Running Out of Options

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Published : October 23rd, 2009
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Category : Crisis Watch

 

 

 

 

In yesterday's post, "Declining Empire, Banana Republic, or Failed State?" the commentators I quoted cited America's profligate ways and growing dependence on borrowed money, especially from lenders based overseas, as one reason for pessimism about our current and future standing. In "Our Drunken Uncle" Investor's Business Daily adds to concerns about the destructive path our nation is on:

 

 

Spending: According to two separate Government Accountability Office scenarios, America's long-term fiscal outlook is "unsustainable." No surprise, since Uncle Sam is spending like a drunken sailor.

 

The GAO, Congress' in-house think tank, warns that in "little over 10 years, debt held by the public as a percent of GDP" will hit a record high, exceeding the debt-to-GDP ratio seen after World War II. Then it will "grow at a steady rate thereafter," according to the government forecasters.

 

"Social Security cash surpluses, which have been used to help finance other government activities, are projected to turn to cash deficits by 2016," the GAO warns.

 

The agency's fall update of its "Long-Term Fiscal Outlook" adds that "the Social Security trust fund will be exhausted in 2037, 4 years earlier than estimated last year." The Medicare trust fund's day of reckoning, meanwhile, "was also moved forward by 2 years to 2017."

 

The GAO used two simulations, an optimistic one making the assumption of historically lower-than-average nonentitlement spending and higher-than-average tax revenues, and a second model assuming that spending and revenues would keep to historical averages. But "both simulations show that the federal government is on an unsustainable fiscal path."

 

The non-optimistic simulation "shows persistent annual budget deficits in excess of 7% of GDP — levels not seen since the aftermath of World War II." Under that scenario, "roughly 92 cents of every dollar of federal revenue will be spent on the major entitlement programs and net interest costs by 2019."

 

Even if revenue remains constant at 20.2% of GDP — higher than the historical average — by 2030 there will be little room for "all other spending," which includes "national defense, homeland security, investment in highways and mass transit and alternative energy sources, plus smaller entitlement programs such as Supplemental Security Income, Temporary Assistance for Needy Families, and farm price supports."

 

It sounds like doomsday. But the politicians who run Washington are ignoring the dire warnings.

 

This week, House Speaker Nancy Pelosi is convening a gaggle of ideologically friendly economists with the aim of getting cover for yet another stimulus — even though the last one of $787 billion made no discernible dent in unemployment, which threatens to reach double digits.

 

And Sen. Ben Cardin, D-Md., appearing on Fox News Wednesday, spoke for lots of his fellow liberals in blithely proposing a brand-new, massive entitlement in the form of a government-run health scheme, claiming that "a public option helps bring down the costs."

 

Also appearing on Fox Wednesday, Sen. Judd Gregg, R-N.H., after accusing Democrats on the Senate floor of a "Bernie Madoff approach to (health care) funding," warned that when disguised funding is tallied up, the true cost of Congress' proposed government health takeover — even without the public option — is $1.8 trillion.

 

Government spending is burning our children's futures to the ground, yet our "leaders" in Washington think it's time to spray the kerosene of still more spending on the fire.

 

But it is not just those who lean to the right who are worried about the consequences of excessive spending and borrowing, ostensibly in the name of returning things to "normal." Whatever the failings of the rating agencies, which includes the fact that they enabled many of the excesses that helped create the mess we are in today, they still know a bit more than most people about evaluating creditworthiness. With that in mind, the following report from Reuters, "Reducing Deficit Key to US Rating: Moody's," suggests the fiscal train wreck now in motion is more than just a Republican talking point:

 

The United States, which posted a record deficit in the last fiscal year, may lose its Aaa-rating if it does not reduce the gap to manageable levels in the next 3-4 years, Moody's Investors Service said on Thursday.

 

The U.S. government posted a deficit of $1.417 trillion in the year ended Sept. 30 as the deep recession and a series of bank rescues cut a gaping hole in its public finances.

 

The White House has forecast deficits of more than $1 trillion through fiscal 2011.

 

"The Aaa rating of the U.S. is not guaranteed," said Steven Hess, Moody's lead analyst for the United States said in an interview with Reuters Television. "So if they don't get the deficit down in the next 3-4 years to a sustainable level, then the rating will be in jeopardy."

