If you've seen The Shining, you know what that spells backwards. It's also a pretty fair description of what Republican fiscal policies -- combined with the aftermath of the 1990s stock market bubble and the costs of our expanding imperial committments overseas -- are doing to the federal budget. But in this horror movie, the red liquid pouring down the hallway isn't blood, it's ink:
White House Acknowledges Ballooning Deficit
WASHINGTON (Reuters) - The White House said on Tuesday the federal budget deficit would balloon to a record $455 billion this fiscal year after absorbing immediate costs from the war in Iraq, and then climb $20 billion higher in 2004, a presidential election year."
That's a 50% increase since the administration's last forecast five months ago -- which, as I also said in another context recently -- isn't bad, even for government work.
But just how not bad is it? This, I'm sure you won't be surprised to learn, depends on who's doing the counting -- and how.
According to the Commerce Department, which tracks the federal budget as part of its national income and product accounts (aka the "NIPAs") the current deficit is already the largest in U.S. history -- $342 billion as of the first quarter 2003, versus a low of $325 billion in the 3rd quarter of 1992, the previous record.
(Both numbers are annualized, meaning that if the budget bled at the same rate as it did in those particular quarters, the damage over the course of a full year would equal the totals shown.)
Needless to say, Shrub and his congressional trained seals want to dress the numbers a little differently -- in something with more of a thinning effect, as it were. So they like to look at the deficit relative to the size of the U.S. economy.
There's nothing wrong with this per se; In fact I can remember the Clintonites making exactly the same argument in early 1995 -- before the Big Dog got religion on balancing the budget. And it makes sense: Absolute numbers aren't very meaningful. What matters is how big the deficit is relative the economic resources available to support the government's borrowing needs.
The problem for the Bushies is that even by this measure, America is quickly sliding back into the deep fiscal hole that it (briefly) emerged from during the Clinton years:
Even given the administration's rosy scenario for federal spending and economic growth, the deficit will pass 4% of GDP by the end of 2004. Plug in more realistic assumptions (by including, for example, the soaring costs of the war in Iraq) and it could easy pass 5%. That would be comparable to the worst levels reached under Bush I, although still a tad better than the supply-side trainwreck of the early Reagan years.
But while comparing the deficit to GDP may be a reasonable approach, it's not necessarily the best approach. When the government goes to borrow money in the bond market, it can't tap the total sum of all goods and services produced by the American economy. Most of that income is already spoken for -- people are spending it on those same goods and services.
This means that ultimately, the deficit has to be paid for out of national savings -- the money that people earn but don't spend right away. So, it might be illustrative to compare the size of the federal deficit to the pool of savings available to finance it.
The problem, as discussed in this post and this one, too, is that the United States doesn't save very much. The personal savings rate has been declining fairly steadily since the early 1980s -- and particularly since the early 1990s. So, even though the economy has grown, and grown a lot, since then, the pool of domestic savings available for the Treasury to borrow hasn't grown nearly as much.
This, in turn, means that the current budget deficit looks quite a bit worse as a percentage of gross national savings than it does as a percentage of GDP:
All told, the deficit currently is swallowing up $1.07 out of every $5 in private savings, versus a peak of $1.37 in late 1992 -- the previous record. The administration's own projections virtually guarantee a new record will be set before Bush II leaves office.
But there's one final ingredient that also should be folded into the batter: state and local government. As bad as city and state finances were in the early 1990s (and the early 1980s), they're a damn sight worse now -- in part because of reckless financial behavior, but also because the politicians in Washington have made a habit of stuffing unfunded spending mandates down the throats of politicians who are not in Washington.
State and local government have to borrow from the same pool of savings the U.S. Treasury draws on. And the economic effects of that borrowing are identical. So it makes a certain amount of sense to combine federal AND state AND local budgets to arrive at a net government deficit. And when you do that, you find America's fiscal situation already is about as bad as it has ever been -- even before that looming wave of red ink comes smashing down on our heads over the next two years:
All this still leaves us with the $64,000 question: Do these enormous deficits matter? There is a respectable case to be made that they do not -- at least in the short term. They may even help. Running big federal deficits in hard economic times is one of those "automatic stabilizers" that help keep recessions from turning into depressions. At this point, they're the main thing separating Shrub from Herbert Hoover.
