Reminders From The 1970s and 1980s: Financial Crises Happen; The Latest Wasn't Unique Or Even Rare; It Was Just A Big One

To hear some talk, one would think our Financial Crisis of 2007-08 was a bizarre event that must have been caused by exceptional circumstances. In size, it may have been somewhat unusual. It came with quite a large market bubble from private institutions going hog-wild for leveraged investments. But we don't even have to go back nearly as far as the Great Depression to find similar -- if smaller -- troubles. The market does this sort of thing quite a bit. Really, we rarely go long without such crises.

Hyman Minsky describes several in "Stabilizing an Unstable Economy", such as:

"The sharp drop in output and the explosive rise in unemployment in the third quarter of 1974 and the first quarter of 1975 were accompanied by the failure of Franklin National Bank, the troubles of the REITs, and a spate of business bankruptcies. It looked as if the economy was on the verge of a great depression; as if the sky were about to fall. But the disaster failed to occur. The combination of a massive government deficit (augmented by a tax rebate) and the lender-of-last-resort interventions contained the recession and reversed the course of the economy. 

... 

Aside from the details of who failed and the nature of the organizations involved, the 1981-82 recession conforms quite remarkably to that of 1974-75. Once again there was a sharp decline in income and output and a dramatic rise in unemployment; once again there was a massive increase in deficits (the extreme Keynesian side of Reaganomics), once again there were both quiet trauma and spectacular declines, and once again there was a spate of lender-of-last-resort interventions by the Federal Reserve. Once again, as the unemployment and bankruptcies situations were getting worse, some six months after a major lender-of-last-resort intervention there was a sharp turnaround in income and employment. Once again the sky did not fall."

The tools of deficit spending and lender-of-last-resort intervention aren't new, radical approaches. They're tried and true; they're traditional methods of kicking the economy back into gear. They've repeatedly shown success.

Unfortunately, our efforts this time were trimmed down by deficit-hawk opposition and not sufficiently scaled to achieve a serious kick start rather than just propping up the sky a bit. And now, with budget cuts, we're on track to the usual means by which recoveries have been sabotaged by fiscal conservatism.

Government As The Homeowner, Revisited: To Scrap Or To Invest?

Consider a homeowner who owes a typical mortgage on a house and makes just enough to keep up with the bills and maybe every once in a while treat the family to something nice like a dinner out or a trip to the zoo.

Does it make sense for that homeowner to sell the car he uses to get to work in order to pay down the mortgage faster?

How about if he skips paying for the annual licensing for his field of employment (required for his career) to pay down the mortgage faster?

In order to pay down that mortgage faster, does it make sense for that homeowner to stop buying food for the kids, getting reasonable check-ups and other medical attention as needed, and keeping the house warm enough that the pipes won't freeze?

Should the homeowner cut out all trips to the library for books for the kids so as to save on gas and send bigger mortgage payments? How about toys? Should the homeowner never buy a toy again until the mortgage is payed off, even if it's a just started 30 year mortgage and he has a newborn with no toys beyond a single teething ring?

Does any of that really, truly make sense?

How about investments? Should the homeowner stop contributing a modest sum to his retirement plan and an education savings plan for his kid? Even if both of those investments are expected to have a return higher than the interest on the mortgage?

And if the homeowner can reasonably expect to get significantly higher pay from investing in his career, what then? Let's imagine this homeowner could put $1,000 on his low interest home equity line and get training and certification that on average increases a certified individual's pay by $1,000 a year. Would it be more sensible, rational, and responsible for the homeowner to get this certification or to avoid taking on a little bit more debt?

Our government is this homeowner. Our debt is this manageable mortgage.

When we're at full employment -- unlike now -- there would be no certification we could expect to be a safe bet to increase our income steadily. But we're not there. Not even close.

When we're well below full employment on account of a consumer demand shortfall -- like now -- just about any additional spending we have the government do can typically be expected to add to commerce and help push us that little bit closer to full employment. That means higher revenues. And that's without even focusing it into the most useful spending, which we can and should do to get the most bang for the buck by spending on adding to infrastructure, R&D, and other investments known to build the most revenue.

