How Bad is The Debt Crisis? John Mauldin
Analyzing the historical cycles and massive debt that surround us, I find myself looking for an “easy” exit. Maybe one exists, but I haven’t found it yet. I think we’re stuck. The building will have to collapse around us before we can leave.
This is obviously not a great situation. For one thing, if we don't plan properly, the building could easily collapse on us instead of around us. Our entrapment may also cause us to neglect other big problems and maybe miss important opportunities.
The sad fact is we have no easy way out of the debt situation. Worse, we are actually choosing this fate. It’s not about individual choices; none of us want the crisis that’s coming. But all the solutions require joint actions we are apparently unable to take. Which means we are, by default, choosing a path which for many will be catastrophe.
We face this not just because of government policy choices but the political process itself. It is a function of the two-party system. Our system has lost the ability to act decisively against big problems we all see coming. We are a nation of deer in the headlights.
But our system won’t stay paralyzed forever. At some point, we’ll see action because the crisis will have become impossible to ignore. Then we’ll respond. It will be a furious, poorly planned response with massive side effects that could have been avoided unless some of us begin thinking about possible solutions in advance.
Melodramatic? Hyperbole? Let's rewind the clock to 2008 when then-Treasury Secretary Hank Paulson literally got on his knees to House Speaker Nancy Pelosi, begging her to authorize the bailout for the banks. The system was getting ready to collapse. The plan was poorly thought out, but that is my point. No one really “war-gamed” the possible solutions and choices in advance. Rather, with leaders on both sides of the aisle staring into the abyss and realizing there was no bottom, they made the best choices they could in a very short time.
Now we have an approaching debt crisis we can actually think about in advance. I believe—and hope it’s not just my naive optimism—we will have some time to consider solutions. And as I have been saying for years, nobody will be happy. We have gone way past the time for relatively easy fixes. Having cut taxes and increased spending, we are running almost $2 trillion deficits annually.
As we will see below, when I suggested part of a future compromise, I got serious pushback from readers on both sides. And the irony is I understand the frustration. Viscerally. I agree that everything that I have suggested in the past few weeks and months are bad choices. But in the future, the worst choice will be doing nothing and letting the economy collapse around our ears. Some might come through it, but the vast, vast majority of us won’t.
That’s not the future I want to predict, but I see no other possibilities. I think we have a few years left but there are already mutterings of stress in the US bond markets.
Unbalanced, Imprudent, and Poorly Timed
Mathematically, balancing the budget is no great mystery. We know what to do: cut spending and/or raise revenue until the two sides match. But that’s where it all breaks down. No one wants their favorite spending programs reduced or their taxes raised.
Our decades of delay mean balancing the budget with spending cuts alone would require draconian cuts that would wreak havoc on the economy. The experts at the Committee for a Responsible Federal Budget put a pencil to this last year. They found balancing the budget by 2033 with spending cuts alone would require immediately slashing 27% of all federal outlays. That would include defense, Social Security, Medicare, veterans benefits, law enforcement, border protection—everything. Source: CRFB
That number rises quickly if you start exempting certain categories. Wall off Social Security, Medicare, defense, and veterans programs (plus interest on the debt!) and balancing the budget by 2033 would require 78% cuts to everything else the government does.
I am not here to argue everything the government does is helpful or productive. A great deal of it isn’t. Waste and fraud happen, too. But if you think such giant cuts wouldn’t cause enormous turmoil and side effects, I think you are sadly mistaken. Our entire economy is optimized to the assumption the government will always do certain things.
For example, if you think air travel is miserable now, wait until they fire 8 out of 10 TSA agents and air traffic controllers. Do you really think the air traffic would be safe in today’s environment without TSA? Yes, we could raise airline ticket fees to pay for the TSA. Maybe we should. But that’s just one small example. There are literally scores of other things we depend on the government to do effectively. Can the private sector do a lot of them? Sure. And that will almost assuredly be part of the solution. But it’s not something we can set up quickly.
What we need is a rational process of balanced, prudent, well-planned privatization, spending cuts, and tax reforms. That is nowhere on the radar right now. When the crisis comes, without some of us thinking about possible solutions, we’ll get the opposite: unbalanced, imprudent, and poorly planned.
And as bad as those changes will be, at that point they’ll be better than the alternatives. Just like 2008.
The most frustrating part is this could all have developed quite differently. As recently as 2001 the federal government had a budget surplus. Revenue was actually about $133 billion more than spending that year. There were smaller surpluses in 1999 and 2000. They resulted from a unique set of circumstances: the strong 1990s economy, low interest rates, and bipartisan tax and spending reforms. Bill Clinton and Newt Gingrich, realizing neither would get anywhere without the other, worked together and (trigger warning!) compromised to get some of what each wanted.
Alas, this brief period of sanity ended after 2001. Had it continued we might have slowly paid down the debt. Fantasy? No, not at all. CRFB issued a report last week showing what might have been. It’s long but well worth reading.
“In 2001, the Congressional Budget Office (CBO) projected that the national debt would effectively be paid off in full by the end of Fiscal Year (FY) 2009. Instead, federal debt held by the public grew from 32 percent of Gross Domestic Product (GDP) at the end of FY 2001 to 98 percent of GDP at the end of FY 2023.
“Reviewing major deficit-increasing legislation and executive actions over the past 22 years, we find that major tax cuts are responsible for 37 percentage points of debt-to-GDP, net discretionary spending increases and major Medicare expansions are responsible for 33 percentage points, and response measures to the Great Recession and the COVID-19 pandemic and recession—before accounting for economic feedback—explain 28 percentage points.
“Absent any two of these sets of policies, the debt-to-GDP ratio would be near the FY 2001 level. Absent these tax cuts, spending increases, and recession responses, debt would be fully paid off.” Source: CRFB
It’s fair to wonder what skipping the “recession responses” would have done. Certainly, some of the spending was excessive and even counterproductive. But leaving millions to fend for themselves in a crashing economy might not have worked out so well, either. Even so, simply omitting the other spending increases and tax cuts over this period would have us in a far better position now.
CRFB looked specifically at the tax and spending bills that account for the debt growth and found it was mostly bipartisan:
“Of the policies we reviewed, 77 percentage points of debt-to-GDP can be explained by legislation with some meaningful level of bipartisan support. Highly partisan Democratic actions explain 12 percentage points, and highly partisan Republican actions explain 8 percentage points. Many bipartisan actions extended policies that were originally more partisan in nature.” Source: CRFB
Let me repeat that: CRFB finds 77 percentage points of the current 98% (122%) debt/GDP ratio can be attributed to legislation that passed with strong bipartisan support. That means the politicians were probably confident their voters would like it.
All this legislation was also scored by the CBO, so representatives and senators knew (roughly) what it would do to the debt. They did it anyway.
More debt growth is coming. Eventually, as I explained in that 2011 quote above, the bond market will stop absorbing it… and then we’ll have the crisis that forces change.
Worse, there is a strong chance this debt crisis will coincide with some kind of cyclical social crisis. Neil Howe, George Friedman, Peter Turchin, and Ray Dalio (among others) have all warned us it will be bad. Add a debt crisis on top? We’d better buckle up.
We will get through it. We always do. But at what cost?
Source: John Mauldin - Mauldin Economics
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