The Austerity Crusade Fails Again; If Only They'd Listen To Keynes

It shouldn't have needed yet another proof, but here it is: as John Cassidy puts it, "an official confirmation from the United Kingdom that austerity policies don’t work."

Anybody who works from a knowledge of economic history already knew that. But the high priests of Supply-side were sure. All they needed to do was to be sufficiently faithful to their doctrine. It didn't work. And nobody who even came close to understanding Keynes was surprised by anything other than the deficit-hawks continued belief that balancing the budget will somehow cure all the ails us. Cure it because ... um ... underpants? Surely that's it. The balancing of the budget would cause the confidence fairy's underpants to fit better and she would come dancing along to rain blessings upon us for so dutifully cutting to balance our budgets.

After all, it surely all comes back to underpants, at least when we're dealing with the faith-based economics of Supply-siders (the Trickle-down-istas). For anyone who's seen South Park's "underpants gnomes" and their business plan:

1. Collect underpants
2. ?
3. Profit!

It's the very same with deficit-hawks:

1. Balance the budget
2. ?
3. Profit!

It really does require a pure leap of faith to jump off that cliff. Sadly, there are sharp, pointy rocks below and there really is no confidence fairy waiting around to boost folks back onto solid ground after they slash budgets during a downturn. So march off to the austerity crusade boys. And don't forget to inflict lots of suffering on your economy because that's the only way to scare the evil spirits out of it. Right? We just have to believe hard enough and the confidence fairy will appear. Never mind those rocks. We're not plummeting towards them, they're just growing bigger. That's all.

But no, that's not all. Austerity fails. At least from where we are. Austerity will be harmful so long as we're demand-constrained rather than supply-constrained. And we're clearly demand-constrained rather than supply-constrained. So anyone who was paying attention should have known not to cut spending. But the Supply-side faithful would have nothing of it. Listen? Pay attention to history? Heck no!

Can we please stop with the misguided, ill-timed budget-cutting when our economy isn't roaring along? Pretty please? Austerity fails. Supply-side fails. Trickle-down doesn't trickle down. We can only safely cut when we're already doing well ... preferably when we're overheated. We're not suffering from overabundance. If we bleed our economy of government spending, all that'll do is make the patient more sick. Enough with the "harsh medicine" already. It'll only hurt.

The Course of the Recovery

The course of the recovery:

Legislation and events marked on the above chart:

• ARRA - i.e., "the Stimulus", signed February 17, 2009
• Chrysler reorganization, emerged from govt backed chapter 11 on June 10, 2009
• GM restructuring, emerged from govt backed chapter 11 on July 10, 2009
• The first budget based on President Obama's proposals entered into effect with the start of the govt fiscal year on October 1, 2009.
• UC extended under the Worker, Homeownership, and Business Assistance Act of 2009
• Payrolls reached their lower point of the decline from the Great Recession in February 2010
• March 2010 saw the signing of both HIRE (Hiring Incentives to Restore Employment Act of 2010) and the PPACA (i.e., "Obamacare")
• The Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law on July 21, 2010
• The Small Business Jobs Act of 2010 was signed on September 27, 2010
• Some provisions of the ARRA (i.e., the "Stimulus") were extended via the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 signed on December 17, 2010
• The Food Safety and Modernization Act was signed into law on January 4, 2011

Our Govt Must Do As We Do

Most of us know what it's like to have to spend money to make money. So why do so many find it counter-intuitive that our nation might have to do the same? We should all know that need from our own lives. Perhaps it's just that our personal vocational spending strikes us as more obvious because we know so directly that we need it.

