Archive for November 11th, 2010

$4 Trillion in Debt Reduction?

President Obama’s commission, chaired by Erskine Bowles (D) and Alan Simpson (R) has come forth with a dramatic call for cutting debt by $4 trillion over ten years, starting in 2012.   Most of the savings come from spending cuts, while about a quarter come from tax revenue increases.   The ultimately goal would be to target both taxes and spending at 21% of GDP, a very low figure compared to the rest of the industrialized world.

So far, Democrats have sounded more negative towards the report, but its not clear how Republicans will react to tax revenue increases.  Moreover, cuts include defense spending cuts and other politically tricky targets.   The retirement age for social security would increase, and there is bound to be considerable debate over the various provisions.   The bottom line is that meaningful cuts won’t happen without controversy, and with power being shared, no political party will get to ram through their own version of what should be done.

President Obama can seize this report and call to enact it, grabbing the fiscal high ground for the 2012 election.  The challenge to the Republicans will be if they mean it when they say they want to cut the deficit and debt.   But given that we’re in a recession, is it good to undertake ambitious spending cuts?

First, the cuts start in 2012.  There’s a possibility we’ll be working out of the recession by then (if my bearish predictions are wrong) and if that’s the case it’s the perfect time to cut spending.  In fact, if the economy is improving, the cuts may be easier to stomach than it now seems.

More importantly, I’ve been mulling over the arguments in favor of stimulus.   Everything is different in a globalized economy.  Stimulating the economy used to be a relatively simple affair: you increase demand, which leads suppliers to put people back to work to satisfy this new demand.  That starts a chain reaction of growth, as these workers then increase demand for other goods.

But now the world is a global market, and economic stimulus might not benefit ones’ own economy (just as tax cuts might end up being used to purchase foreign goods).   What we really need is direct infrastructure improvement with an eye on keeping the country productive in the 21st century, but the stimulus that we had didn’t really do that job.   Moreover, stimulating the economy when demand is low may also be counter productive when debt is high and credit remains cheap.   I’m not just talking government debt here, but private and corporate debt as well.  The problem has been inflated demand (consumerism) for the twenty to thirty years before this crisis hit.   This crisis emerged from an overstimulated economy.

So decreasing debt seems a smart thing to do, especially if we land at a sustainable balance of taxing and spending.   I don’t think too many people would consider 21% of GDP a high level of government spending, after all.    This also comes as President Obama meets with world leaders at the G-20 conference, trying to argue that China, Germany and Japan can’t expect to maintain such large trade surpluses with the US.    The debt reduction plan may produce a jolt of strength in the dollar, which goes against what I was arguing in the last post.   Yet that could help pressure China to allow the Renminbi (or Yuan) to revalue against the dollar.   There are reasons a stronger currency may be in China’s interest as the global economic system rebalances.

I feel a bit of schizophrenia in my posts, bordering from talking about this as a global depression and a civilizational crisis for the West, to seeing some positive signs and thinking maybe the rebalancing can be done successfully.   This blog not only records my predictions, but also shifting moods.   When I think a lot about energy/oil, as well as the dangers of global warming, I veer into a more pessimistic view towards the future.  If I try to contemplate how the world can deal with such massive debt — heavy debt in the entire west, from Japan to the EU to the US — it becomes easy to imagine a deep and lingering recession.

Yet if oil really doesn’t peak until 2030, and if the worst predictions of global warming are exaggerated, then signs of gradual debt reduction (private and public) and economic restructuring seem to indicate the landing could be softer.  Don’t get me wrong — we won’t see the consumerist orgy of the 00’s return, nor will the US remain the dominant world economy.   There will be a shift in economic and political power away from the US towards a multi-polar world.  That is something Americans will have to learn to accept.

We also need to come to grips with the fact that the financial crisis represented really a giant fraud, as big investment bankers siphoned billions of money from innocent investors by packaging up mortgages into bonds (and then those bonds into other bonds, etc.)     Even the investors who failed ultimately still pocketed millions during the boom years, and those who lost had been told they were in secure investments.   They choose AAA bonds for security, not out of greed.  We have to have a regulatory structure so investment is honest and does what investment is supposed to do, and not simply be legalized gambling.

Proposing cuts and passing them are two different things, and we’ll see where this plan goes.   But it does appear that there is a serious effort in the US to restructure government taxing and spending to cut debt and develop a sustainable blueprint for the future.   That to me is a good thing.

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