But when structural deficits -- that is, those not caused by the normal ups and downs of the business cycle -- get out of control, the economic effects can be just the opposite. Bond yields can rise, choking off private investment, making an economic slump even worse. This, of course, was the source of Jim Carville's wistful comment than in his next life he wants to be reincarnated as the bond market, because then he'll be able to intimidate the hell of out of everybody.
This argument hasn't had much traction lately, as bond yields have fallen to 50-year lows even as the deficit has gone up and up and up. In part, this reflected the eagerness of foreign investors to supplement our meager pool of domestic savings with their own. It was also a credit to the Fed's ability to communicate it's gnawing fear of deflation to fixed-income investors, which for a time made even record low bond yields look not low enough.
But the combination of soaring deficits and plunging bond yields always was one of those marriages that makes friends and relatives on both sides shake their heads and say: "It'll never last."
And it hasn't. Over the past few weeks, bond prices have dived, pushing bond yields sharply higher. The deteriorating deficit outlook isn't the only, or even the main, reason for the retreat: Bond investors have been struck by the ugly thought that the long-awaited acceleration in economic growth might finally be at hand.
The jury is still very much out on that last bit. But, either way, rising bond yields aren't what a smart doctor would order for the U.S. economy right now -- unless maybe Dr. Kevorkian was writing the prescription. If growth is poised to shift into higher gear, an interest rate spike could knock it right back into first. If the recovery is a mirage, and the economy is still teetering on the brink of deflation, then an interest rate spike could be the nudge that pushes it over the edge.
In other words, this isn't a good time to be showing the bond market a deficit horror show. It's enough to make you wonder whether Bush has been taking lessons from Jack Nicholson.
Heeeeere's Georgy!
Thanks for this, Billmon, I have been waiting to see a good analysis of how the different types of deficits and savings problems will impact us in the future. There is also another bad side effect, the problem of giving tax breaks for dividends, as skimble points out.
Once again, I just gotta do the Wayne's World chant:
We are not worthy...
We are not worthy...
Billmon, ever thought of a stint at Treasury?
Except it might be a punishment for the first year or so...
it's not like the Fed and the Treasury aren't full of people who know this stuff. they even model and publish the likely economic effects. the problem is that economic policy is has been set, as in so many other policy areas, based on some combination of naked selfishness and ideological conviction.
tax cuts are good, because, you know, they lead to more things and growth and stuff. honest. what are you, a communist? besides, who cares if that's wrong when people in my bracket are going to save fifty grand next April.
with my analyst's hat on, I don't mind the basic idea of deficit spending this moment, since I think there's a good argument to be made that the US economy is running short of potential. however, I think the consensus is right that any such Keynesian stimulus should be explicitly temporary and counterbalanced by automatic countercyclical measures designed to reach a surplus during good times.
might make too much sense for the tax-cuts-for-the-wealthy-above-all crowd, though.
A Bushie friend of mine claims that surpluses and deficits are nothing more than projections, and therefore don't ultimately matter. He claims that it's ridiculous to hold the Administration accountable for numbers that ultimately mean nothing and have nothing to do with the fiscal well being of the country. I don't agree with him but I had absolutely no way to counter his argument. He's telling me the surplus/deficit numbers don't matter... do they?
Krugman repeated the standard Econ 101 view of deficits in a January column.
the relevant pull-quote is:
"There's a reason...to worry about deficits. When the government sells bonds it competes with private borrowers. By the usual rules of economics, this competition should, other things equal, drive interest rates higher and investment lower."
I could go on, but that'll give you a talking point. if you're planning on having a deeper argument, you may have to go read a little more somewhere else first.
