Image by Voetmann via FlickrI receive Gary North's Reality Check every weekday but read it only once every extreme once-in-a-while. And today was one of those once-in-a-whiles. Or, I should say, today I read Friday's "Reality Check." North said Storms on the Horizon by Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas, is the scariest speech he has ever read, and "I have been reading speeches for a living for over 40 years."
Things are worse than I had imagined, and my scenario has been bad. This dwarfs my scenario. Coming from the person who delivered it, you had better take it seriously.
I have no further comments. Click. Print. Read.
Coming from Gary North--a guy known as "Scary Gary" for his rampant pessimism and doomsday scenarios--his comments are probably a bit of hyperbole. But maybe not.
Mr. Fisher's comments, certainly, merit attention. I think North is correct: "Coming from the person who delivered [them], you had better take [them] seriously."
Fisher, speaking on May 28th this year, said,
Eight years ago, our federal budget, crafted by a Democratic president and enacted by a Republican Congress, produced a fiscal surplus of $236 billion, the first surplus in almost 40 years and the highest nominal-dollar surplus in American history. While the Fed is scrupulously nonpartisan and nonpolitical, I mention this to emphasize that the deficit/debt issue knows no party and can be solved only by both parties working together. For a brief time, with surpluses projected into the future as far as the eye could see, economists and policymakers alike began to contemplate a bucolic future in which interest payments would form an ever-declining share of federal outlays, a future where Treasury bonds and debt-ceiling legislation would become dusty relics of a long-forgotten past. The Fed even had concerns about how open market operations would be conducted in a marketplace short of Treasury debt.
That utopian scenario did not last for long. Over the next seven years, federal spending grew at a 6.2 percent nominal annual rate while receipts grew at only 3.5 percent. Of course, certain areas of government, like national defense, had to spend more in the wake of 9/11. But nondefense discretionary spending actually rose 6.4 percent annually during this timeframe, outpacing the growth in total expenditures. Deficits soon returned, reaching an expected $410 billion for 2008—a $600 billion swing from where we were just eight years ago. This $410 billion estimate, by the way, was made before the recently passed farm bill and supplemental defense appropriation and without considering a proposed patch for the Alternative Minimum Tax—all measures that will lead to a further ballooning of government deficits.
In keeping with the tradition of rosy scenarios, official budget projections suggest this deficit will be relatively short-lived. They almost always do. According to the official calculus, following a second $400-billion-plus deficit in 2009, the red ink should fall to $160 billion in 2010 and $95 billion in 2011, and then the budget swings to a $48 billion surplus in 2012.
If you do the math, however, you might be forgiven for sensing that these felicitous projections look a tad dodgy. To reach the projected 2012 surplus, outlays are assumed to rise at a 2.4 percent nominal annual rate over the next four years—less than half as fast as they rose the previous seven years. Revenue is assumed to rise at a 6.7 percent nominal annual rate over the next four years—almost double the rate of the past seven years. Using spending and revenue growth rates that have actually prevailed in recent years, the 2012 surplus quickly evaporates and becomes a deficit, potentially of several hundred billion dollars.
He goes on to outline how pessimists have usually fingered the unfunded liabilities of the Social Security system as one of the key factors we need to beware of in the not-so-distant future. But "Social Security is the lesser of our entitlement worries. It is but the tip of the unfunded liability iceberg. The much bigger concern is Medicare," he says.
The amount of money the Social Security system would need today to cover all unfunded liabilities from now on—what fiscal economists call the “infinite horizon discounted value” of what has already been promised recipients but has no funding mechanism currently in place—is $13.6 trillion, an amount slightly less than the annual gross domestic product of the United States. . . .
The infinite-horizon present discounted value of the unfunded liability for Medicare A [what covers hospital stays] is $34.4 trillion. The unfunded liability of Medicare B [which covers visits to the doctor] is an additional $34 trillion. The shortfall for Medicare D [the drug benefit that went into effect not quite three years ago, under the pressure of our current president] adds another $17.2 trillion. The total? If you wanted to cover the unfunded liability of all three programs today, you would be stuck with an $85.6 trillion bill. That is more than six times as large as the bill for Social Security. It is more than six times the annual output of the entire U.S. economy.
Add Medicare to Social Security, and, between those items alone, you have a total unfunded liability of $99.2 trillion.
Let’s say you and I and Bruce Ericson and every U.S. citizen who is alive today decided to fully address this unfunded liability through lump-sum payments from our own pocketbooks, so that all of us and all future generations could be secure in the knowledge that we and they would receive promised benefits in perpetuity. How much would we have to pay if we split the tab? Again, the math is painful. With a total population of 304 million, from infants to the elderly, the per-person payment to the federal treasury would come to $330,000. This comes to $1.3 million per family of four—over 25 times the average household’s income.
