By George P. Shultz, Michael J.
Boskin, John F. Cogan, Allan H. Meltzer and
John B. Taylor
Sometimes a few facts tell important
stories. The American economy now is full of facts that tell stories that you
really don't want, but need, to hear.
Where are we now?
Did you know that annual spending by
the federal government now exceeds the 2007 level by about $1 trillion? With a
slow economy, revenues are little changed. The result is an unprecedented
string of federal budget deficits, $1.4 trillion in 2009, $1.3 trillion in
2010, $1.3 trillion in 2011, and another $1.2 trillion on the way this year.
The four-year increase in borrowing amounts to $55,000 per U.S. household.
The amount of debt is one thing. The
burden of interest payments is another. The Treasury now has a preponderance of
its debt issued in very short-term durations, to take advantage of low
short-term interest rates. It must frequently refinance this debt which, when
added to the current deficit, means Treasury must raise $4 trillion this year alone.
So the debt burden will explode when interest rates go up.
The government has to get the money
to finance its spending by taxing or borrowing. While it might be tempting to
conclude that we can just tax upper-income people, did you know that the U.S.
income tax system is already very progressive? The top 1% pay 37% of all income
taxes and 50% pay none.
Did you know that, during the last
fiscal year, around three-quarters of the deficit was financed by the Federal
Reserve? Foreign governments accounted for most of the rest, as American
citizens' and institutions' purchases and sales netted to about zero. The Fed
now owns one in six dollars of the national debt, the largest percentage of GDP
in history, larger than even at the end of World War II.
The Fed has effectively replaced the
entire interbank money market and large segments of other markets with itself.
It determines the interest rate by declaring what it will pay on reserve
balances at the Fed without regard for the supply and demand of money. By
replacing large decentralized markets with centralized control by a few
government officials, the Fed is distorting incentives and interfering with
price discovery with unintended economic consequences.
Did you know that the Federal
Reserve is now giving money to banks, effectively circumventing the
appropriations process? To pay for quantitative easing—the purchase of
government debt, mortgage-backed securities, etc.—the Fed credits banks with
electronic deposits that are reserve balances at the Federal Reserve. These
reserve balances have exploded to $1.5 trillion from $8 billion in September
2008.
The Fed now pays 0.25% interest on
reserves it holds. So the Fed is paying the banks almost $4 billion a year. If
interest rates rise to 2%, and the Federal Reserve raises the rate it pays on
reserves correspondingly, the payment rises to $30 billion a year. Would
Congress appropriate that kind of money to give—not lend—to banks?
The Fed's policy of keeping interest
rates so low for so long means that the real rate (after accounting for
inflation) is negative, thereby cutting significantly the real income of those
who have saved for retirement over their lifetime.
The Consumer Financial Protection
Bureau is also being financed by the Federal Reserve rather than by
appropriations, severing the checks and balances needed for good government.
And the Fed's Operation Twist, buying long-term and selling short-term debt, is
substituting for the Treasury's traditional debt management.
This large expansion of reserves creates
two-sided risks. If it is not unwound, the reserves could pour into the
economy, causing inflation. In that event, the Fed will have effectively turned
the government debt and mortgage-backed securities it purchased into money that
will have an explosive impact. If reserves are unwound too quickly, banks may
find it hard to adjust and pull back on loans. Unwinding would be hard to
manage now, but will become ever harder the more the balance sheet rises.
The issue is not merely how much we
spend, but how wisely, how effectively. Did you know that the federal
government had 46 separate job-training programs? Yet a 47th for green jobs was
added, and the success rate was so poor that the Department of Labor inspector
general said it should be shut down. We need to get much better results from
current programs, serving a more carefully targeted set of people with more
effective programs that increase their opportunities.
Did you know that funding for
federal regulatory agencies and their employment levels are at all-time highs?
In 2010, the number of Federal Register pages devoted to proposed new rules
broke its previous all-time record for the second consecutive year. It's up by
25% compared to 2008. These regulations alone will impose large costs and create
heightened uncertainty for business and especially small business. This is all
bad enough, but where we are headed is even worse.
