The Core of the Problem
Not that you could tell by the pronouncements of either major party presidential candidate, or anyone in the financial mandarin class, the US is hurtling itself toward a fiscal cliff that will prove shattering for most and create a moment of serious danger in the likely rise of a “populist” authoritarian. I’m talking about a real authoritarian, not a lazy ass dilettante like Donald Trump. Let’s examine the core of the problem.
The core is ultimately the voters. People demand, expect and vote for those who will give them goodies. The problem is, of course, that those “goodies” must come from someone. It is the process of diverting these goodies from some to others that is so economically damaging.
Economically speaking it is the spending that matters. All government spending is a transfer, or diversion of scarce resources from the producers of those resources to a non-producing class of consumers. It changes the allocation of scarce resources from a cooperative market-based process, in which both sides to the transaction win, to a politically based, one side wins, the other side loses process. This necessarily leads to a misallocation of resources, as outlined by the so-called “socialist calculation problem”. This process also flat out makes us poorer. The reason is that the level of taxation is the level of spending, and all spending discourages the production of goods and services. So, the core of the problem is the level of government spending.
What About the Debt?
I have specifically focused on spending. However, many will call alarming attention to the federal debt, driven by increasingly high deficits. The newish school of thought called Modern Monetary Theory claims that deficits and the debt do not matter. In fact, they will claim that the debt is really an asset. That is true in an accounting sense. The debt carried by the entity owing the money is a liability on their books. The debt loaned by an entity is carried as an asset. They must match, which is why it is called a balance sheet. So, the big “insight” of the MMT group is a big accounting yawn.
Economically the size of the debt does not really matter. It only reflects part of the past burden of government diversion of scarce resources to the nonproductive sector. The part not fully paid for by direct taxation. There is a political aspect to the debt that makes it relevant, however. If the government wants to keep funding its favored interest groups (trust me they do), they are likely to do so in addition to paying an ever-larger debt service bill. In fact, they are likely to add debt upon debt in an ever-increasing spiral of spending that serves to divert more scarce resources to the nonproductive sector, further retarding wealth creation. Again, the focus must be on spending, at least as a percentage of the economy.
The other main problem a deficit, and its attendant debt poses is the temptation to “monetize” the deficits. That is to cover the deficits by creating more money, that is, inflating the currency. This is a form of taxation, and an insidious one at that. The way that money is created and injected into the money supply is particularly damaging to the economy as I outlined here. That said, once again, it is the level of spending that really matters, because it drives all manner of bad policy, including the temptation to inflate the currency to cover the spending, with all its deleterious knock-on effects. It is less damaging to have a government of $2trillion dollars per year, all financed by debt, than one of $6trillion dollars per year financed all with taxes.
This dynamic is true even of the so-called “entitlement” programs of Social Security and Medicare. These programs are seriously out of actuarial balance and if nothing is done, they will automatically cut their payouts by about 20%. The danger is that the government will tap into the general fund (as opposed to the payroll taxes that mostly fund these programs) and pay off 100% of promised benefits on top of all the other spending.
The (not so) Long-Term Effects of this Spending.
All this spending will and is having a damaging effect on the economic growth of the US. The savings rate has cratered, capital formation is dropping, productivity has slowed dramatically, and real incomes have stagnated. I outlined all that here.
This will only continue to get worse. This will have a dramatic impact on the lives of people, particularly those headed for retirement. The implosion of both Medicare and Social Security is all but certain. Neither major party is willing to even have a conversation about what to do about this. At the same time these programs go bust, the economy will continue to lag, and stagnate under the weight of all the spending. So, the ability to grow the economy out of this trouble will be greatly reduced, if not eliminated altogether.
