For the past three weeks I’ve been discussing the economic realities the new president will face when he or she takes office next January, using the device of an “open letter to the next president.” Mostly, we’ve been dealing with the economic realities that other countries face and with how difficult the global economic climate is going to be during the next president’s first four years. I briefly outlined last week the stark reality of what will happen to the deficit and national debt in the next four years, and I offered a chart of what would happen if (as I think likely) we have a recession within four years. The deficit would immediately blow out to $1 trillion. That figure is before any stimulus and in all likelihood does not include the significant amounts that will have to be spent on unemployment reserves, etc.
Just to refresh your memory, let me reproduce the two key graphs. The first shows that entitlements, defense, and interest will consume all tax revenue by 2019. Thus, any spending beyond those three items will require the United States to borrow money and continue to grow its soon-to-be $20 trillion debt.
This second chart shows what will happen if we have a recession in 2018 and if lost tax revenue is roughly what it was during past recessions (in terms of a percentage of overall spending). The deficit would quickly rise to $1.3 trillion a year and according to current CBO projections would not fall below $1 trillion over the following 10 years. Even at low interest rates, net interest expenses become bigger than defense spending during that period. And I should point out that the chart below does not increase net interest expense in line with what will be a much larger rise in debt. If anything, the chart below understates the amount of net interest that will accrue.
Today we are going to look at what the next president might do in response to recession – and possibly even to prevent a recession. I actually think a positive path can be found, but following it will take an enormous political effort and a big shift in the current environment of noncooperation.
In trying to outline how we might proceed, I am reminded of a story about a small Baptist church in a rural area of Eastern Kentucky. The preacher decided to talk to his congregation about the evils of sin. He started out by declaring that he was against the sin of lying, the sin of adultery, the sin of theft, and the particularly pernicious sins that accompany dancing. As he was warming to his topic, he was getting a steady chorus of amens from the assembled, which of course stoked his enthusiasm.
So he decided to get to one of the real big sins on his list. He announced that he was against the sin of making and drinking moonshine. At which point five members of the congregation, including two of his deacons, stood up and started to walk out. Somewhat baffled, he asked, “Where are you gentlemen going?”
“Well, pastor,” drawled one fellow as he walked out the door, “it seems to me that you done stopped preachin’ and gone to meddlin’.”
(For my non-US readers who might be scratching their heads at this, the mountainous areas of the Southeastern US are famous for their “nonregulated” (read illegal) “moonshine” liquor production. In certain areas, the production of moonshine was widespread during prohibition and continues today. Those of us of a certain age can remember sipping such illegal contraband from fruit jars. For my French and European readers, think of your countries’ “Eau de Vie” (for my US readers, that’s “water of life,” and it’s every bit as potent as moonshine. Both can be used either as a beverage or as paint thinner. Back to the main plot.)
This letter is definitely going to fall into the category of meddlin’. I can pretty much guarantee that no matter where on the political spectrum you fall or which economic philosophical camp you pitch your tent in, the policies that I’m going to recommend to the next president will horrify you. You will think that these are unbelievably bad choices. And the irony is that in some cases I’m even going to agree with you. But hard choices are what we have come to. We have a divided nation that’s not going to be any less divided after the coming election, and no one is going to get what they want.
An Open Letter to the Next President, Part 4
Dear Mr. or Ms. Future President,
Last week we looked at what will happen to the budget deficit and national debt if we enter into a recession during your first term in office. I think you will agree that the picture looks ugly. As it happens, a whole host of economic analysts are worried about just that possibility. Their concern is summed up by this statement from Bill Gross:
The reality is this. Central bank polices consisting of QE’s and negative/artificially low interest rates must successfully reflate global economies or else. They are running out of time. To me, in the U.S. for instance, that means nominal GDP growth rates of 4–5% by 2017 – or else. They are now at 3.0%. In Euroland 2–3% – or else. In Japan 1–2% – or else. In China 5–6% – or else. Or else what? Or else markets and the capitalistic business models based upon them and priced for them will begin to go south. Capital gains and the expectations for future gains will become Giant Pandas – very rare and sort of inefficient at reproduction. I’m not saying this will happen. I’m saying that developed and emerging economies are flying at stall speed, and they’ve got to bump up nominal GDP growth rates or else.
You, as the next president, can help get GDP moving again. But let’s be clear, if we slog along in the same general direction, entrusting our national future to the same general policies we follow today, there will be a recession on your watch. If you wait until there’s a recession and then hope the Federal Reserve will do something to pull us out of a nosedive, it will already be too late. The good news is that there are policies you can enact during your first 100 days in office to radically alter the growth path of the United States. The bad news is that those policies are going to be politically difficult to effect and you are going to have to spend a great deal of the new political capital you have to do so. But it will be the most important thing you do in your first term. (If, on the other hand, you don’t act decisively, it may be your only term.)
It is not news to you that there is political gridlock in Washington. Republicans and Democrats in Congress don’t agree on the economic policies I’m going to suggest. There are entrenched ideas on both sides of the aisle about the best way forward; and, to be generous, those ideas are mutually exclusive. Your problem is that you need to balance the budget. One side wants to do it by cutting spending, and the other side wants to do it by raising taxes and spending even more. The country seems to want a great deal more healthcare but doesn’t want to actually pay for it. How can you satisfy both Republicans and Democrats while at the same time creating a few million jobs in the very short term to forestall a recession?
You are going to get Congress to compromise. That means giving each side something it wants badly enough to be willing to let the other side get something it wants and needs. Here is what I think you could do. Let me note that numerous economists and politicians will tell you that different pieces of what I am suggesting are impractical or are philosophically just plain wrong. It’s just that they won’t agree as to which pieces are the problem. Your task is to get them to compromise so that something can actually be done.
Where to Find $1 Trillion of Free Money
When there is another recession, the Federal Reserve is going to cut rates back to 0% and will likely enter into another round of aggressive quantitative easing. (Interest rates and QE are just the tools they have left in their bag.) They will do this even though their own economists don’t think quantitative easing works all that well as far as Main Street is concerned. QE is very good at propping up stock prices, but it didn’t do much for the economy and just made the rich richer, breeding a lot of resentment.