Stark Raving - hard to argue with someone who believes the $6.4 trillion and counting National Debt is a mirage but Saddam's WMD are real even if we never find any of them.
A Bushie friend of mine claims that surpluses and deficits are nothing more than projections, and therefore don't ultimately matter.
Yep, sounds like a Bushie all right -- arrogant AND ignorant.
As I noted in the post, there is an argument to be made that deficits don't matter, or at least, don't matter right now. I think they do, but I understand the reasoning behind the contrary view.
There is NO coherent argument that says deficits don't matter because they are "only projections." If you believed that, you would also have to believe that projected earnings don't matter to the stock market, or projected inflation doesn't matter to bond investors. Go try and sell them on that idea.
There aren't too many things all economists agree on, but one of them is that future expectations are more important than current conditions. That's because current conditions are already known -- investors and businesspeople and workers and consumers have already taken them into account. Or, as the jargon goes, they've been discounted.
This means that expectations -- and more importantly, changes in expectations -- are what drive changes in economic behavior. People react and make decisions based upon the latest forecasts, including deficit forecasts.
It's funny, the GOP is supposed to be the Party of Capitalism, but it's amazing how many Republicans I meet who are completely clueless about economics. Which explains why the supply siders have thrived over there, I suppose.
A Bushie friend of mine claims that surpluses and deficits are nothing more than projections, and therefore don't ultimately matter.
The easy answer to that part is that the coming-year deficits are projections. Last year's deficit is a fact. The amount of money the government took in and spent are known.
And if he, like many Republicans, thinks Democrats in government spend too much, ask him why. If deficits don't matter, then why shouldn't government spend enough to give us everything we want? (Unlike many people here, I don't know enough economics to give more than a layman's answer to that question, but if he can't answer it, at least you won't have to listen to that old canard any more. :-)
This stuff completely befuddles me, as I suspect it does a good chunk of the electorate. Is it fair to say that these frightening numbers still don't present an accurate picture of the problem, as much of the tax cut is backloaded?
Quiddity also points to an obscure graf from the Post in which congressional aides claimthat $150 billion in Social Security taxes are being used to offset the deficit. Is this unusual?
This stuff completely befuddles me, as I suspect it does a good chunk of the electorate. Is it fair to say that these frightening numbers still don't present an accurate picture of the problem, as much of the tax cut is backloaded?
Well, for someone who is supposedly befuddled, you certainly have zeroed in on a key point. I didn't go into this in my post, but yes, the tax cuts are backloaded in a big way - in the sense that they are supposed to "expire" near the end of decade, while Shrub's budget forecasts only go out five years. So once you get into the "out" years -- 2008 and beyond -- the deficit positively explodes, IF you assume (as everybody seems to do) that the tax cuts will be made permanent.
But I was focusing on the short-term disaster, which is bad enough.
It's funny, the GOP is supposed to be the Party of Capitalism, but it's amazing how many Republicans I meet who are completely clueless about economics. Which explains why the supply siders have thrived over there, I suppose.
Well, they used to be capitalists. Your modern-day Congressional Republican is a fundamentalist Reaganite whose gospel is simple. Government is evil. All bow before the free market. The free market must be regulated by us, so that the folks who give us money benefit, that they may reward us with more money, and invite us to their clubs. Salvation is available to those who cut taxes. (Gospel of St Thomas de Lay, Chapter 7, verses 6-9)
in re: backloading, yeah, it's an issue. politically, it seems pretty clear that the initial, pre-9/11 cut was consciously designed with expiring provisions so that the GOP could stump for making them permanent in later elections. subsequent cuts, however, seems to have been backloaded solely for the purpose of hiding their true massiveness, to what political end I don't know.
in re: payroll taxes and the Social Security "trust" you need to remember that it's all an accounting illusion. a corporation can have a fully funded pension plan, but an entire economy can't, full stop, unless you think nationalization congrues with funding pensions. so, yes, payroll taxes are technically being diverted, but since the underlying structure is a fiction in the first place, it's not worth getting exercised over it.
there is an entitlement crisis coming, and the only rational answer, it seems to me, will make the right very unhappy when it comes. as I see it, the only way to afford medical and retirement benefits for the baby boomers' demographic bulge will be to convert them to pay-as-you-go welfare programs -- which I've never seen on any right-wing wishlist.