It should already be an obvious choice. But unlike the homeowner, the government gets an additional win by investing that spending in increasing revenue. Since additional employment means less unemployment, medicaid, and other liabilities, the government reduces its costs by increasing its revenue. That's not just a win-win ... it's a no-brainer. It's stunningly obvious. We should be investing in raising our revenue by engaging some short term spending (preferably including long term investments in that short term spending).

Now if only the budget cutters in Congress could see that.

Jobs Versus Budget Cuts: It's One Or The Other

So many still seem to be missing this basic point:

"Right now the central challenge is to reignite the economy — getting jobs back, improving wages, and restoring growth.  

Deficit reduction moves us in the opposite direction. That’s because most consumers (whose spending is 70 percent of economic activity) are still losing ground, and businesses won’t expand and hire without more consumers." 

- Robert Reich in "The Economic Challenge Ahead: More Jobs and Growth, Not Deficit Reduction"

At least, so many among the Republican movers and shakers and apparently in the Oval Office too. Why? One can only presume that they're still taking it on faith that reducing the deficit is the most important thing ever, despite all the mountains of reason to believe otherwise.

One data point in that mountain, as Reich puts it,

"Likewise, cuts in government spending, such as occurred in the fourth quarter of 2012, cause the economy to contract — as it did in the fourth quarter."

In order to move the country in the right direction, policy needs to get the basic problem correct. So long as they figure deficit reduction via budget cutting is the order of the day, they'll continue to hurt. Everything. Including the deficit.

"For 60 years (!) the pattern has held. When unemployment drops, the deficit as a percentage of GDP drops. When unemployment rises, the deficit rises." 

- Joe Weisenthal in "There's Only One Way To Fix The Deficit — And Actually It's Totally Painless"

Sure, we could possibly have jobs despite their budget cutting. After all, we've had some recovery so far, if a rather anemic one. But that's despite their budget cutting. The whole economy -- including the debt/deficit picture -- would be better off if deficit hawks weren't hamstringing us with their fixation on budget cutting.

Why The Focus On The Debt? Why Now?

A question that needs to be asked anytime anyone rants about debt/deficit: why the focus on the debt? Why now?

Or as Krugman put it in an interview with Bill Moyers while answering who the Very Serious People are,

"People for whom this, it's axiomatic that the budget deficit is the most important problem. And that what we really, really need to do right now at a time of mass unemployment is worry about the debt to GDP ratio ten years from now. And it's a very hard thing to crack, partly because it's not actually a rational argument. You very rarely, very rarely see on the Sunday talk shows, people asking, "Why exactly are you so concerned about the deficit right now?" That's sort of a given. That's a starting point. Everybody serious understands that, except that if you ask them why exactly, they can't give you a very good answer."

We as a society need to stop accepting without question that the debt/deficit is somehow an urgent matter. Just because it's a numeric value outside of our usual realm of day-to-day household numbers does not make it a crisis.



So what about the converse? Why shouldn't we focus on the debt instead of jobs? Well, rather than duplicating what's already been said well enough by others, here's an excerpt from the Moyers-Krugman interview that answers that question:

"BILL MOYERS: We keep hearing from the right that we're here on the path to becoming Greece, and you say that that's impossible? 

PAUL KRUGMAN: Yeah. We, even if, suppose that people decided, investors decided they don't like U.S. government debt, it can't cause a funding crisis because the U.S. government prints money. It’s even hard to see how it can drive up interest rates because the Fed sets interest rates at the short end, and why exactly would the long run rates go up if you don't expect the Fed to raise rates? It could lead to a weakening of the U.S. dollar against other currencies. 

But that's actually a good thing. That would make U.S. exports more competitive. That would actually boost our economy. So it's, actually impossible to tell that story, as far as I can tell. And yet, it's not, again we're mostly not in the realm of rational discourse here. It's one of those things where people say it, they hear other people saying it. And they don't actually try to work it through. 

And it plays a big role, I'm sorry, in influencing our public discussion. Interestingly, people who actually have money on the line, that is people who are buying bonds, just keep on driving U.S. interest rates ever lower. So actual investors don't care about this stuff. But our political class does. 

BILL MOYERS: Why don't they care? 

