President Obama announced a Commission to attack the deficit problem. Few will be excited by this move, and I agree.
Most people come to a discussion of debt and budget deficits with their minds made up. People love to take their own experience and use it as a model for how organizations do and should make decisions. It is the starting point for a beginning social science student. The key is to learn why organizations do not behave like the individual members.
The basic argument is that you cannot run your family budget at a deficit, so why should the Federal government be any different? That is enough to carry the day with most people.
I am going to attempt something that is difficult to do, and therefore foolish to try. I am going to do three things:
- Outline the public policy viewpoints, the way I might have done many years ago in the classroom;
- Analyze the political situation and venture a few predictions about the outcome; and finally
- Explain what this means to us as investors.
Moreover, I propose to do this without bias toward any political or policy viewpoint, and also while citing supporting evidence. I fully expect those (from all sides) who have an opinion set in concrete will accuse me of bias, so it should be a lively discussion.
The piece is also too long, too scholarly, too boring, and includes too many references. Since no one will really read the entire article, much less the excellent citations, here is the executive summary:
Obama appoints a commission in a symbolic gesture. All will shrug. We will continue to spend to stimulate the economy. Most mainstream observers think this will work in the short run. It might lead to later problems. It is all probably bullish short-term, but we need to keep a close eye on the economic indicators.
Death to Deficits
A strong anti-debt perspective comes from David Merkel. We like his approach because it is principled rather than overtly political. Merkel writes as follows:
Debt levels in an economy matter. They matter a lot. An economy that is financed primarily by debt can be like a chain of dominoes.
and...
Economies are more stable when they limit fixed claims and encourage financing via equity rather than debt. Imagine what the economy would be like if interest was not deductible from taxable income, but dividends were deductible.
Readers know that I am a fan of Merkel's work, perhaps more so when he is analyzing rather than advocating. He has an advocacy position here, but he puts the case better than other advocates.
Aggressive Partisans
Some commentators are identified with the Obama Administration. It does not mean that they are wrong, but it is something to keep in mind. Here are the observations of Robert Reich, Secretary of Labor in the Clinton Administration and regular liberal presence on talk shows:
1. Government spending needed to offset the continued reluctance of consumers and businesses to spend. You don’t have to be an orthodox Keynesian to understand that as long as the private sector is deleveraging, the public sector has to borrow and spend in order to keep the economy moving forward.
The current stimulus will peak in a few months. Add in unemployment insurance payments and outlays for the jobs bill, and the stimulus will be about $90 billion larger. But this sum is not likely to be enough to make up for the shortfall in private spending. Consider also that state and local governments are also slashing jobs and services -- and raising taxes about $350 billion over this year and next -- and Obama needs to spend more.
Just look at projected unemployment. Since the start of the recession in December 2007, the labor market has shed 8.4 million payroll jobs. Add to these the number of new jobs needed to keep up with population growth and we’re about 11 million jobs behind the pre-recession unemployment rate. To fill the 11 million jobs gap, employment would have to increase by over 400,000 jobs every month for the next three years, starting now.
Paul Krugman, via Mark Thoma:
Thus Krugman believes the United States has benefitted from the $787 billion federal stimulus package that was signed into law in February 2009... Krugman thinks the legislation helped alleviate the recession’s effects. “We would probably have 12 percent unemployment in the U.S. if we didn’t have the stimulus,” he said. Yet the seemingly long odds against additional government spending are leading Krugman to think we may well be headed for a double-dip recession — the contemporary counterpart to the slump that occurred in 1937, just as the U.S. economy was recovering from the worst of the Great Depression.
And Krugman also calls the fixation on deficits "fiscal scare tactics."
Bill Mitchell, a provocative Australian econonmist, has a strong economic viewpoint. From his perspective, many of those citing Austrian economics are "deficit terrorists." In one article he does a rather comprehensive analysis of a John Mauldin weekly letter, concluding as follows:
Anyway, what you soon realise is that the newsletter uses a common ploy among these “terrorist” types – ask a lot of pointed questions – make it sound like the sky is falling in, but don’t go into too much detail. The tactic just turns all the emotional knobs that the author knows will exploit the ignorance (in these matters) of the readers. Work on the emotional rather than reasoned and informed plane.
(I'll be happy to highlight any substantive reply from Mauldin, but there has been nothing so far.)
