Category Archives: Deficit

Tax Hikes and the 2011 Economic Collapse, Laffer

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Tax Hikes and the 2011 Economic Collapse

By Arthur Laffer

June 7 (WSJ) —People can change the volume, the location and the composition of their income, and they can do so in response to changes in government policies.

It shouldn’t surprise anyone that the nine states without an income tax are growing far faster and attracting more people than are the nine states with the highest income tax rates. People and businesses change the location of income based on incentives.

Likewise, who is gobsmacked when they are told that the two wealthiest Americans—Bill Gates and Warren Buffett—hold the bulk of their wealth in the nontaxed form of unrealized capital gains? The composition of wealth also responds to incentives. And it’s also simple enough for most people to understand that if the government taxes people who work and pays people not to work, fewer people will work. Incentives matter.

People can also change the timing of when they earn and receive their income in response to government policies. According to a 2004 U.S. Treasury report, “high income taxpayers accelerated the receipt of wages and year-end bonuses from 1993 to 1992—over $15 billion—in order to avoid the effects of the anticipated increase in the top rate from 31% to 39.6%. At the end of 1993, taxpayers shifted wages and bonuses yet again to avoid the increase in Medicare taxes that went into effect beginning 1994.”

Just remember what happened to auto sales when the cash for clunkers program ended. Or how about new housing sales when the $8,000 tax credit ended? It isn’t rocket surgery, as the Ivy League professor said.

On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. President George W. Bush’s tax cuts expire on that date, meaning that the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. Lots and lots of other changes will also occur as a result of the sunset provision in the Bush tax cuts.

Tax rates have been and will be raised on income earned from off-shore investments. Payroll taxes are already scheduled to rise in 2013 and the Alternative Minimum Tax (AMT) will be digging deeper and deeper into middle-income taxpayers. And there’s always the celebrated tax increase on Cadillac health care plans. State and local tax rates are also going up in 2011 as they did in 2010. Tax rate increases next year are everywhere.

Now, if people know tax rates will be higher next year than they are this year, what will those people do this year? They will shift production and income out of next year into this year to the extent possible. As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be.

Also, the prospect of rising prices, higher interest rates and more regulations next year will further entice demand and supply to be shifted from 2011 into 2010. In my view, this shift of income and demand is a major reason that the economy in 2010 has appeared as strong as it has. When we pass the tax boundary of Jan. 1, 2011, my best guess is that the train goes off the tracks and we get our worst nightmare of a severe “double dip” recession.

In 1981, Ronald Reagan—with bipartisan support—began the first phase in a series of tax cuts passed under the Economic Recovery Tax Act (ERTA), whereby the bulk of the tax cuts didn’t take effect until Jan. 1, 1983. Reagan’s delayed tax cuts were the mirror image of President Barack Obama’s delayed tax rate increases. For 1981 and 1982 people deferred so much economic activity that real GDP was basically flat (i.e., no growth), and the unemployment rate rose to well over 10%.

But at the tax boundary of Jan. 1, 1983 the economy took off like a rocket, with average real growth reaching 7.5% in 1983 and 5.5% in 1984. It has always amazed me how tax cuts don’t work until they take effect. Mr. Obama’s experience with deferred tax rate increases will be the reverse. The economy will collapse in 2011.

Consider corporate profits as a share of GDP. Today, corporate profits as a share of GDP are way too high given the state of the U.S. economy. These high profits reflect the shift in income into 2010 from 2011. These profits will tumble in 2011, preceded most likely by the stock market.

In 2010, without any prepayment penalties, people can cash in their Individual Retirement Accounts (IRAs), Keough deferred income accounts and 401(k) deferred income accounts. After paying their taxes, these deferred income accounts can be rolled into Roth IRAs that provide after-tax income to their owners into the future. Given what’s going to happen to tax rates, this conversion seems like a no-brainer.

The result will be a crash in tax receipts once the surge is past. If you thought deficits and unemployment have been bad lately, you ain’t seen nothing yet.

Yes, those are very strong forces, especially for the second half.

