Posted by: dstieglitz | July 31, 2011

WHAT’S NEXT?

     In July, my lifetime retirement savings fell nearly 5% when the stock market reacted to the debt ceiling stalemate. Leaders on both sides are as stubborn as children in their “terrible twos.” In the next election, my intention will be to put them in a corner for a permanent time-out. The world’s largest economy, struggling to recover from one self-inflicted financial disaster, is racing toward another. Unless Congress and the White House agree on spending cuts and increase the debt ceiling by August 2nd, the U.S. could default on its debts. Some freshman congressmen aren’t sure there is even a problem. They don’t remember September 29, 2008 when the market dropped 777 points after the House defeated the Troubled Asset Relief Program (TARP) – hopefully, they won’t get to be sophomores. 

     Facts of the Matter. It’s politics as usual in Washington, but with higher-than-usual stakes. The debt ceiling, now $14.3 trillion, has been raised 39 times since 1980 including three times under President Obama, the last in October 2010. The Treasury Department says it will run out of cash August 2nd unless the ceiling is raised. In reality, the debt ceiling has nothing to do with budget deficits. Congress determines tax and spending levels during the annual budget process. For them to refuse to let Treasury borrow to pay for spending that Congress itself has authorized is ludicrous. Furthermore, even $3 trillion in cuts over 10 years is just a band aid – that’s only $300 billion per year when the 2010 deficit was $1.6 trillion! 

     Political Rhetoric.  President Obama himself is an example of the rhetoric that always surrounds debt ceiling debates.  In 2006 then Senator Obama voted against George W. Bush’s request to raise the debt ceiling saying: “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. Increasing America’s debt weakens us domestically and internationally. Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren.”  Apparently, Obama has acquired new insights now that he is the president. 

     The Sky Won’t Fall. The odds of the U.S. actually defaulting are small.  Facing the deadline, Congress will find an awkward compromise (to do otherwise would be irresponsible), but don’t expect a grand solution. Instead, they will leave the core problem to be solved another day, and the economic and employment damage from their bickering will stay with us.  Even if they don’t raise the ceiling, either of two strategies could prevent the sky from falling. First, don’t be surprised if Treasury Secretary Geithner miraculously finds new ways to juggle cash flow and delay default by several days.  And second, Obama could avoid a meltdown by using the 14th Amendment which says: “the validity of the public debt of the United States…shall not be questioned” to justify ordering Treasury to pay the bills regardless of the ceiling. Republicans would howl about the president deciding which law to enforce, but the debt ceiling crisis would be over.  Unfortunately, it’s likely the U.S. will begin fiscal year 2012 on October 1st with a big debt and no budget because Congress failed to do its job – again. 

     Cyclical and Structural Deficits. The annual budget deficit is the sum of two parts: cyclical and structural.  At low points in the business cycle (like today), unemployment is high, tax revenues are down, and entitlement spending rises.  The reverse happens in cyclical peaks like the Dot-Com boom during Clinton’s presidency. By definition, cyclical surpluses during peaks entirely offset cyclical deficits in bad times.  In 2010, the U.S. government had a $1.6 trillion deficit. Economists say $900 billion of that deficit was cyclical, and $700 billion was structural.  Core spending exceeded core revenues by $700 billion even after the recession and the Stimulus Act were excluded. 

     How Did We Get Here? In 2001, just 10 years ago, the U.S. had a budget surplus of $127 billion, and the Congressional Budget Office projected a surplus of $2.3 trillion in the years 2002-2011. How did a $2.3 trillion surplus become a $10.4 trillion deficit? The New York Times attributed the $12.7 trillion swing about equally to the recession, President Bush’s policies, and policies enacted or continued by President Obama. The specific drivers were:

  •      Revenue decline during recession        $ 3.6 trillion (28%)
  •      Defense spending increases                   $ 1.9 trillion (15%)
  •      Bush tax cuts in 2001 and 2003           $ 1.7 trillion (13%)
  •      Increased interest on national debt      $ 1.4 trillion (11%)
  •      Non-Defense spending increases           $ 1.3 trillion (10%)
  •      Obama tax cuts                                        $ 1.0 trillion (8%)
  •      Obama stimulus spending                      $ 0.8 trillion (7%)
  •      Medicare Part D spending                      $ 0.3 trillion (2%)
  •      Other factors                                            $ 0.7 trillion (6%)                 

Interestingly, the TARP bailout of banks and automakers isn’t on the list since it produced a profit for the government. The ugly truth is nearly three-quarters of the representatives and senators who are bickering about the debt ceiling voted for one or more of the legislative actions that contributed to the $12.7 trillion swing. 

      Governing Through a Rearview Mirror. The U.S. is having a tough time today because Congress governs through a rearview mirror.  They debate things that have already happened (e.g., 9/11, huge windfall, or severe economic downturn) instead of using foresight to avoid such situations. Politicians are swayed by special-interest demands like the feel-good (but unrealistic) pledge not to raise taxes, and the Tea Party’s ranting about excessive spending instead of building the foundation for a strong economy. Today, congressional leaders are addressing huge deficits, high unemployment, and a moribund housing industry in ways that are likely to exacerbate the jobs deficit. What they need to do is make cuts and investments that stimulate growth and provide clear policies for education, energy and immigration. 

     Conclusion. The problem we have today isn’t too much government – it’s too much bad government! There’s no doubt that budget-cutting is tough – it forces choices no one likes. Mindless across-the-board cuts kill innovation, diminish the effectiveness of government, damage the morale of public servants, and erode citizens’ confidence. Such cuts produce a bunker mentality where spending for management reform, new technologies and training is considered a luxury.  Identifying potential savings through policy changes and process improvements is the easy part. The challenge is to generate the collaboration and creativity to transform ideas into results. Successful businesses use budget cuts as a catalyst for change. They invest to promote growth, eliminate program overlaps, share back-office services, simplify the organization, reduce energy usage, and monetize assets. It will be interesting to see how this all plays out over the next two years. Will the eventual budget agreement include investments that promote growth and cut the job deficit; or will the cuts increase unemployment, retard economic growth, and adversely affect the performance of government agencies?

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Categories

%d bloggers like this: