through these debates every year.” There is an alternative, of course: we could raise taxes to pay for the services we’ve determined we are going to provide. (I’m not saying that’s the best solution, but it is an alternative. And if we really aren’t willing to touch the sacred cows of military and entitlements, then there’s little choice. Sustainability is clearly an issue there, however.)
Geoff,
One of my chief worries regarding this entire debacle is that I think establishing a precedent where the president (or the secretary of the Treasury) has to sit down and figure out which bills get paid and which don’t is incredibly dangerous. No company entering into a contract with the government will be sure if it will get paid. Governments do run like that, but they pay very high interest because nobody has faith in them.
Which leads to the chiefest of all worries. There may have been a time when default wasn’t a big deal because we operated on a gold standard and, whether or not we had some assumed value, we had gold. Nowadays, confidence in our national ability to pay debts, regulate spending, collect revenue, etc. is what our national value is based upon. If we have to start picking and choosing our creditors and contracts, it seems to me that both national and international confidence in our country and economy will wane.
We shouldn’t be making a big issue out of this vote. We should go ahead and raise the thing. There is another budget battle upcoming (its due in a mere two months). There is a whole election upcoming. Turning this particular vote into something other than a given is dangerous. There are plenty of ways to stage this debate without it.
We’ll be going into default on some of our obligations next week unless Congress (and the House in particular) undergoes a massive personality change.
Adam G, Gary Johnson will not be president. Ron Paul has a small chance, although at this point I would put my money on Perry to win the R nomination, with Romney a distant possibility. Both Perry and Romney would be better than Obama, but neither would deal with the structural problems involved. The Republicans would still be the tax collectors for the welfare/war state, which may be OK with you but definitely is not with me.
I think perhaps the real problem is that the U.S. no longer will have the global economic status we have become accustomed to. Which, measured by our education and lifestyle, is going to happen. The question is only whether or not we want to ease the passage or live in our superiority bubble a few more years and go out in a blaze of inglory.
I think I just figured out my political party. I’m a Cynic.
“Obviously we need some sort of strategy for making Social Security/Medicare/Medicaid sustainable.”
The United States and its citizens survived before these existed and they will after they are gone. And someday, because we decide and prepare or let it happen as a catastrophe, it will all be gone. My generation and the one behind it don’t believe it will be there for us anyway. We will be forced to change how things are done and it will be hard on those who are “expecting” to be fed by the government fantasy largesse, but it will save this nation from financial ruin. I have yet to hear a better argument for keeping these than “granny will die.” So will the government and our freedoms if we don’t drastically cut back or get rid of the programs.
“we could raise taxes to pay for the services we’ve determined we are going to provide.”
The more the government controls our purse strings, the less free we are because all the money belongs to those in power. If, as those who continually use this analogy, its between roads and freedom then I’ll take freedom. Citizens can always seek to raise money on their own for causes they care about. Why are the rich liberals always saying “tax the rich” when they end up (like Obama supporting GE) finding tax-free loopholes anyway? Because they know that those taxes will end up getting paid by the middle class anyway as they hide their money across the pond. Since those rich people are also the ones behind the government because they can afford to influence Washington politicians, they then will have *more* money to control the rest of the U.S. citizens. I would support the “tax the rich” more if I believed the taxes would actually get paid. Even worse, if they do pay it then the costs will go up for things so that the profit margin remained the same or higher. We don’t need more taxes. We need a better tax system that frankly eliminates tax deductions of any kind.
I am also against reducing the amount paid the military until there are other less important cuts. We don’t need to research everything. Again, lots of things could be paid by grants from citizens who care about the research, rather than the big pot of fools gold filled with the hard earnings of people who don’t care or even are offended. Get rid of the size of government, literally. There are committees of committees, even sometimes to determine if there should be committees. Then there are the number of agencies, with agencies inside agencies that don’t do anything other than say “yes” to the higher agencies. Most redundancies are to check for possible flaws, these just put in a check mark and cash the checks for themselves.
Government is top heavy and will fall if we don’t trim, rethink, and let more people go.
“Republican Study Committee chairman Jim Jordan apologized to members at a closed-door meeting because a junior RSC staffer, Wesley Goodman, earlier this week sent an email to conservative outside groups identifying which members were undecided on how they will vote on Boehner’s debt ceiling legislation.
‘There was a sense of frustration that, we’re on the same team, how could you do this?’ says a source who was in the room.”