PAUL KRUGMAN: Because first of all, because I think at some level investors understand what I'm saying. That it's very difficult to see any reason why the Fed would raise short term rates, which it controls for years to come. And in that case, long term debt even at a pretty low interest rate is a reasonable investment. Hard to see how a financial crisis actually develops against the United States, U.S. government, which is in this you know, has all the luxury of printing its own currency. 

And investments are always about compared to what, right? If you if you say, 'Well, the U.S. is a dangerous place to invest,' I don't think it is, but particularly where is the safe place that people are going to invest? You know, what is this other asset that they're going to buy? And it doesn't really exist."

Big Government in 1975 And In The Lesser Depression

Whether our current level of government is big or small, not everyone has always written about "Big Government" as if it were necessarily a bad thing. Here's Hyman Minsky from "Stabilizing an Unstable Economy", writing about the impact of Big Government towards avoiding deep depressions,

"Big Government, with its potential for automatic massive deficits, puts a high floor under an economy's potential downward spiral. Although this high floor is important in itself, it is particularly important in a world with business and household debt because corporate gross profits and household savings are essential to validate such debt.

Without the emergence of a huge government deficit in 1975, the debt-carrying capacity of business and households would have been severely compromised. Such compromising, due to an iterative, downward spiral of income and profits, led to the debt deflation and deep depressions of the past. The sectoral budget impact of Big Government that sustains business profits is precisely what makes such a cumulative interactive decline impossible."

The Lesser Depression

Impossible is a strong word, and arguably a bit overboard. Given that Minsky would say we have "Big Government" and the experience of the Lesser Depression starting in 2008, it seems rather clear that a sufficiently large financial crisis without sufficient mitigation from increased discretionary spending can indeed still create such a decline even with our size of government. However, "Big Government" certainly slows the decline. (And even an under-sized increase in discretionary spending -- one not large enough to make up for the output gap -- can still help bring about an anemic recovery ... if not the robust recovery we'd see from an appropriately scaled fiscal mitigation.) As larger government create resistance to decline, it partially stabilizes the economic system. That's likely more or less what Minsky meant in describing the beneficial impact of big government, even if he may perhaps have employed a touch of hyperbole when making that point.

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.

Fiscal Conservatism And Necessity

We're in a depression. To many, that's stating the obvious. But it seems not quite everyone realizes just yet.

GDP depressed below normal levels from 2008 through this writing

Our commerce has been significantly below capacity for several years. By the end of 2008 the quarterly output gap exceeded even the previous record (from 1982) for output gaps since 1949. We've seen the main characteristic factors of depression beyond just the raw output gap: increased unemployment, tight credit for consumers and small business, and bank failures (though many of the potential failures were averted). And as anyone familiar with Irving Fisher's work should know, we'd surely have had significant deflation from the paying down of private debts were it not for a series of Fed actions to mitigate deflationary forces.

Deficit hawks ignore the reasons for our deficits in recent years. Depressions increase short-term costs. People out of work utilize the safety net when they wouldn't otherwise. We have a severe short-term increase in costs. At the same time, depressions also reduce revenue. We bring in less tax money because fewer people are getting paid, and often smaller real wages.

There's one clear answer to get rid of deficits: get people back to work. Rev up the economy back to potential. Close the output gap. Until we do that, we'll continue to have increased costs and reduced revenues.

In our attempts to close that output gap, today's fiscal conservatives hamstring us with massive state budget cuts to avoid the temporary tax increases and/or bond issuance needed for dealing with the downturn. Their unwillingness to raise revenue means lots of layoffs, slowing down our economy while hurting the quality of services that we the people want. Many of us would willingly pay more in taxes to keep quality of service through an economic downturn. Many of us would be more than willing to pay more in taxes to keep investing in the sort of growth-spurring government measures that can get us back to expansion. But fiscal conservatives will brook no such sensibility. So instead we get slower growth and less prosperity. Like our slow recovery? Thank a fiscal conservative. Like our rising tuition costs for students? Thank a fiscal conservative. Like our broken roads increasing business costs? Thank a fiscal conservative. Like fewer research patents being licensed to domestic businesses than we'd otherwise have over the coming years? Thank a conservative.