Obviously, that's not going to happen.
So what else can we do?
[A] permanent 68 percent increase in federal income tax revenue—from individual and corporate taxpayers—would suffice to fully fund our entitlement programs. Or we could instead divert 68 percent of current income-tax revenues from their intended uses to the entitlement system, which would accomplish the same thing.
Wouldn't that be great? Maybe!
Suppose we decided to tackle the issue solely on the spending side. It turns out that total discretionary spending in the federal budget, if maintained at its current share of GDP in perpetuity, is 3 percent larger than the entitlement shortfall. So all we would have to do to fully fund our nation’s entitlement programs would be to cut discretionary spending by 97 percent. But . . . discretionary spending includes defense and national security, education, the environment and many other areas, not just those controversial earmarks that make the evening news. All of them would have to be cut--almost eliminated, really--to tackle this problem through discretionary spending. . . .
[J]ust to drive an important point home, these spending cuts or tax increases would need to be made immediately and maintained in perpetuity to solve the entitlement deficit problem. Discretionary spending would have to be reduced by 97 percent not only for our generation, but for our children and their children and every generation of children to come. And similarly on the taxation side, income tax revenue would have to rise 68 percent and remain that high forever. . . .
No combination of tax hikes and spending cuts, though, will change the total burden borne by current and future generations. For the existing unfunded liabilities to be covered, . . . someone must pay $99.2 trillion. , , , This is a cold, hard fact. The decision we must make is whether to shoulder a substantial portion of that burden today or compel future generations to bear its full weight. . . .
[L]et me come back to monetary policy and the Fed.
It is only natural to cast about for a solution--any solution--to avoid the fiscal pain we know is necessary because we succumbed to complacency and put off dealing with this looming fiscal disaster. Throughout history, many nations, when confronted by sizable debts they were unable or unwilling to repay, have seized upon an apparently painless solution to this dilemma: monetization. Just have the monetary authority run cash off the printing presses until the debt is repaid, the story goes, then promise to be responsible from that point on and hope your sins will be forgiven by God and Milton Friedman and everyone else.
We know from centuries of evidence in countless economies, from ancient Rome to today’s Zimbabwe, that running the printing press to pay off today’s bills leads to much worse problems later on. The inflation that results from the flood of money into the economy turns out to be far worse than the fiscal pain those countries hoped to avoid.
So what should we do?
I found it interesting that Fisher never mentioned a "solution" that I've been scared our government will choose: attempt to extort concessions--"forgiveness of debt"--from other nations through war. How awful would that be?
Fisher concludes,
Purging rampant inflation and a debased currency requires administering a harsh medicine. . . .
Failing to face up to our responsibility will produce the mother of all financial storms. The warning signals have been flashing for years, but we find it easier to ignore them than to take action. Will we take the painful fiscal steps necessary to prevent the storm by reducing and eventually eliminating our fiscal imbalances? That depends on you.
I mean “you” literally. . . . When you berate your representatives or senators or presidents for the mess we are in, you are really berating yourself. You elect them. You are the ones who let them get away with burdening your children and grandchildren rather than yourselves with the bill for your entitlement programs. . . .
When George Shultz, one of San Francisco’s greatest Republican public servants, was director of President Nixon’s Office of Management and Budget, he became worried about the amount of money Congress was proposing to spend. After some nights of tossing and turning, he called legendary staffer Sam Cohen into his office. Cohen had a long memory of budget matters and knew every zig and zag of budget history. “Sam,” Shultz asked, “tell me something just between you and me. Is there any difference between Republicans and Democrats when it comes to spending money?” Cohen looked at him, furrowed his brow and, after thinking about it, replied, “Mr. Shultz, there is only one difference: Democrats enjoy it more.”
Yet no one, Democrat or Republican, . . . wants to see the frightful storm of unfunded long-term liabilities destroy our economy or threaten the independence and authority of our central bank or tear our currency asunder.
Of late, we have heard many complaints about the weakness of the dollar against the euro and other currencies. It was recently argued in the op-ed pages of the Financial Times that one reason for the demise of the British pound was the need to liquidate England’s international reserves to pay off the costs of the Great Wars. In the end, the pound, it was essentially argued, was sunk by the kaiser’s army and Hitler’s bombs. Right now, we--you and I--are launching fiscal bombs against ourselves. You have it in your power as the electors of our fiscal authorities to prevent this destruction. Please do so.
Are you ready to do your civic duty and say no to any candidate who is unwilling to say no to further deficit spending and who is unwilling to say yes to massive cuts in federal entitlements?
If not, who do you expect to to bring the federal deficit under control and the debt back to a level that can actually be managed? And by what means do you think the deficit is to be cut and the debt to be retired?