Oil draining during auto maintenance

We live with many ways we must spend money to maintain our income, let alone increase it. For many, we start by taking out loans for a college degree, but that's only the beginning. Some of us have to purchase training or educational materials every year to keep current. And some must pay annual license or certification fees. Commuters, the vast majority of Americans, must travel to work to keep earning a paycheck, so the car payments must go out every month, the tank must be filled, and the maintenance must be done. Those in snow-prone states must buy shovels and often find ice-melting products an income-preserving investment. Telecommuters have a different set of bills for virtually getting to work, but the costs are no less necessary. Various craftsmen must spend significant amounts on raw materials. Often, the total annual material cost dwarfs the profit from the craft after covering material costs. Most shopkeepers know that story well, as it's a lucky business indeed whose net profits from selling products are significantly larger than the wholesale costs paid year after year.

What's this have to do with our government? Our government's income comes from the economy at large. That economy at large has needs just as we do individually. Commerce grows on better roads and stagnates on worse roads. Businesses thrive on an availability of healthy, qualified workers who can concentrate on their work confident that govt services such as fire and police protection will be there for their homes. And some of those workers are available during the day because after decades of honest work their parents were able not only to retire and get by in a reasonably dignified manner but also with basic medical needs covered. These things cost money. Without them, our nation's commerce would stagnate, reducing tax revenues. We can only maintain our federal income by spending on a variety of national necessities that keep our system of commerce working.

How much spending to make money is reasonable? Individually, that depends on the profession. But the simple answer is: that which at least covers what's necessary to get by but beyond that is not so much we can't profit. With all the attention on our debt, one might think we've been spending more than we can call profit. But there's more than one way to profit. The masters of finance and investment don't focus just on leveraging costs alone but also consider rates of return as well as inflation when deciding where to place bets and for how much. As Ezra Klein pointed out recently, negative real yields on Treasuries can mean "the government is getting paid to keep money safe." This implies that our safe-haven status could -- at least for a while -- mean we're profiting from our borrowing even before considering what we might be doing with that money to increase commerce. But then add in what we can be doing with the money to improve infrastructure, access to healthy, qualified workers, and more. If we do the basic maintenance on our economy plus some efforts at improvement, we should generally expect better growth. If that spending helps national income growth outpace the growth of the debt, what more justification should it need? After all, most of us invest in increasing our own incomes even when it's an ongoing cost.

But how much debt can we manage to juggle to keep oiling the gears? While that's a difficult question to answer, one might consider that historically the full faith and credit of the US govt has been more stable than houses, especially recently. Let's imagine our national govt were looking for a new home loan. We're currently taking what amounts to a voluntary pay-cut with the temporary tax cuts. Given the 2010 GDP of $14.5 trillion and our historical average revenue of 18% of GDP, we should theoretically have had a 2010 revenue around $2.61 trillion. For 2010, playing it safe by using a conservative 28% payment-to-income ratio for affordability, our theoretical govt-as-homeowner loan could have been around $14.5 trillion. In 2010, our debt was $13.5 trillion, around 7% lower than we could have afforded by traditional home purchase standards. And that's not even accounting for the full faith and credit being more solid than houses.

We Could Pay Off The Debt. But Should We?

We could do it. If we wanted to, we could eliminate the deficit with taxes alone. The real question is whether we should.

Debt in perspective

Yes, you've probably heard that we can't. You've probably heard the claim that the deficit is unmanageable. You've probably heard the claim that the debt is some grand, unapproachable amount that we already can't possibly hope to pay off. You've probably heard the claims that our debt is so high there aren't enough assets or income in the country to cover it.

They're flat-out false. The only question is whether they believe what they're saying or they're purposefully lying.

Here are the numbers from the census data, the treasury, the fed, and the standard deficit projection:

• Number of households in 2010: 118,682,000
• Mean 2010 household income in 2010 dollars: $67,530
• 9/23/2011 current debt: $14.7 trillion
• Projected 2011 deficit: roughly $1.3 trillion
• Household 2010 net worth: roughly $57 trillion

So take those numbers above and we can see that:

• Net worth / household: $480,275
• Federal debt / household: $123,861
• Net worth after US debt / household: $356,414 (far higher than median net worth)
• National income / household: $67,530
• Federal deficit / household: $10,954
• Net income after deficit: $56,574 (significantly higher than median income)
• Deficit / income / household: 16.2%

The particular items of interest here are: 

• $356,414 dollars left over if we were to pay all all federal debt from all household net worth today
• 16.2% as the mean increase required to eliminate the deficit with tax increases alone

As $356,414 is far above the median net worth, most people would say that's far from broke. There would be lots of problems with actually liquidating private net worth, of course, so that's strictly hypothetical. The fact remains, however, that there is enough household net worth in the US to do it and still have quite a bit of wealth. Just because it isn't something we want to do doesn't mean it couldn't be done.