This impact is nothing new. We had deficit hawks and credit growth hawks to thank for the recession of 1937-38 when attempts to balance the budget and tighten monetary policy put a crimp in recovery from the Great Depression. We had sharp cuts in the name of balanced budget zeal to thank for the recessions and increased unemployment under Eisenhower. Time and again, we keep having to re-learn the lesson that sharp cuts hurt even when they're earnestly meant to help.

We're long overdue to stop letting fiscal conservatives shape the narrative. We need to stop worrying about balancing the budget when we're in the midst of a downturn. When the economy's roaring at full steam, then we can afford to mess about with budget balancing. Until then, we can't afford their cuts.

One needs to already be in good shape to recover from a deep, large, sharp cut. Until we've eliminated the output gap, we need more recovery efforts ... not more cuts.

Government and Job Creation: Where Both Candidates Got It Wrong (Although One More So), Government Does Create Jobs

No binders involved in this jobs question, not even Mitt's "binders full of women" for filling state cabinet positions. In the Presidential debate last night neither of the Presidential candidates got it right on government and job creation. One, of course, was more wrong than the other ... but neither got it right.

Mr. Romney:

"Government does not create jobs. Government does not create jobs. (Chuckles.)"

 President Obama (in response to "What do you believe is the biggest misperception that the American people have about you as a man and a candidate?"):

"... a lot of this campaign, maybe over the last four years, has been devoted to this notion that I think government creates jobs, that that somehow is the answer. That's not what I believe. 

I believe that the free enterprise system is the greatest engine of prosperity the world's ever known. I believe in self-reliance and individual initiative and risk-takers being rewarded. But I also believe that everybody should have a fair shot and everybody should do their fair share and everybody should play by the same rules, because that's how our economy is grown. That's how we built the world's greatest middle class."

Given his relatively conservative budget policy and restraint -- arguably ambivalence -- on fiscal stimulus, it seems plausible that the President really doesn't get that government can create jobs. Sure, he could have just been playing to conservatives, but his actual record suggests he really meant it. He may see more of a role for government in helping free enterprise than his opponent. But that just makes him less wrong. He apparently doesn't particularly believe in fiscal stimulus as a major tool to raise actual GDP towards potential GDP, which shouldn't be surprising to all of the Keynesian economists who called for a much larger, better stimulus and who read the accounts of how we came to get what stimulus we got, mostly without the President seriously pushing for any more. Sure, it might not have been politically feasible to get more, but that was partially because the President wasn't using the bully pulpit to push hard for more. Why? Apparently because he believes the widespread conservative myth that "government does not create jobs".

Despite what the candidates appear to believe, the fact of the matter is clear. Government most certainly can create jobs when actual GDP is significantly below potential GDP. Such as now.

As Dean Baker put it in summing up a different debate, "the Baker-Rowe-DeLong-Krugman Deficit Debate",

"First, we all seem to agree that in a situation where the economy is clearly operating well below its potential, governments can run deficits to boost employment and output. I believe we all agree that in principle the government can also use these deficits to increase future output through productive investment in either physical or human capital. This would make future generations better off on net as a result of deficits today, since the economy will be larger than it would be without the deficits."

When the economy is running at capacity, deficit spending generally won't stably boost us above potential. At that point, extra government spending risks crowding out private enterprise and in some cases certainly will do so. We're not at that point. Heck, we're nowhere near that point. The economy is gradually improving, but we've got a long way to go. While we're still plugging an output gap, deficit spending most certainly can and does create jobs whereas government cuts directly reduce overall employment.

Yet deficit spending during a downturn just illustrates one of many ways that government can create jobs. Progressive tax rates combined with social safety-net programs mitigate inequality and -- by getting money to those who have more want than means to fulfill it -- increase commerce, both effective and potential. Then there's research and development, for which various estimates show it's just a matter of exactly how many dollars are added to the economy for each dollar we've spent on NASA research that we've patented and licensed out to domestic firms. The only question is the exact multiplier; it's certain that NASA spending (not to mention DARPA and others) has created some number of private enterprise jobs beyond those that would have existed without the space program.