Exactly! How dare someone describes to the constituents the feelings of those they voted into office. As privileged high and mighty government elites, they don’t need to answer to anyone. After all, concerned citizens might get . . . concerned.
“Brian Straessle, a spokesman for Jordan, called the email from the junior staffer “inappropriate.”
‘Earlier this week, an RSC staffer sent an inappropriate email to outside groups that identified members of Congress he believed were undecided on the debt reduction proposal offered by the Speaker. This action was clearly inappropriate and was not authorized by the Chairman or any other members of the staff. This has never been – and never will be – the way we do business at the RSC. We apologize to everyone affected, and we have already taken steps to ensure that it never happens again – either by this staffer or any other RSC staffer,’ Straessle said.”
Closed doors The only way to go! If you tell the unwashed masses who put hired us then there is going to be punishment. I’d like to find out who this Jim Jordan is and ensure he gets fired.
Good points, SR and Jettboy.
Why keep Social Security and Medicare? It doesn’t make sense, as SS has a terrible return on investment, and Medicare has tens of trillions in unfunded liability waiting just around the corner. Government shows that it handles these poorly. There is at least $200-400 billion in waste in Medicare/Medicaid/Welfare each year.
Let’s phase them out. Then, instead of Social Security, let’s give retirement accounts to each person. We take the 12% from each individual from the first $200,000 of income, split it up evenly among all involved, and place it in individualized accounts. Half the money is kept in safe returns, and the rest the individual can decide what to do between a variety of approved mutual funds, and even commodities like gold and silver.
Medicare we should turn into vouchers that can be used at any state approved insurance company. In exchange, the insurer must accept the voucher and provide a Toyota Corolla level of service. If a person wants a Camry or Lexus level, they can pay for additional insurance. No more unfunded liabilities.
In fact, we can do this for all Americans (provide a voucher), so all have basic coverage, but the freedom to get more. Businesses could get out of the insurance program altogether, making them more competitive. It would be portable. There would be no giant government overhead. Competition would still be there, as you could choose your own insurer, and pay more for better coverage.
We’ve had a couple commenters say, “raise taxes on the rich.” I want to address the realities of this.
There are really four kinds of federal taxes that are under discussion. The first are payroll taxes for Social Security and Medicare. Nobody is seriously discussing raising these taxes. The second is the capital gains tax. The third is the federal income tax. The fourth is the AMT.
On a local level, most people reading this pay property taxes, car taxes and state income taxes, as well as various registration fees, licenses and other fees on a local basis.
First point: when we compare tax rates in, say, 1979 with today, we need to realize that local and state taxes were much, much lower. So, the top rate in 1979 was 70 percent. But your local taxes were practically nonexistent in those days compared to now.
Second point: there were, believe it nor not, many more deductions in 1979 than there are today. So, in reality nobody paid 70 percent in taxes.
In fact, as a percentage of GDP total taxes are remarkably stable. They usually average about 18 percent of GDP no matter what the tax rate is. Your average rich person in 1979 probably paid 30-35 percent of his or her income in taxes in 1979.
Reagan radically lowered tax rates to 28 percent by 1987, but he increased payroll taxes. Capital gains taxes also increased. Bush 1 raised the top rate into the 30s, and then Clinton raised it to 39.6 percent. Bush 2 cut the top rate, and all rates, by a few percentage points. These are the famous “Bush tax cuts” liberals love to hate.
But it is important to remember that Clinton also cut the capital gains rate, which helped fuel the 1990s boom in revenue. Revenue as a percentage of GDP topped 20 percent in 1999 and 2000. But this primarily happened because Clinton and the Republican Congress 1)raised taxes when the economy was booming and 2)lowered the capital gains rate.
But this is crucial: rich people still paid only 30-35 percent of their income (at the most) in taxes during the Clinton years.
The dot.com bust in 2000-2001 led to the Bush tax cuts. They were intended to help overcome the recession, and it is standard Keynesianism, completely accepted by 90 percent of economists, that you lower taxes during a recession. The economy did indeed respond to Bush’s lower tax rates in the mid-2000s. But Bush made a fatal mistake: he passed Medicare Part D, he expanded the Education department and he spent money on unnecessary wars. If Bush had kept the growth of government modest in the 2000s, we would be talking about the Bush 2 economic boom. Instead, the Fed kept an easy money policy that, together with the deficit, led to the housing bust in 2007-2008. So, Bush’s problem was spending, not revenue. Revenue was fine during most of the Bush years — it was his reckless spending that led to the mess we are in now.