President Obama's budget will raise
the federal debt-to-GDP ratio to 80.4% in two years, about double its level at
the end of 2008, and a larger percentage point increase than Greece from the
end of 2008 to the beginning of this year.
Under the president's budget, for
example, the debt expands rapidly to $18.8 trillion from $10.8 trillion in 10
years. The interest costs alone will reach $743 billion a year, more than we
are currently spending on Social Security, Medicare or national defense, even
under the benign assumption of no inflationary increase or adverse bond-market
reaction. For every one percentage point increase in interest rates above this
projection, interest costs rise by more than $100 billion, more than current
spending on veterans' health and the National Institutes of Health combined.
Worse, the unfunded long-run
liabilities of Social Security, Medicare and Medicaid add tens of trillions of
dollars to the debt, mostly due to rising real benefits per beneficiary. Before
long, all the government will be able to do is finance the debt and pay pension
and medical benefits. This spending will crowd out all other necessary
government functions.
What does this spending and debt
mean in the long run if it is not controlled? One result will be ever-higher
income and payroll taxes on all taxpayers that will reach over 80% at the top
and 70% for many middle-income working couples.
Did you know that the federal
government used the bankruptcy of two auto companies to transfer money that
belonged to debt holders such as pension funds and paid it to friendly labor
unions? This greatly increased uncertainty about creditor rights under
bankruptcy law.
The Fed is adding to the uncertainty
of current policy. Quantitative easing as a policy tool is very hard to manage.
Traders speculate whether and when the Fed will intervene next. The Fed can
intervene without limit in any credit market—not only mortgage-backed
securities but also securities backed by automobile loans or student loans.
This raises questions about why an independent agency of government should have
this power.
When businesses and households
confront large-scale uncertainty, they tend to wait for more clarity to emerge
before making major commitments to spend, invest and hire. Right now, they
confront a mountain of regulatory uncertainty and a fiscal cliff that, if
unattended, means a sharp increase in taxes and a sharp decline in spending
bound to have adverse effect on the economy. Are you surprised that so much
cash is waiting on the sidelines?
What's at stake?
We cannot count on problems
elsewhere in the world to make Treasury securities a safe haven forever. We
risk eventually losing the privilege and great benefit of lower interest rates
from the dollar's role as the global reserve currency. In short, we risk passing
an economic, fiscal and financial point of no return.
Suppose you were offered the job of
Treasury secretary a few months from now. Would you accept? You would confront
problems that are so daunting even Alexander Hamilton would have trouble preserving
the full faith and credit of the United States. Our first Treasury secretary
famously argued that one of a nation's greatest assets is its ability to issue
debt, especially in a crisis. We needed to honor our Revolutionary War debt, he
said, because the debt "foreign and domestic, was the price of
liberty."
History has reconfirmed Hamilton's
wisdom. As historian John Steele Gordon has written, our nation's ability to
issue debt helped preserve the Union in the 1860s and defeat totalitarian
governments in the 1940s. Today, government officials are issuing debt to
finance pet projects and payoffs to interest groups, not some vital, let alone
existential, national purpose.
The problems are close to being
unmanageable now. If we stay on the current path, they will wind up being
completely unmanageable, culminating in an unwelcome explosion and crisis.
The fixes are blindingly obvious.
Economic theory, empirical studies and historical experience teach that the
solutions are the lowest possible tax rates on the broadest base, sufficient to
fund the necessary functions of government on balance over the business cycle;
sound monetary policy; trade liberalization; spending control and entitlement
reform; and regulatory, litigation and education reform. The need is clear. Why
wait for disaster? The future is now.
The authors are senior fellows at
Stanford University's Hoover Institution. They have served in various federal
government policy positions in the Treasury Department, the Office of
Management and Budget and the Council of Economic Advisers.
Source: WSJ September 16, 2012, 7:03 p.m. ET
Comments:
It’s no longer political; it’s survival. It’s time to fire Obama in November.
Norb Leahy, Dunwoody GA Tea Party Leader
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