Private enterprise certainly excels at many things and government would be the wrong choice for a number of tasks, especially producing most kinds of manufactured products from MP3s to ice cream. So please don't misconstrue this as suggesting that more government is always better; there's a limit to what government reasonably can be expected to do or should do. President Obama is correct to believe that a major part of government's role consists of working towards creating a level playing field for private enterprise. But like Mr. Romney, he's wrong to fall for the conservative delusion on government and job creation. Government most certainly can create jobs. And right now, even more than usual, we very much need government to stop cutting back and do all that it can to create jobs.

But how do we get these politicians and the general public they serve to understand that?

The "Burden of Debt" versus the Burden of a Weak Economy

Dean Baker from "Brad Delong Beats Me To Responding to Nick Rowe":

"... The burden of the debt only exists if there is reason to believe that debt is somehow displacing investment in private capital, which is certainly not true at present. 

I would probably argue the case even more strongly. In a depressed economy like we have today, there is reason to believe that the deficit, by boosting demand, is actually increasing investment, thereby making future generations wealthier. There is also the issue of human capital, that by keeping workers employed and keeping families intact, it is improving the productive capacities of the labor force in the future. 

Perhaps most importantly,it is essential that people understand that the measure of the burden of the debt in future generations is not the size of the debt, but the extent to which we believe the debt has reduced output in the future compared to a counter-factual where we did not run the debt. If the debt did not reduce the economies' future productive capabilities (or even raised them) then there is no burden of the debt. In any case, how well we are treating our children is measured first and foremost by the health and the economy and the society we pass on to them, not the amount of government debt."

(Emphasis added by me)

This is part of why it makes sense to put deficit spending into fixing the output gap. While the economy is rolling, it's rolling slower than it ought to be. If we use deficit spending to push our economy up to its potential, we pass on a more healthy economy to our children.

(For other related comments, see Mark Thoma's "Bogus Arguments about the Burden of the Debt")

And the reverse also holds. In a depressed economy, austerity should shrink what we're handing to our children. Apparently the IMF is starting to learn that lesson about Europe, though as Krugman points out, the GOP seems not to have caught on to the lesson.

Moody Broody Debt

From "Moody's threat to downgrade US debt is political, not fiscal":

"In the real world, the US doesn't even have a debt problem – net interest payments on the public debt are less than 1% of America's national income, or as low as they have been for more than 60 years. And the long-term deficit projections are a result of our healthcare system: if you substitute the healthcare costs of any other high-income country (or any country with a life expectancy as high as ours) in the US's budget, the long-term deficit turns into a surplus.
But Moody's wants us to be scared of the federal debt, so as to advance a rightwing agenda. But what they are doing is making a good case for serious reform of the ratings agencies."

Grunwald Clarifies Exactly Where Ryan Stands

Highlights from Grunwald on Ryan in "Paul Ryan and the Stimulus: A Match Designed to Make My Head Explode":

"Funny, Ryan somehow forgot to mention that he was one of those proponents. He had voted for the Bush stimulus, along with the Bush tax cuts, the Bush wars, the Bush security spending binge, the Bush prescription drug benefit, the Bush highway bill that included the Bridge to Nowhere, and the Bush bank bailout. Fiscal conservatism!"

and

"Republicans never explained how $715 billion worth of tax cuts and spending could be good public policy while $787 billion worth of tax cuts and spending was freedom-crushing socialism. In the minority, they didn’t have to. And Paul Ryan? As usual, he fell off both sides of the horse. He voted for the ideological tax-cut bill that would have increased the deficit, and the political spending bill that would have increased the deficit. And then he railed about Obama and the Democrats increasing the deficit."

Grunwald, of course, gave more detail around the above, but those're the real biting crux of it. For all of his reputation, Paul Ryan really turns out to be about nothing more than GOP partisan politics. His records shows that he's got the typical Republican history of ranting about Democrats and deficit spending out of one side of his mouth while voting for Republican budget-busting policies with the other.

Contraction Leads to Contraction. Go Figure.

Krugman on "What Greece Means": "But what Greek experience actually shows is that ... trying to eliminate deficits once you’re already in trouble is a recipe for depression. ... There is growing evidence that it is self-defeating even in purely fiscal terms ..."