The 16.2% seems like a massive tax increase. But then consider that we've had higher taxes than that before. It wouldn't be all that bad if such an increase were done in a progressive manner. For the bottom 50% of taxpayers, losing 16.2% more of income would be catastrophic. But together they only make about 12.75% of total AGI, so managing without the bottom 50% isn't so hard. For the top 1% such an increase would be easily survivable and still far below what folks with such incomes would have paid in the 1950s and 60s. Based on the AGI's if we taxed the top 1% an additional 40%, that alone would cover over half the deficit. Just for a rough example, if we were to raise effective tax rates by 40% on the top 1%, 15% on the rest of the top 5%, 10% on the rest of the top 10%, 5% on the rest of the top 25%, and 2% on the rest of the top 50%, that would net us an additional $1.38 trillion. That'd be well more than enough to cover the deficit. Whether we want to do something like that or not, the fact remains that it could be done. If we collectively wanted to, we clearly could close the deficit with tax increases alone.

If you don't believe my numbers, please look them up yourself. If you don't believe these basic calculations, please pull out your calculator or spreadsheet and run them yourself. You'll find the same thing. We could cancel out the deficit if we wanted to. And we could pay off the debt if we really wanted to. That's part of why our debt is an international safe-haven investment at very low interest rates. But there's another side to the story. Do we really want to have no national debt?

2010 Intragovernmental Holdings

Of that $14.7 trillion, $4.6 trillion is intragovernmental holdings. Over $2.6 trillion is held by the Social Security trust fund alone. Social Security needs someplace secure to hold that cash till it's needed. We don't want them gambling it on stocks or volatile commodities like gold or oil. Even if the rest of the world weren't seeing lots of instability, U.S. Treasuries are the only reasonable option. That means our federal govt must borrow at least enough to be able give the Social Security trust fund a safe place to invest. The same holds true for at least most of the rest of intragovernmental holdings, many of which are insurance or retirement accounts. We don't want them anywhere less safe; and anywhere else is less safe.

So far, we've identified roughly $4.6 trillion of debt that we want right where it is. It would be senseless to force ourselves to find alternatives less secure than the full faith and credit of our own government for those holdings.

Holders of debt, Dec 2010

The rest? As of the end of 2010, there was $802 billion in pension funds. Shall we tell all the pensioners their funds have to be less secure because our debt hawks don't want us to have govt debt anymore? There's $517 billion held by state and local govts. Shall we force our other levels of govt to engage in risky speculation? Depository institutions (i.e., banks) hold $323 billion. Didn't we already get burned by letting banks increase their risk? Do we really want to go there? Wouldn't that be exactly the opposite direction from where we've been trying to push the financial industry? Insurance companies hold $244 billion. Guess why they've put it into Treasuries ... because they need the stability in order to keep insuring us without entirely relying on risky sources to back up our claims. Then there's another $2,046 billion held among mutual funds, savings bonds, and other investors. All of whom look to Treasuries for low-risk investments to balance out our riskier investments with some safe, guaranteed income. Shall we deny all our investors -- both wealthy folks and the grandmother nearing retirement -- the opportunity to choose additional investment beyond Social Security that's backed by the full faith and credit of our govt? To stop issuing federal debt would be to say, "No, you may be ready to retire and seeking to move your funds out of risky assets, but we're not going to let you have this guaranteed income option." Do we really want to say that? Seriously?