They will also cause tax collections to go up this year, reducing non gov net financial assets which means we go into next year’s slow down that much weaker financially.

The thing that can reverse it is an acceleration of borrowing to spend in the domestic private sectors. That’s usually from housing, cars, maybe cap ex, commercial construction, etc. But those traditional areas of credit growth aren’t showing any signs of being able to take up the slack, at least yet. while the employment picture is modestly improving (see Karim’s work on total hours worked) seems to me it has a long way to go before it generates robust credit growth.

And, of course, the external risks remain.

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G20 rules out fiscal expansion

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G20 Says Expansionary Fiscal Policy Not Sustainable

The G20 has dropped its support for fiscal expansion. The deficit hawks are prevailing. But why is that? We all either know or should know that operationally Federal spending is not constrained by revenues, as Chairman Bernanke stated last year, when asked on ’60 Minutes’ by Scott Pelley where the funds given to the banks came from :

“…we simply use the computer to mark up the size of the account that they have with the Fed.”

We know that when the Fed spends on behalf of the Treasury it simply credits a member bank or foreign government’s reserve account at the Fed.

We know that a US Treasury security is a credit balance in a securities account, also at the Fed.

We know that buying a Treasury security means US dollars (numbers on the Fed’s spreadsheet) shift from a Fed reserve account to a Fed securities account, which adds to the ‘national debt.’

We know that government deficits = ‘non government’ saving (net dollar financial assets) to the penny, as a matter of national income accounting.

And we know paying off the Treasury securities happens continuously when Treasury securities mature and the Fed simply shifts those US dollars from the securities account back to a Fed reserve account (including the interest).

So why should we care if US dollars are in a Fed reserve account or a Fed securities account?

We should not, yet most still do.

There are two featured sides to the argument, pro and con, deficit hawks and deficit doves. The deficit hawks aren’t the problem. They have no argument that makes any sense as a point of simple monetary operations. There is no such thing as the Federal Government running out of money, being dependent on foreigners or anyone else for funding to be able to spend, and the US is not the next Greece.

The problem is the deficit doves featured by the media don’t understand actual monetary operations and reserve accounting, and so they take the same ‘fundamentally wrong’ positions as the deficit hawks. The difference is nothing more than timing and degree. In effect, the media is showing only one side of the argument.

To be a credible media deficit dove, you agree deficits are ‘bad’ but in the long term, arguing that in the short term we need tax cuts or spending increases now, and deficit reduction later. You agree that deficits can be too high, but argue they have been higher, particularly in World War II, so current levels should be easily manageable, further agreeing there is a level that could not be manageable. You agree markets could be ‘unfriendly’ and a lack of confidence could translate into far higher interest rates, but argue that the current low rates for Treasury securities are the markets telling us that currently they do have confidence in the US and they are eager to fund current deficits. You agree that ‘bang for the buck’ matters and support tax cuts and spending increases based on higher ‘multipliers.’

The two ‘sides of the story’ are in fact on the same side, just with differing degrees. The media does not feature the true deficit dove story. Nor do any of the true doves have even a small piece of the administration’s ear, or the ear of anyone in Congress willing to speak out. There are maybe a hundred of them, including many senior economics professors. The nagging question is why this professional, highly educated, highly experienced collection of true doves, who happen to be correct and could get us back to full employment and prosperity in reasonably short order, does not get a fair hearing.

The answer may be credentials. My BA in Economics from the University of Connecticut in 1971 doesn’t cut it, nor the fact that the very large fund I managed was the highest rated firm for the time I ran it. And my net worth never getting anywhere near a billion hasn’t helped either. Seems billionaires get celebrity status and airtime for just about anything they want to say.