The best way for a nation to pay off large debts is to invest in its future and increase revenue. We say it about businesses all the time, you have to spend money to make money. So why not apply to the gander that which we apply to the goose? Businesses have to spend money to make money. Households that want to increase their income have to spend money to make more money. While there are limits to how much one can reasonably compare a national economy to a household budget, some comparisons do hold: we can't increase our future earnings by slashing government investment in our future earnings.

Yet denying that truth remains popular among our conservatives. Krugman sums up the dangers of listening to them fairly well: "The truth is that if you want to know who is really trying to turn America into Greece ... it’s the people demanding that we emulate Greek-style austerity even though we don’t face Greek-style borrowing constraints, and thereby plunge ourselves into a Greek-style depression."

What Caused the Deficit and Who Should Pay?

James Crotty's entry in the January 2012 issue of the Cambridge Journal of Economics, "The great austerity war: what caused the US deficit crisis and who should pay to fix it?" reads like it has a bit of a chip on its shoulder ... but perhaps reasonably so. Crotty clearly cares about what he sees happening.

According to his analysis from the abstract, "our deficit crisis is the result of a shift from the New Deal-based economic model of the early postwar period to today’s neoliberal, free-market model. The new model has generated slow growth, rising inequality and rising deficits. Rising deficits in turn created demands for austerity."

The piece begins with a brief history of how we got into such a mess from the twists and turns of interaction between economics and politics. That history leads naturally into discussing the method through which the right-wing's neoliberal model works its madness.

"Since the right-wing economic model relentlessly pursues regressive tax cuts and slows the economic growth rate, it has a strong structural tendency to restrain the growth of government tax revenue. While committed to reducing government spending on the social safety net and public investment, it supports increased defence expenditure and giveaways to corporate America. However, proposals by conservative politicians to defund or privatise popular spending programmes such as Social Security and Medicare have, until recently, triggered a powerful political backlash that has made them impossible to implement. In practice, at least until now, the model restrains revenue growth more effectively than it lowers spending. This combination has made rising deficits a structural attribute of the right-wing model."

Another observation along the way that would probably surprise the "taxed enough already" crowd is that we're very lightly taxed by international standards.

"Total federal tax revenue in 2010 as a percentage of GDP was at a 60-year low (Bartlett, 2011). The fact that the USA is, by international standards, a very lightly taxed nation suggests that it would be possible to raise substantial additional tax revenue without serious economic side effects. If the USA had the same tax-to-GDP ratio as the median country in the Organization for Economic Co-Operation and Development (OECD) country in 2009, we would have had $1.4 trillion in extra revenue that year and we would not have a deficit problem at all." 

But we don't even need to go that far. Simply letting the so-called temporary tax cuts finally expire in 2012 and massively reducing troop numbers in Iraq and Afghanistan by 2015 should, according to Crotty, "cut the prospective decade-long deficit in half, reducing it to manageable proportions without gutting important government programmes."

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?

Why Business Hires, and the Deficit Isn't It

Why would you hire a new employee for your business assuming you had one? All of the answers generally come down to one root: to make the company better.

Better could be a lot of things: producing more products/services, reducing vulnerability to some risk, producing better products/services, improving public image, broadening supply resources, strengthening relationships with vendors/clients/customers, etc. They all more or less seek the same goal. You want your company to bring in more income and do so more reliably.

What's this have to do with the deficit? Nothing.

Seriously, how many businesses can you name that consider the deficit when making a hiring decision? A few financial companies may occasionally see some impact from really big deficit changes on the need to create or eliminate positions related to bond trading. That's most of the jobs that are impacted by the deficit in any real way. Ordinary businesses hire because they need more employees to cover their production or to pitch their products, with absolutely no factoring in the size of the deficit.

None the less, Republicans want us to focus on cutting the deficit despite that many of them campaigned on the idea that they would improve the job situation. So now they're trying to make people think there's a connection between what they promised and what they're trying to do.

