Several of the Fairfax newspapers ran this op ed by Laurence Kotlikoff. The linked version is superior to the local version because of the valuable IMF hyperlinks it contains. The stalling of the US recovery is no news to anyone who watches international equity markets. The bloodbath over the last few days reflects these fears but also perhaps a growing sense that doomsayers such as Kotlikoff might be right – the US is broke and, given its current economic sickneeses, there are no low pain options.
The notion that dealing with the massive public debt can occur after addressing shorter term economic weaknesses seems increasingly unrealistic.
I excerpt (the bold is mine):
“…….closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.
Such a tax hike would leave the U.S. running a surplus equal to 5% of GDP this year, rather than a 9% deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It’s also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.
Is the IMF bonkers?
No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.
‘Unofficial’ Liabilities
Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our “official” debt and our actual net indebtedness isn’t surprising. It reflects what economists call the labeling problem. Congress has been very careful over the years to label most of its liabilities “unofficial” to keep them off the books and far in the future.
For example, our Social Security FICA contributions are called taxes and our future Social Security benefits are called transfer payments. The government could equally well have labeled our contributions “loans” and called our future benefits “repayment of these loans less an old age tax,” with the old age tax making up for any difference between the benefits promised and principal plus interest on the contributions.
The fiscal gap isn’t affected by fiscal labeling. It’s the only theoretically correct measure of our long-run fiscal condition because it considers all spending, no matter how labeled, and incorporates long-term and short-term policy.
$4 Trillion Bill
How can the fiscal gap be so enormous?
Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today’s dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year.
This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.
Herb Stein, chairman of the Council of Economic Advisers under US President Richard Nixon, coined an oft-repeated phrase: “Something that can’t go on, will stop.” True enough. Uncle Sam’s Ponzi scheme will stop. But it will stop too late.
And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.
Worse Than Greece
Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.
Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run.
This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14% of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance.
Demand-siders say forgoing this year’s 14% fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue.
My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no- pain, all-gain “solutions.””
Kotlikoffs ‘unpleasant arithmetic’ is rejected by James Galbraith in this Economist article. The substance of his argument seems to be that the US can always inflate away its debt. If this occurs there will be a bout of world-wide inflation and geared-up debt holders generally will be advantaged.
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Well at least some can still laugh at it all if only hysterically-
http://www.atimes.com/atimes/Global_Economy/LH12Dj01.html
The final end game for Keynesian money printers everywhere Harry.
Rather than doubling income tax, they could instead drastically reduce their military budget.
If the USA got its health care expenditure down to the level of Australia’s – we outperform the USA on just about every health metric – that would save 5% of GDP.
If it cut its military expenditure to the level of Russia, there’s another percentage point or so.
But, yes, in the long term taxes have to rise or benefits have to be cut. It seems to me that given that the vast majority of income growth in the USA over the past few decades has gone to the top income decile (and much of that to the ultra-wealthy) they can be the ones who should be first cabs off the rank to pay more tax.
In any case, Harry, look at the numbers. Keynesian stimulus now is almost irrelevant to the long-term budget picture.
They could reduce their health care budget by allowing citizens to go to Cuba for treatment. I’m sure the USA health industry will love that!
Robert & Conrad,
Agreed anything to cut spending and taxes – this might not be health – will help longer term. The question is when will they be introduced given fears about the current state of the US economy.
“The substance of his[Galbraith's] argument seems to be that the US can always inflate away its debt.”
My take is China is moving rapidly to cut off that avenue for the Keynesian cat-burglars everywhere and in any case pushing on monetary rope appears futile at present, with little to indicate that will change. Which only leaves real taxation and expenditure. You’d have to conclude that will see the rapid demise of Pax Americana and the welfare state as America withdraws and slashes its military and the nanny state. Unprecedented demographics that drove a false belief that nearly half a nation’s income can come from financial services will now demonstrate its full force on the downside. That’s a recipe for Depression and War, the latter due to a false belief elsewhere around the globe that they could rely upon American military power for free. Those who were critical of the use of that power will now need to be careful about what they wished for as its withdrawal will create the inevitable vacuum for all sorts of less benign power brokers and old score settlers to rush in to fill. They’d be licking their lips at the thought now.
Harry, if this scenario is inevitable, or just highly likely, it should be reflected in bond rates now. It isn’t.
It is a question of the extent of this belief in this scenario. The moment the belief becomes solid equity and bond markets would collapse. It won’t be pre-announced. Kotlikoff has been a doomsayer for years and may get it wrong. Even if he does his theories and those of Roubini could trigger a speculative collapse. The bell just rang – you heard it didn’t you?