The same is true of the Economics professors who’ve got it right. Without being from and at the usual ‘top tier’ schools none can even get published in main stream economics journals, where submissions featuring obvious accounting realities are routinely rejected. In fact, any economist who states accounting identities and operational realities such as ‘deficits = savings’ or ‘loans create deposits’ or ‘Federal spending is not constrained by revenues’ is immediately labeled ‘heterodox’ and unworthy of serious mainstream consideration. Even the late Wynne Godley, who did have reasonable credentials as head of Cambridge Economics, and was the number one UK economics forecaster, was labeled ‘unorthodox’ because his mathematical models featured the deficits = savings accounting identity.

The breakthrough could happen at any time, in addition to economists at the ‘right schools’ or right financial sector firms, there are government officials with sufficient credentials to lead the breakthrough, including the head of the CBO and OMB, the Treasury Secretary and Fed Chairman, as well as former Fed officials, particularly from monetary operations.

Unfortunately Treasury Secretary Geithner, a potential hero due to the celebrity of his office, and the rest of the G20 are acting out the deficit hawk position, acting as if they do indeed believe the US has run out of money, is dependent on its creditors, and could be the next Greece. They speak as if they have no idea that the euro nations operate within a unique institutional structure that puts them in a ‘revenue constrained’ financial position similar to the US States, but with nothing equivalent to the US Treasury to run the countercyclical deficits for them. They speak as if they have no idea that the US, UK, Japan, and others with ‘normal’ central governments taxes function to regulate aggregate demand, and not to raise revenue per se. They act as if they don’t realize they can immediately make the fiscal adjustments- cut taxes and/or increase government spending- that will restore aggregate demand, employment, and output. In short, they act as if they were all still on the gold standard, an institutional arrangement where indeed government spending was constrained by revenues, and, as a consequence, the world witnessed repetitive, devastating deflationary depressions, far worse than what we’ve seen so far in this cycle.

The results of unnecessarily allowing a universal lack of aggregate demand to persist are already tragic, and if policy continues along the line of this weekend’s G20 results no relief is in sight, and it could all get a whole lot worse.

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7DIF and national security

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Euro May Rise to $1.60 Due to Austerity: Economist

“a group of logistics officers at the Industrial College of the Armed Forces developed a national security strategy as a class exercise. Their No. 1 recommendation for maintaining U.S. global leadership was “restore fiscal responsibility.”

Sec. of Defense Gates also got involved. All of them seriously misinformed, and think “fiscal responsibility” equals strangling a growing economy with a fixed currency supply. It’s a crisis of misinformation. Logistics training obviously doesn’t prepare one for sound systems, operations, ecology or macroeconomics analysis. You have to wonder if they’ve all adopted the “Scorched Economy” security model from Peter-the-Not-so-Great.

New Obama security strategy hardens economic resolve

“If you owe all this money you become less independent in the broader sense because you have to worry about where you are going to raise the next loan,” he said

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Our govt molding our children’s minds

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See below what our govt. is directing at our children.

Truly depressing.

All donations to my campaign are added to what I’m spending anyway to try to get the word out.

Many thanks to all of you who have already donated, no matter how small!!!
It all goes into the pot to sustain the effort.

Also many thanks to all of you who continue to try to organize meetings and speaking events for me- much appreciated!

CBO’s Director’s Blog: Letter to a Seventh Grader

A short time ago, I received an interesting letter from a young man in Michigan asking about federal budget deficits. I thought that perhaps other students would be interested in the kinds of questions he asked and how I answered him, so I’ve decided to share my letter to him with all of you. Here’s what I wrote:

1. What are the primary causes of the current federal budget deficits?

The current large deficits are the result of a combination of factors. These include an imbalance between tax revenues and the government’s spending that began before the recent economic recession and turmoil in the financial markets, sharply lower revenues and higher spending related to current economic conditions, and the budgetary costs of policies put in place by the government to respond to those conditions.

2. How will budget deficits affect people under the age of 18?

The government runs a budget deficit when it spends more on its programs and activities than it collects in taxes and other revenues. The government needs to borrow to make up the difference. When the federal government borrows large amounts of money, it pushes interest rates higher, and people and businesses generally need to pay more to borrow money for themselves. As a result, they invest less in factories, office buildings, and equipment, and people in the future—including your generation—will have less income than they otherwise would.