What's that leave? The foreign portion, under a third of our debt. That's the part we could seriously consider. That's the part we could pay off without forcing our own govt institutions, companies, and individuals to shift all of their investments into riskier options. But what does that part mean to us? Foreign investments aren't invested in our debt because of attractive rates to them. Quite the opposite; they could easily choose any number of investments with higher rates. But those higher rates all come with more risk. We're the place nations stow cash in case everything else fails, safer than burying it. It isn't about making money off us; it's about making sure they've got enough money socked away where it is more certain to be available than any other option. It's about stability. That means we're issuing debt at very low rates, lower than ordinary inflation. After factoring for inflation, all the world is literally paying us to hold their money safely for them. Why should we turn that down instead of using it to improve our infrastructure and lower our domestic cost of doing business?

Gross Govt Impact

The idea that we should make huge govt budget cuts is premised on the notion that our economy would be better off that way, wouldn't be hurt by it, or at least would soldier on about the same. Sometimes the best insight into that notion comes from people who weren' even discussing budget cuts directly. Daniel Gross's recent article about whether to buy bonds or not didn't touch on the idea of budget cuts at all. It's one and only focus was on whether US govt bonds are still a safe-haven investment compared to stocks. To explain that, he covers the impact on stocks if the US runs up against the debt ceiling and stops spending to not default on bonds.

"The U.S. government occupies a pretty large footprint in the economy. It employs 2.85 million people directly. Next, think of all the businesses, many of them publicly held, that rely on the government  for a big chunk of their business. For-profit education companies, defense contractors, the entire health care industry, Wal-Mart and other retailers that cater to people who depend on federal benefits to help pay their grocery bills. Every large consulting firm, every large tech firm (from Microsoft to IBM) has a large unit that provides services and products to the federal government.

Should the U.S. bump up against the debt limit without resolution, it's possible the Pentagon would delay indefinitely the signing of new contracts for fighter jets. Or agencies would cancel or slowdown payment on IT projects. Or Congressmen and their staffers would see their wages reduced. Or fewer people would get food stamps. The cumulative impact would be less demand, less economic activity, more uncertainty."

In pointing this out, Mr. Gross was ostensibly more concerned with explaining why bonds seem a relatively safe investment at this point. He says, "government reliance on debt to fund of operations and investments is so great that they'd rather alienate workers and citizens and taxpayers than anger the bond market." So all the explanation of what they'd have to do to avoid angering the bond market just explains why stocks are the more risky bet despite debt ceiling fears.

Yet there's a far more important take away than Mr. Gross's surface question of whether it makes more sense to invest in bonds versus stocks. Those payments we'd have to avoid making? They're a lot like the cuts the GOP wants to make. If the Republicans got their way -- the whole thing for which they're playing chicken with the debt ceiling -- we'd see most of those cuts. No wonder they don't care about the debt ceiling, if what they figure we'd avoid paying to avoid default are the things they don't want to fund anyway. And "Of course, all these moves would be contractionary — they'd help slow economic growth."

Contraction, by the way, is more or less a general term for things like recessions and depressions. Mr. Gross didn't speculate on whether those non-payments (or cuts, if de-funded in a relatively orderly manner) would cause a mere recession or a full-fledged depression. But that's really the remaining question for anyone who might be paying attention to where the Republicans goals would shove us. If the Republicans get their massive budget cuts, the question isn't whether it'll hammer the economy, the question is only how hard ... and whether we've ever seen it hammered that hard before.

Plan For Growth

"It takes as much energy to wish as it does to plan." - Eleanor Roosevelt

We have uncomfortably high unemployment. We want that to come down. We also have an uncomfortably high deficit. That needs to drop too. What we need is a plan. One that can do both. One that can work.

Our new House majority has loudly pushed focusing on the deficit with budget cuts. The trouble, as I've previously shown and discussed in relation to specific budget cutting figures, is that any significant budget cuts are very, very likely to steer us into far higher unemployment. That would further reduce tax revenues and make the deficits worse. So that just won't work. We can't get rid of the deficit by chopping growth and making the deficit worse.