I searched, but it is impossible for me to do justice to the Mitchell arguments with a single quotation. Another Mitchell article offers an explanation related to another blogger:
The problem is that if I just said “governments can spend what they like” and left it at that, imagine the reception! I get it anyway, but at least thoughtful antagonists such as Kid Dynamite do feel the need to engage and delve a bit more deeply as to why an otherwise smart sounding character (senior professor, PhD, lots of high quality academic publications etc) would say something as “stupid as that”.
It is useful and zesty commentary, but prepare to spend some time there.
Classical Keynesians
Joseph Stiglitz (via Mark Thoma) attacks the "deficit fetishists":
Obama must resist 'deficit fetish', by Joseph E. Stiglitz: ...Don’t give into deficit fetishism. ... The real risk for America right now is a prolonged weak economy - something that a mindless focus on deficits can help ensure.
The deficit hawks from the banking system went on vacation from the fall of 2008 through the spring of 2009, while they demanded money be doled out freely - to themselves. But now that the public clearly won’t stand for another free lunch at its expense, the deficit hawks are back at work, more vocal than ever about the need to cut government spending.
They say it was necessary to the health of the economy to dole out money to the banks; but not necessary to the health of our society to make sure everyone has access to health care. It was not acceptable to alter the contracts of the AIG personnel, even those “key” and irreplaceable personnel who made the mistakes that led to a $180 billion bailout, but acceptable to break the social contract between America’s elderly and the rest of society, by cutting back on Social Security.
The bankers were short sighted when getting the country into the mess. But deficit fetishism is equally short sighted. ...
Barry Ritholtz takes a similar view, criticizing "recent deficit hawks as follows:
How is it that they only learned of the evils of deficits after they lose power? How very convenient.
The current group of anti-deficit spenders are pro-cyclical, rather than counter-cyclical. This means that during an expansion, they have no problem with expanding deficits, running big spending programs, giving generous tax cuts. During a recession is where they suddenly rediscover fiscal prudence.
This is ass backwards. During an economic expansion, with employment gaining and GDP growing is when you should be thinking about saving for the next rainy day. Counter-cyclical spending means that governments should watch the budget carefully during the good times, but spend spend more freely during the downturns. What we are hearing from this crowd is the exact opposite of what should be.
The Pragmatists
Bob McTeer is a conservative but also a pragmatist. He does not like excessive spending any more than you, or I, or David Merkel. The difference is all about timing.
U.S. debt is a problem, but not a crisis. If worse comes to worse, the Treasury (with the help of Congress) could prevail on the Federal Reserve to buy its debt at prices more favorable than those demanded by foreign creditors. If not sterilized, thus neutralizing the impact of the purchases on the money supply, the Fed would be monetizing the debt and a pickup in inflation would be the likely outcome. Indeed, that is what people mean when they refer to “inflating your way out of debt.”
Similar advice comes from James K. Galbraith (HT, James Altucher, now added to our featured sites). The Galbraith interview is rich with ideas on many themes -- well worth reading. For today's purposes, this is the key observation:
First of all, it’s very clear that the United States government is not constrained externally, and it’s clear that quite apart from the stimulus package, the automatic stabilizers and the financial rescue, which greatly ballooned the public debt of the United States, have had no effect on the ability of the United States government to fund itself and no effect on the interest rates that the government pays. So, it, I think, follows from that logically and straight-forwardly that we have nothing to fear from additional efforts as long as they are necessary. And they’re obviously very clearly necessary. So the question is: what should be the structure of those efforts?
Political Conclusion
Forming a Commission is a standard operating procedure when dealing with a tough question. There is widespread agreement about the deficit problem. The nature of our political system is biased toward greater spending and lower taxes. Honest observers will see that this has been true regardless of which party is in power.
I have personally been part of such Commissions at the state level, and observed them closely at the Federal level. I have a number of great stories, but you can all guess the truth. These Commissions are formed to take the political heat away from the current administration and Congress. It is an alternative method of forging a bi-partisan conclusion. Sometimes it actually shows some progress.
For now, it is the President's way of making a symbolic action, while continuing to follow the "pragmatist" course described above.
Investment Conclusion
As investors we need to start with facts. Here is the most important:
The accepted policy is to reduce deficits through economic growth, not by cutting spending or raising taxes.
If you reject Keynesian economics, you will expect the policy to fail.
Now we have the question of time frames. The Keynesian stimulus may work in the short term, but lead to future problems.
I cannot tell you what to do, but here is my plan. I am carefully following economic statistics and corporate profits. I suspect, but cannot prove, that there will be a positive impact from government policies over the next year. My crystal ball gets pretty cloudy when I look more than nine months ahead.