 

Moody's has a stable outlook on the U.S. rating, which indicates a change is not expected over the next 18 months.

 

Earlier this year, financial markets were spooked by concerns about the risk of the United States losing its top rating after Standard & Poor's revised its outlook on Britain to negative from stable, indicating the risk of a downgrade.

 

Hess said that reducing the budget deficit would be a challenge.

 

"Raising taxes is never popular and difficult politically so we have to see if the government can do that or cut expenditure," he said while adding it would be tough to reduce expenditure.

 

That said, while efforts to boost revenues won't go down well, harsh fiscal realities -- and a quick read of history -- suggest that it won't be long before the urge to raise taxes becomes overwhelming and widespread. One look at the following chart, included in a June Clusterstock post, "Look What Happens To Tax Rates When Debt And Deficits Balloon," and it's hard not to concede that Washington will be looking to garner a bigger share of what people earn to compensate for a yawning gap.

 

 

In the meantime, despite the inevitable public uproar, those who run the country will also be forced to slash spending however they can, which may be even more problematic than boosting taxes given that some of the biggest beneficiaries of government largesse (e.g., the elderly) are a political force to be reckoned with. Nonetheless, it probably won't be long before we start seeing "studies" and other such efforts like the one detailed by Britain's BBC News in "Call to End Middle Class Benefits":

 

Benefits for the middle classes should be taken away to avoid higher taxes, a centre-right think tank has suggested.

 

Reform says payments including maternity pay, child benefit, the winter fuel allowance and TV licences for the elderly could be scrapped.

 

It says the UK spends £31bn a year on such benefits, equivalent to an extra 8 pence on the basic rate of income tax.

 

In a report, it also argues that flexible savings accounts should be set up to replace pension contributions.

 

Chancellor Alistair Darling has predicted that public borrowing will reach a record £175bn next year.

 

Reform says while times are hard, the leanest welfare system focused on the most needy, is all the UK can afford.

 

It defines middle class as a household where the total income equates to £15,000 a year for each adult and £5,000 per child.

 

The message is provocative and reignites the long running debate about the scope of the state, says BBC social affairs correspondent Sue Littlemore.

 

Small print

 

In its report, The end of entitlement, Reform suggests the "middle classes are being bribed with their own tax money".

 

It says there is a political consensus for limited aspects of welfare reform but to deliver real benefits the UK needs a radical plan.

 

Reform says recent proposals by the Conservatives did "not go far enough" as they promised to keep many middle class benefits in place.

 

In his conference speech, shadow chancellor George Osborne was wrong to pledge to keep winter fuel payments, free TV licences for the over-75s and child benefit for middle class families, it says.

 

Reform argues his plan to means test child trust funds and abolish tax credits for people on an annual income of more than £50,000 would only save £700m a year.

 

At the same time, the welfare system also has to improve for the poorest, the report says.

 

Reform says rules on social enterprises and other organisations providing welfare-to-work services are too tight for them to make a real difference to the unemployed.

 

Director of Reform Andrew Haldenby said: "The middle classes need to read the small print of the welfare state."

 

"They may think that benefits and subsidised higher education are a good deal. In fact they will cost an extra 8p on the basic rate of income tax in the next Parliament because of the hole in the public finances." [Hat tip to ff.]

 

Yet even if attempts to boost revenues and cut expenses prove somewhat successful, the sheer scale of the fiscal holes now opening up, as well as the political and social costs associated with trying to fill them in, suggest that our government will ultimately have little choice but to go down the the same road that many of our similarly constrained predecessors did -- that is, inflating their way out of it.

 

Michael J. Panzner
Editor,
Financialarmageddon.com

  

Also by Michael J. Panzner

 

Michael J. Panzner is a 25-year veteran of the global stock, bond, and currency markets and the author of Financial Armageddon: Protecting Your Future from Four Impending Catastrophes, published by Kaplan Publishing.

 

 

 

 

 

 

 

 

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Michael J. Panzner is a 25-year veteran of the global stock, bond, and currency markets and the author of Financial Armageddon: Protecting Your Future from Four Impending Catastrophes, published by Kaplan Publishing.
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