Well consider this-
“Ten-year Treasury yields dropped another 14 basis points (bps) last week to 2.68%. Yields on benchmark Fannie Mae mortgage-backed securities (MBS) sank 13 bps to a record low 3.43%.”
The US Govt hocks up its aging citizens to put a floor under their collapsing asset prices and then pays the same citizens between 2.68-3.43% to borrow it back and then plays games with hedonic inflation indexes to mask the fact its citizens are really getting zero or negative real returns back from the Govt. This is because the Govt couldn’t possibly pay any real return anyway but then neither can the real economy without investors taking very large risks which they aren’t prepared to do. With an aging population and a Govt with no inclination whatsoever to be the overt bearer of bad tidings this steady state condition can continue for a long time. Just ask the Japanese? The underlying problem with all this is really one for the young facing high tax to prop it all up and yet high asset prices as they want to take over the capital reins and house themselves. Naturally the more well to do BBers step up to the plate to bankroll their kids in that regard.
I should point out that Keensians feel emotionally that this is the best outcome for all while Austrians think it’s all somewhat irrational but it’s best to leave such nuanced judgements to randomly selected collections of 150 ordinary folk in marginal seats.
I should add that Keensians feel emotionally that this is the best outcome for all while Austrians think it’s all somewhat irrational but it’s always best to leave such nuanced judgements to randomly selected collections of 150 ordinary folk in marginal seats.
According to table 4.4 in the latest OECD Economic Outlook, the increase in total US pension, health care and long-term care spending over the next 15 years is the third lowest in the OECD – only Greece and Sweden have lower increases (but from much higher starting points).
The US social security system is sustainable with relatively small changes in parameters. Their health care system less so.
Remember those ratings agencies and a certain conflict of interest Peter? Try here-
http://www.shadowstats.com/
It’s a bit like being told our Govt are going to rollout an NBN at 1GB/sec (latest news flash), which if you do the sums equals $4777 per instal IF it comes in under the back of that beer coaster budget. You think about that for every 9 out of 10 homes and businesses, including the grandmas and grandads and public and rental housing and it just aint gunna happen unless we rapidly join PIIGSUS. And this when Victoria is rolling out smart power meters to taper power for the non-paying battlers among other things?
We’re fast going into debt with an aging population and Westpac just upped home loans by 0.25% yet not a peep out of the media on that. There are Keensians everywhere and they all wanna believe in fairies which is why the developed world is in the mess it’s in, albeit we’re the odd very lucky standout. For how long remains to be seen.
I’d liken the NBN furphy to climate change and the hockey stick. You tell a big enough fib and spruik it earnestly enough and often enough and despite the facts (like that Congressional debunking by M&M and Wegman and now the latest heavyweight statisticians weighing in to Mann’s hockey schtick) they’ll believe it. Is it the degree factories or the parents I wonder and I see I’m not perplexingly alone-
http://blogs.news.com.au/heraldsun/andrewbolt/index.php/heraldsun/comments/column_witch_way_to_madness/
Fairy dust or witches brew kiddies, take your pick.
Still not convinced about Keensian fairy dust everywhere folks? Try this for size. The financial media have been intimating for weeks that the banks need to raise interest rates to reflect the market rise in their funding costs and here’s a typical late example-
http://www.businessspectator.com.au/bs.nsf/Article/banks-election-CBA-financial-services-Westpac-ANZ–pd20100817-8E4EM?OpenDocument
At the same time our esteemed RBA Board release the minutes of their August meeting on rates. The usual pontificating and mumbo jumbo by committed Keensians (perhaps apologies to Warwick M here) to justify those salaries and get to the money quote here-
“The board therefore judged the existing level of the cash rate as still appropriate, and decided to leave it unchanged for the time being, pending further information.”
You got that? The same omniscient, unelected coven of Keensians that were busy raising interest rates just before the humdinger GFC and indeed with no compunction whatsoever about raising them unprecedentedly during the election campaign to decide if Kevin07 was to replace he who shall not be mentioned in polite company. So now we have an outer financial media reporting the banks cost of funds is getting increasingly ominous, yet this elite inner circle of eggsperts with a finger actually on the pulse with access to the figures of the whole banking sector, decides they’ll leave interest rates “unchanged for the time being, pending further information.” while Westpac raises rates before they can release their minutes and not a peep out of our budding Woodward and Bernsteins. Fairy dust or witches brew, take your pick kiddies!