"Cutting the federal deficit will create jobs" -- Rep. Cantor (R-VA)

That's completely and utterly divorced from any sort of reality on where we get jobs. The GOP have begun spinning elaborate stories to try to pretend there's a connection. Why is Rep. Cantor making that claim? Voters are concerned about jobs. The Republicans know that right now there's no better pitch for anything than jobs. And they wants to eliminate any govt program they can get their hands on. There's no way to get more support for their plans to ransack govt than to convince voters that it'll help what voters really care about: jobs. Unfortunately, the truth is quite the opposite. The truth is that -- during a troubled economy -- the sort of cuts the Republicans are pushing are worse than doing nothing at all.

Cutting the deficit won't give businesses more customers. Cutting govt spending takes customers away from businesses that provide goods and services to the govt. That's most businesses. Indirectly, that's all businesses. During good times, when the economy is humming along at a fast pace, a govt cutback wouldn't necessarily be a big problem. With the economy struggling to recover from the massive credit crunch and layoffs that were the finale of the Bush II administration, we can't afford so many businesses losing demand from govt purchases. The most obvious reason to hire is to handle greater demand. The most obvious reason for layoffs is because of a drop in demand. There's no more surefire way to drive ourselves back into recession -- or worse -- than massive budget cuts. That's a recipe for even higher unemployment.

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On a related note, for a decent catalog of the Republican record as far as jobs, see ""Where Are The Jobs?":The GOP's Two-Year Campaign Against Job Creation and Economic Growth"

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.

The Cost of Cuts

To break even on employment, we need around 2 or 3% growth in GDP.

"Putting this in our current context we can see that growth has to do two things. First it has to cover, or absorb, growth in the workforce due to population changes. A good rule of thumb in the US is that GDP needs to rise by about 2.5% for unemployment just to stay even with such changes." from "Sticky unemployment – Okun’s Law" by Peter Radford

Our GDP, the amount of goods and services we produce, comes from the amount that is spent on American goods and services ... the supply rises and falls to meet the demand. Of that spending (or demand), private sources (individuals and corporations) spend only a portion of the total that makes up the GDP. The government also spends, and that spending makes up a portion of the total demand for goods and services.

Supply doesn't discriminate. Supply is blind to the source. It doesn't care whether the demand comes from private or public sources. No matter what portion of the demand comes from each, supply doesn't care about anything other than the total. If the total demand rises, supply will meet it and require more workers to do so. If the total demand falls, supply will meet it and require fewer workers to do so.

Government's share of GDP has mostly risen over the years, although not in an exactly straight line. Some hate this fact; but whether you call it positive, negative, or neutral, there it is. Government's shared of GDP has been estimated at 25% (or even 43.85% by one source) for 2010. For the sake of avoiding any exaggeration of the impact of government spending cuts, let's go with that smaller 25% figure. At 1/4 of GDP, a 10% cut in government spending would mean about a 2.5 % reduction in GDP. Let's simplify the numbers so that is easy to see. Imagine if we had a total GDP of 100 million dollars and 25 million of that were from the government:

100 - (25 * 0.10) = 100 - 2.5 = 97.5

So there you have it, a 10% cut in govt spending would shrink our GDP by 2.5%. Of course, this assumes that what we're cutting is to make up for deficit spending, i.e. govt foreign borrowing. Considering that the main reason there's talk of cutting government spending in the US is to reduce foreign borrowing, that seems a safe assumption. Borrowing brings in money from outside, so a reduction in debt-based spending does not get offset inside the system. If we had a balanced budget and were cutting spending in order to lower taxes, the offset might just be shifted from public to private spending. But that's not where we are. We're looking at cuts to reduce the amount of GDP we cover by bringing in money from outside, which means we'd reduce the total spending in the system, the total demand, the total GDP.

But what does it mean to have a cut in government spending reduce our GDP? This brings us back to that minimum GDP growth of about 2.5% in order to keep employment stable. Estimates vary, but many forecasts for 2011 US GDP growth are around 3%. So if we cut our government budget by about 10%, that'd subtract 2.5% and give us a GDP growth of about 0.5%, which is roughly 2% below the level needed to sustain stable employment. That means we'd have rising unemployment. Of course, rising unemployment lowers payroll tax revenues. Dropping payroll tax revenues increase the deficit. Deficit increases make people think about cutting more from the government spending. See how this could spiral?