What can we do?

Well, what happens if we maintain the status quo? What happens if we proceed with spending at the exact dollar amount it is now, keep tax rates exactly where they are, and manage to keep the pace of growth at the roughly 3% estimated for 2011? (Note that spending is scheduled to shrink in 2012 with the expiration of stimulus programs and the winding down of expensive wars. So this assumes we actually spend more than is currently expected for some of these years.)

Deficit/surplus assuming budget holds steady, 3% GDP growth, and revenue stays at the current 14.81% of GDP

Interesting. We'd have a surplus by 2029 at that rate and could start reducing our debt. That's without budget cuts. That's even assuming more spending for at least one of those years than is currently projected. We'd all love to see that budget gap closed sooner, but that's going in the right direction.

OK, how can we speed that up? What happens if we go back to the 30-year average of revenue as a percentage of GDP starting in 2012 but keep all else as before, with spending staying at the 2010 dollar level and a 3% GDP growth rate?

Deficit/surplus assuming budget holds steady, 3% GDP growth, and revenue goes back to 18.2% of GDP in 2012

A bit better. That'd have the surplus and its potential paying down of the debt begin in 2022. But let's try for more. What happens if we go back to the 30-year average of revenue as a percentage of GDP starting in 2012, keep spending at the 2010 dollar level, and find some way to increase our growth rate over 3%? For the sake of charting, let's imagine we get it up to 4% in 2012, peak at 5% in 2013, and then manage 4% thereafter.

Deficit/surplus assuming budget holds steady, but revenue goes back to 18.2% of GDP and avg. 4% GDP growth from 2012

That's more like it, don't you think? If we could achieve an average 4% GDP growth over that time, we could be seeing revenue eclipse spending in 2019, assuming we keep spending at the dollar amount from 2010 and return revenue back to the 30-year average of 18.2%. That's just 8 years from now. I don't know about your kids, but that's even before my older daughter will start college.

That's fairly vague, I'll admit. I've left a lot of room for what exactly those efforts to increase the rate of GDP growth might be. Where to get the money? I'm not a defense expert, but even some conservatives are suggesting we have some fat to trim in the defense spending. Imagine if we took those proposed cuts on spending beyond what the Pentagon actually needs to do its job and transferred that money into real job creation programs.

Off the top of my head, I can come up with several ways we could be doing more to create jobs through our Federal govt:

1. a reborn national Civilian Conservation Corp chartered for 5 with potential to renew
2. repairs to all of our crumbling bridges (and maybe revamping some roads too)
3. high tech research towards "green" energy and products

The first two of these would easily pay off right away. We've got a lot of unemployed construction workers, and it shouldn't take a terrible lot of retraining to put a lot of them to work in a CCC or on improving our transportation infrastructure. The research part might take a bit longer to get going, but the pay-out would go even further. Well beyond when we might have brought our unemployment down using a CCC and beefed up infrastructure projects, we could be benefiting from jobs and sales in exporting of green tech, just like we've benefited from Defense Department and NASA research in our computer industry. That's investing prudently in a future for our children.

It's time.

GOP Seeks Lower GDP

Sen. Rand Paul

Sen. Richard Shelby (R-AL) feels we can cut 30% across the board. Or maybe 10%. According to Ben Armbruster of ThinkProgress, "It is unclear which reduction figure, 10 percent or 30 percent, he is officially advocating." On ABC's "Top Line", Rep. Michele Bachmann (R-MN) says that she's found "about $450 billion worth of cuts." That'd be around 12%. Sen. Mike Lee (R-UT) has talked about cutting the budget by 40%. Sen. Rand Paul (R-KY) strikes it at a balanced budget, which means roughly 33%.

As previously detailed, when we cut the budget to avoid borrowing, those cuts don't come from nowhere. They come out of spending, reducing demand, lowering our nation's GDP. In good times, that's fine. When GDP growth is high enough, we can afford to cut. But we can't afford to drop our growth below around 2.5%. Otherwise we get rising unemployment. One would hope that these members of Congress understand national budgets, have done the math, and wouldn't propose a drop that would take us below 2.5% GDP growth, right?