This stagnating economy presents real social and political dangers as well. The entirety of this century, as the charts in the previous links show, has been marked by a middle class being hollowed out and faced with declining prospects. This is, I think, the driving force behind the “Occupy Wall Street” protests of the 2010s, as well as the rise of the angry Trump and Bernie Sanders voters. If the economy further stagnates, or even cracks wide in a “Great Depression” manner, then the time would seem ripe for the rise of an authoritarian demagogue. When the middle gets desperate, they are ripe pickings for a skillful liar to promise them security for their freedom. However, as history has shown, in such situations people end up with neither freedom nor security.
Cutting this Gordian Knot
How then do we cut this Gordian Knot and return the economy to a sustainable and honest basis? First, massively cut government spending, across the board. Let’s start with the big-ticket items-Medicare and Social Security. You cannot cut the benefits of those in retirement or near retirement (it’s a political nonstarter anyway). So run off the obligations of those retirees out of current spending and/or asset sales of the immense holdings of federal real estate. As for those farther out from retirement (and therefore able to shift course) means test all these benefits. This simply means that benefits are provided to those that truly need them, the impoverished. This provides the incentive, and the freed-up resources for people to provide for their own retirement, and a safety net for those that cannot. All other government subsidies, corporate and otherwise should be cut off immediately, and those corporations living off the dole can earn their profits in an honest marketplace.
As for defense spending, that should be massively cut as well. Let’s start with the last Eisenhower defense budget of 1961, which was $50billion. Plug that number into an inflation calculator and you get a 2024 total of just over $526 billion, roughly half of what the US spends today. How do we do this? Close the 800+ bases in over 150 nations around the planet. Mothball all but 2-3 of the aircraft carrier battle groups, which are only offensive in nature. Also cut the standing army in half to protect the US homeland (protected by two large moats known as the Atlantic and Pacific oceans), and line the coast with low-cost shore defenses, and the use of satellite tracking ability (and defensive measures to protect those satellites). Also, you can eliminate the air and land-based legs of the nuclear deterrence triad, which will leave mobile undetected submarines to act as deterrence. This will also make the world safer (that is for another post), as well as save a crap ton of money. In short, dismantle the empire and stand-up multiple poles of power to create no one imperial behemoth (this concept is also in need of a further essay).
As for the existing debt, and the payments on it, repudiate all of it. There is no moral case to be made in paying back money that was stolen with money that is stolen. It would be like making a moral case for the Corleone crime family to repay a loan from the victims of its protection rackets. Also, this has the added benefit of making the whole world leery of ever loaning the US government money in the future.
This would cause a drop in value of the holdings of this debt to be sure. In fact, the entire project of massively cutting federal spending will see the market drop precipitously. This is because the market is almost entirely supported by unsustainable money creation and is thus not on a real footing. However, if allowed to, the real economy will recover within a reasonable amount of time (18-24 months) and thus will begin to right the finances of the entire economy.
In any event, very little of United States debt is held directly by individual investors. A third of US debt is foreign owned, and of the two thirds domestically owned, only about 22% of that is held outside of institutional investors. A fuller breakdown can be found here. Besides all that, I got news for bond holders. The value of their holdings is highly likely to drop in the long term regardless of whether the debt is repudiated outright or not. With so much more debt being issued by the US government the value of those bonds will drop. This is simply a case of supply and demand.
All of this will take a sea change in political attitudes about what government can and should do. This will not be easy. It may take a breakdown of the current regime to give space for this. As I said that kind of breakdown presents great danger to our freedom, and indeed world peace. Such a moment will see the rise of demagogues willing to steal your liberty. However, if we stand ready with a workable plan to correct the problem, we stand a better chance of defeating the silver-tongued sophists, sure to try to take advantage of economic instability.
For the faithful, I would urge trusting in God, and the peace and freedom He wants for all His children, all over the planet. Trust in the righteousness of a free and cooperative economy, that eschews the blatant rip-off of the politically disconnected, and provides space for a just and nonviolent sustainable economy. Everything that is broken can be fixed, if we but trust God enough to use the brains He gave us.
Praise Be to God