Thanks everyone for the comments. I honestly felt at a loss with this guy, since he is an economy major and I am not. Your points are all well taken, and well stated.
I honestly felt at a loss with this guy, since he is an economy major.
Where, at the Columbia School of Broadcasting? Or one of those schools that advertise on the back of matchbook covers?
The main thing to remember about Social Security and all other retirement programs is that while individuals can save and invest, society can't. All pensions are paid out of current production, whether collected by taxes like Social Security or as bond interest or stock dividends, which are essentially claims on current corporate (or government, in the case of Treasury notes) income. IMO, the Democratic leadership was sold a bill of goods by the Greenspan Commission back in 1982, raising payroll taxes in workers to "save" for the boomer retirement, which monies were then used to help finance the Reagan deficit spree.
Two measures that I think merit attention. All govt (Fed + state + local) expenditure as % of GDP, nearing historic wartime peak in 1944, and all govt debt as % of L (total liquidity, M3 plus near-money).
Bill, you always do a good job, even with public finance data. Sincere thanks for a good read.
Wolf DeVoon
Billmon said:
"...rising bond yields aren't what a smart doctor would order for the U.S. economy right now -- unless maybe Dr. Kevorkian was writing the prescription. If growth is poised to shift into higher gear, an interest rate spike could knock it right back into first."
Billmon, do you mean to say that rising bond yields will prompt a spike in the Fed's overnight rate? Is that because of an ideological disposition of the Fed to automatically kow tow to signals from the Bond market, or is there a deeper relationship between the two that I am missing? Does today's news of the Fed's commitment to low interest rates point to an ideological shift from that position toward the Keynesian approach of deliberately inducing price inflation (bonds be damned)? If that's the case, wouldn't a rising bond yield only point to the fact that expectations for immediate short term growth have prompted people to get out of the bond market and nothing more?
Let me know if I'm talking out of my ass here. The subject of economics is not my strong point, but I would really like to make an effort to get my head around it.
"IMO, the Democratic leadership was sold a bill of goods by the Greenspan Commission back in 1982, raising payroll taxes in workers to "save" for the boomer retirement, which monies were then used to help finance the Reagan deficit spree."
Well, it did shift the tax burden from those at the top of the food chain to those at the bottom. And average Joe Smoe has never figured this out.
Billmon, do you mean to say that rising bond yields will prompt a spike in the Fed's overnight rate?
My bad. I should have been clearer. I meant interest rates in the broad sense -- which includes bond yields. The Fed only controls the overnight interest rate; all the other rates are set by the market, which means when investors sell bonds and other fixed-income securities, rates go up.
If economic growth and/or inflation is accelerating, and bond investors correctly perceive this, then rising rates are a logical reaction and should do no harm. But if investors incorrectly percieve that growth and/or inflation is accelerating, when it isn't, then rising interest rates can do damage.
Something like this happened in 1994, when the Fed raised rates, investors became worried that the Fed knew something they didn't, bond yields shot higher, and it almost derailed the recovery.
Cool, thanks for the clarification. I'll have to dig deeper and try to make sense out of what happened in 1994 to see how that works I guess. Perhaps the safe thing to say is that any time a major player in the economy guesses wrong about the future, there is bound to be some fall-out.
"U.S. Treasury Secretary John Snow welcomed a call by French President Jacques Chirac for a temporary suspension of European budget-deficit limits to allow governments more room to boost economies close to recession." -- July 15 (Bloomberg)
"U.S. Treasury Secretary John Snow on Tuesday said the record budget deficit forecast by the White House was manageable, but unwelcome, and the Bush administration must do all it can to close the gap." -- July 15 (Reuters)