To balance the 2011 budget, we'd need to cut government spending by about $1.27 trillion. The total spending for 2011 at this point is estimated around $3.83 trillion. This means that we'd need to cut the budget by around 33% in order to balance revenue with spending.

Assuming the lower 25% share of GDP, thus less impact, a 33% drop in government spending strictly to avoid taking on more debt would slash 8.25% from our GDP.

100 - (25 * 0.33) = 100 - 8.25 = 91.75

Downward spiral

Pulling 8.25% from our GDP growth would leave us with a GDP growth of around -5.25 for 2011, which is a severe contraction. Remember that we need around 2.5% growth to keep unemployment stable and higher than that to see a reduction in unemployment. So with a -5.25% contraction in GDP, unemployment would go up, up, and up some more. That rising unemployment would promptly lower our revenue (and increase our costs for the unemployed) and give us a deficit again. That deficit might make people cut more, which would lower our GDP further and bring more unemployment.

"What you see is that unemployment tends to fall when growth is high, rise when it’s low or negative. You also see that growth has to be fairly fast — more than 2 percent — just to keep the unemployment rate from rising. Why? Well, productivity is rising, so that you can produce any given level of output with fewer workers; so output has to rise to keep employment from falling. And the working-age population is growing, so you need positive employment growth just to keep unemployment from rising." from "Growth and unemployment" by Paul Krugman

Bad recipe. Clearly, we can't cut our way out of this deficit. We have no choice but to find a way to grow. If we had high GDP growth (like 7%), we could to cut meaningful amounts (like maybe 10%, assuming 7% GDP growth), and still have rising employment, reducing unemployment. Rising employment would also mean more payroll tax revenues, thus lowering the deficit directly. Growth such as this is the only way to spiral upwards. During slow growth, cuts force a downward spiral.

We can't afford cuts. We have to find a way to grow.

Austerity in Modern History

"Those who cannot remember the past are condemned to repeat it" - George Santayana

On the Dylan Ratigan show, Mark Ames, founder of exiledonline.com, describes what happened in the Weimar Republic when they implemented the measures that the GOP are currently pushing in America::

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"The incoming Republican congress is promising to deliver a megadose of austerity this year and the media and financial elites are telling us we need a major dose of austerity for our own good, whether we like it or not. But what none of the dictionaries or politicians or financial experts are telling us us is that austerity's been tried before -- many times, which might make you think "Oh great, so it's been tried and it works, right?" And that's where things get a little tricky. For example, one of the most infamous austerity programs was tried out in Germany in 1930 by Chancellor Bruning, one of those fiscal responsibility buffs who was sure that the answer to Germany's economic problems was to balance the budget and strengthen the currency by slashing unemployment benefits, pensions, and wages, hiking taxes, and sticking to the gold standard. The result: unemployment exploded, riots in the streets, the collapse of democracy, and the rise of Adolf Hitler. The rest is history. But hey, at least he got that deficit under control."

(Ames also added a further example that he witnessed first hand, the total collapse of the Russian economy in the 1990s after they implemented austerity measures.)

Republicans are fond of referring to the Weimar Republic whenever they're fear-mongering about inflation and advocating the ransacking of our social safety net. What they don't mention -- perhaps cannot remember -- is that the Weimar Republic coped with its inflation and stabilized its currency. It was not their hyperinflation that caused the demise of the Republic by descent into fascism.

Not that inflation was nothing. The hyperinflation was painful. And it was used politically. But the Republic survived the inflation itself, handled the situation, and got on with life after the hyperinflation with a currency that had been mostly stable for years after the reset of 1923/1924 established the Reichsmark. They didn't just achieve stability. The prosperity of the Roaring Twenties ran beyond the United States. In the latter 1920s, Germany also boomed after the hyperinflation under the Weimar Republic.

Then the Great Depression hit, giving the Nazi party more discontent with which to work. Then Chancellor Brüning slashed and burned what remained of the German economy with austerity programs. In theory, austerity was meant to deal with the financial problems of debt and the Great Depression while avoiding a return to inflation. But it was those austerity efforts and their side effects that collapsed the Weimar Republic and the launched Germany into fascism.

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.