And thus we come to the heart of the matter with regard to my VAT proposal. If we don’t bring the budget deficit beneath the nominal growth rate of GDP (which is unlikely to go above 4% in the near future), our debt will explode during recessions; and we will ultimately face a debt crisis. Those never end well. The choices we will have at that point will be far fewer and even more stark.
Let’s wargame our situation for a few minutes. What will happen if we increase taxes and cut spending enough to get the deficit and debt under control? Getting there will take compromises along the lines of what Clinton and Gingrich did, but I truly hope we’re capable of them. With our debt as large as it is, we are going to be in a somewhat slower-growth economy; but if we get rid of enough shackles on growth and get the incentive structure right with the proper tax mix, the American entrepreneur can probably get us out of the hole we’re in without its getting too much deeper.
With the amazing new technologies that are coming along, we can probably get to a point where we can in fact grow our way out of our debt problem over the next 10 to 15 years.
What happens if we don’t? The more benign outcome is that we end up looking like Japan. We grow the debt to the point where we actually have to monetize it. Perhaps not the end of the world but certainly not the high-growth, job-creating machine we would like our economy to be. The income and wealth divide would deepen, and if you think there was pushback in the last election, just wait. We might see even higher taxes and a slower-growth economy; and entrepreneurs, established businesses, and investors would just have bigger headaches. Remember, that’s the best possible outcome if we don’t deal with our deficit and debt.
What happens to the value of the dollar in that scenario? Six years ago I would have confidently told you it would go down. Now, as I observe the Japanese experience (and even though I recognize a number of differences between our economies), I suspect that the dollar might rise, not fall. Or rather, it wouldn’t fall relative to the other global currencies, and not nearly as much as my hard-money friends seem to think. We would truly find ourselves in a world for which we have no historical analog.
If the country with the world’s reserve currency starts printing money merely to service its debt because people don’t buy its debt, and in a world where most other major economies are also in trouble (as I logically assume they would be), then where are we? And remember, this would be a future in which total global debt would be in the $500 trillion range and global GDP would top $100 trillion. Monetizing $1–2 trillion a year (we are talking 10+ years out) – roughly the equivalent of what Japan is doing today – might be like spitting in the ocean. Money will be far more fungible and liquid and movable in the financial-technology world that we are evolving to. It would be the height of hubris to think we can know with any degree of certainty what would happen.
Now I don’t think the failure-to-act scenario will happen, but we’re in wargame mode, so we have to think the unthinkable. Maybe the world decides it wants another reserve currency or substitutes something new. We don’t know. Lots of things are going to be possible in 10 years that we have no clue about today. In such a scenario, the dollar could in fact lose a great deal of its purchasing power. That would create a great deal of uncertainty and volatility, and I can see a global deflationary debt scenario unfolding, followed by massive monetary creation.
I guess the critical factor for me is that I can see no scenario where we don’t deal with the deficit and the debt and enjoy a positive outcome. It’s a binary choice to me. So I choose to suggest what I think is the only politically possible thing to do; and that is to restructure the tax code, balance the budget with an increase in taxation, roll back as many rules and regulations as we can, hope we get the healthcare issue right – and then see what happens.
Let me end with a story. I was on a plane going from New York to Bermuda and had been lucky enough to be upgraded to first class. It was 1998 – just a few days after the resolution of the Long-Term Capital Management crisis. The markets had seen a rather harrowing time.
The gentleman who was seated next to me ordered Scotch as soon as the wheels were up and basically indicated to the stewardess to keep them coming. You could see that he was emotionally shaken. I engaged him in conversation after a few drinks, and when he found out that I was allied with the hedge fund business and coming from New York, he assumed I knew a lot more about the world than I did. It turns out that he was the vice-chairman of one of the largest banking conglomerates of the time. We all know the name.