So, let’s talk what taxes can be raised. Payroll taxes? No, unacceptable, not even up for discussion (these are the most regressive taxes and hurt the poor the most). Capital gains taxes? Maybe. The income tax rates, back to Clinton levels? No. Ending the AMT patch? Definitely no.
How much revenue can be raised in a best-case scenario?
1)Raising the income tax rate on “the rich” back to Clinton levels? Maybe $70 billion a year, but probably much less.
2)Raising the income tax rate on the middle class back to Clinton levels? Maybe $100 billion a year.
3)Ending the AMT patch? Maybe $120 billion a year (this disproportionately affects middle-income people).
4)Raising the capital gains rate to 30 percent? Maybe $50 billion a year.
So, if we raise all these taxes we get at most $340 billion a year in new revenue. But let’s look at how this would affect different income groups:
–$40k a year family: $2500 a year in additional federal taxes.
–$60k a year single person: $5000 a year in additional federal taxes.
–$70k a year family: $5000 a year in additional taxes.
–$100k a year single person: $8000 a year in additional taxes.
–$150k a year family: $10,000 a year in additional taxes.
–$200k a year single person: $15000 a year in additional taxes.
–$250k a year family: $15000 a year in additional taxes.
–$1 million a year single person: $30,000 a year in additional taxes.
–THIS IS CRUCIAL: THE MAJORITY OF PEOPLE WHO MAKE MORE MONEY THAN THIS WILL NOT PAY MORE IN TAXES BECAUSE THEY WILL FIND A WAY TO HIDE THEIR INCOME. THEY WILL EITHER MOVE THEIR BUSINESSES OR THEY WILL STOP WORKING. THIS IS SIMPLY REALITY.
So, if we increase these taxes, we do get some additional revenue. But at what cost? How many people do you know who can afford, in this economy, to pay thousands more a year in taxes? I certainly cannot. I barely make my mortgage payment every month, and I’m sure most people reading this are in the same situation.
The deficit is $1.6 trillion. If we tax everybody out of existence we get $340 billion. We still have to make up $1.2 trillion or so to balance the budget.
Sorry, raising taxes just doesn’t do it. I could actually see an argument for raising the capital gains rate, but keep in mind that the really rich hedge fund managers you want to “get” will just find a way not to pay the taxes. This is just reality. There is no low-hanging fruit. Raising taxes is not the solution.
When I lived in Germany, they raised taxes and presented people with a moral dilemma. Either they could keep working and not make enough to survive, or they could quit and live off the government. The members were struggling with this, especially in light of German work ethic and LDS self-sufficiency standards.
We can look at this another way, as well. Mike Tyson earned about $350 million boxing. Michael Jackson earned about $750 billion. Both declared bankruptcy.
Was this because there wasn’t enough revenue coming in for a comfortable living? Or was it because they found a way to spend more than they earned?
The reality is, even if they had earned twice the amount they made, both would have probably still gone bankrupt, because they would not curb their spending.
And so it is with Congress and the President. For the last 7 or more years they have not had a problem with creating ever increasing levels of debt. Taxing the people will not bring us close to parity, as programs like Medicare will continue growing in unfunded mandates to the tune of tens of trillions of dollars (many think as much as $60-100 Trillion). We can’t pay that kind of debt off in several lifetimes.
Personally, I think we are coming ever closer to just one option: pushing the reset button, as the former Soviet Bloc did. They ended up struggling with austere measures for a decade (some countries still are after 20 years). Re-starting from scratch is never easy, but sometimes necessary.
And as President Thomas Jefferson stated, we need a good revolution in every generation. Hopefully, it is a peaceful revolution.
Can’t touch Medicare? Take a look at these stats just out:
http://www.thedailybeast.com/cheats/2011/07/28/u-s-health-bills-to-hit-4-6t-in-2020.html?om_rid=D35lbT&om_mid=_BOMWpIB8chCmET
Currently we spend $2.7 Trillion a year for medical needs. By 2020, it will be at least $4.6 trillion, or 1/5 our economy.
#27: It amazes me that people think the government is exempt from the same principles that govern personal or family budgeting–that if you spend more than you earn, you’re in trouble. You can transfer credit card balances around and do all kinds of shuffling, but sooner or later you’re not going to have enough funds to pay your obligations. And as you earn more, your lifestyle is going to inflate to keep pace with or exceed the additional funds if you’re not careful. The government is experiencing this, on a massive scale.