So what would each of those figures mean? We can plug these into a rough formula. Some of the lower estimates figure the government around a 25% share of GDP. To give these members of Congress the most benefit of the doubt, we'll go with this low estimate. So when you cut government spending by a percentage, you effectively cut the GDP (or more precisely lower the percentage change in GDP) by roughly 1/4 of the percentage by which government spending was cut. Applying Okun's Law (or Okun's Rule of Thumb), we can expect roughly a 1% drop in employment per 2% reduction of the GDP growth below 2.5%. It's a rough figure, but it tells us more or less what we should expect.

Govt budget cut % / 4 = -% GDP impact

Our baseline is 3%. Why? That's a typical estimate for our GDP growth for 2011. Since the stable point for unemployment is around 2.5%, we might theoretically be able to take about a 0.5% drop in GDP without adding more to the unemployment roster and reducing our payroll tax revenue (thus increasing the deficit).

Let's start with the most modest of these, Sen. Shelby's 10% (assuming he didn't really mean 30%).

10% budget cut / 4 = 2.5 % GDP impact

est. 0.5 % GDP meaning 1% added to unemployment rate

Well, that's not very pleasing. So what do we get from the others?

Rep. Backmann's 12%:

12% / 4 = 3%

est. 0% GDP meaning 1.25% added to unemployment rate

Sen. Paul's 33%:

33% / 4 = 8.25%

est. -5.25% GDP meaning 3.875% added to unemployment rate

Sen. Lee's 40%:

40% / 4 = 10%

est. -7% GDP meaning 4.75% added to unemployment rate

So just how much unemployment do they suppose we can handle? Either the answer is above, or they just don't realize that their slash and burn plans would raise unemployment. Even the most modest of them would cause unemployment to rise at this point of not particularly fast growth.

Meanwhile, each of these increases in unemployment would mean fewer people on payrolls. That means less income tax revenue. Since a drop in revenue doesn't generally cause our costs to drop, that means that assuming we went with Sen. Paul's balanced budget, we'd build ourselves a brand new deficit because of that extra almost 4% tacked onto the unemployment picture. So to use Sen. Paul's "ironclad" balanced budget rules, we'd have to make further cuts. Assuming nothing else rescued our GDP from outside, that'd mean a further drop in GPD and more unemployment. Let's not do that. Not now. Not while we don't have enough growth to afford cuts.

Austerity: just painful? Or insane?

"Tensions Rise in Greece as Austerity Measures Backfire"

A glimpse of the future? Those folks screaming for focus on deficit reduction -- massive budget cuts -- if they succeed, they may be sending us down the path that Greece is currently taking into the abyss. Austerity is dangerous, especially in a slow economy.

"In Ireland, a Picture of the High Cost of Austerity"

Ireland, Greece, ... the other side of the Atlantic is giving us plenty of dire example for what can happen when you focus on deficit reduction while your economy is running slow. In slow times, cuts may take away what little demand there is ... which means less payroll tax income ... which can mean bigger deficits. Ironic, eh?

Update 01/06/2011:

Germany has joined the club of pain and protests have started there.

UK: UK labor unions warn of surge in strikes

Italy: Italian students are protecting austerity measures. The NY Times reports, "Giuliano Amato, an economist and former Italian prime minister, was even more blunt. “By now, only a few people refuse to understand that youth protests aren’t a protest against the university reform, but against a general situation in which the older generations have eaten the future of the younger ones,” he recently told Corriere della Sera, Italy’s largest newspaper."

Spain: "New austerity measures in Spain, where the overall unemployment rate is 20 percent, the highest in the European Union, are further narrowing the employment window. Spain has pledged to raise its retirement age to 67 from 65, but incrementally over the next 20 years."

All because they're embracing austerity rather than splitting up the currency and having the struggling economies apply the medicine they really need.