Also, the government needs to pay interest on the money it borrows, which means there will be less money available for other things that the government will spend money on in the future. Squeezing other spending affects different people in different ways, depending on their individual situations. For example, many young people benefit from government programs that provide money to families in need of food or medical care or to people who have lost their job, or from the financial support the federal government provides to local schools, or from the grants or loans the government offers to help pay for college education.

3. How is the U.S. government working to reduce budget deficits?

The President created a National Commission on Fiscal Responsibility and Reform to draw up plans to address the deficit problem. Most of the people on the commission are Members of Congress.

The commission will consider ways to reduce the budget deficit by 2015 as well as ways to improve the long-term budget outlook. Under current government policies, the gap between the government’s spending and revenues in coming years will be large. Therefore, balancing the budget would require significant changes in spending, taxes, or both. On CBO’s Web site, you can find information about the budget outlook during the next 10 years and over the long term.

More information about the commission can be found on its Web site: http://www.fiscalcommission.gov.

Congress also has enacted a new law (called “Pay-As-You-Go”) that typically requires legislation that increases spending or lowers tax revenues to include other measures to offset the costs of those changes.

4. What can people, and especially school-aged children, do to help curb budget deficits? The most important thing that school-aged children can do to help reduce future deficits is to study hard and acquire the best possible education. This will help you and your classmates get better jobs when you grow up, which will help the economy grow. In turn, a stronger economy will produce higher tax receipts for the government, which will lower the deficit.

When young people get jobs, they should be sure to save some of the money they earn. Through a fun and important bit of math called compounding, savings of small amounts can grow over time into significant amounts. For the economy as a whole, the more people save, the more money is available for businesses to invest in factories, office buildings, and equipment. For individuals and families, more savings provide a financial cushion in times of economic difficulty. In particular, more savings can help people pay large medical expenses or save their home in case they lose their job or become ill, thus helping them avoid needing government assistance.

People of all ages can also help to reduce the deficit by learning how the government spends money and from whom the government collects money. Understanding the current budget is essential for choosing intelligently among different ways to change programs and policies in order to reduce deficits.

5. If I am to convey one key message to my school regarding the federal budget deficit, what would it be?

The prospect of budget deficits for many years in the future is a serious problem for our country. Ultimately, people in the United States will have to bring into balance the amount of services they expect the government to provide, particularly in the form of benefits for older Americans, and the amount of taxes they are willing to send to the government to finance those services. Because it takes a long time to implement major policy changes, deciding what those changes will be is an urgent task for our citizens and for our policymakers.

Thank you for taking the time to write to us about these difficult issues.

Best wishes,

Doug Elmendorf

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latest Senatorial release

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The JOBS candidate Warren Mosler announces his
Million Dollar Challenge to Senate CANDIDATES

Middletown, Conn. (June 2, 2010) – Warren Mosler, Independent candidate for US Senate, knows for a fact that, operationally, there is no such thing as the US government running out of dollars, being dependent on foreign borrowing, or potentially facing a solvency crisis like Greece, and he has pledged $1 million of his own money to any of his Senate opponents on the ballot who can prove him wrong.

“Those concerns are due to pure fear mongering from supposed experts. They have no factual basis, and they have become the true obstacles to the return of full employment and prosperity” said Mosler, who added “and there is absolutely no financial reason to cut Social Security or Medicare benefits.”

Many have also argued that the nation’s growing debt rules out further tax reductions, but Mosler says those assertions are blatantly untrue, proposing a full payroll tax (FICA) holiday for employees and employers that will add over $300/mo to the take home pay of someone earning $50,000 a year. This plan and similar initiatives will reintroduce the capital the economy needs to prosper and grow.

“We lost over 8 million private sector jobs primarily for one reason- sales collapsed,” said Mosler. “My full payroll tax (FICA) holiday for employees and employers boosts take home pay and helps lower prices to quickly restore those lost sales which brings back the lost jobs, fixing the economy the right way, the American way, from the bottom up.”

In the midst of our social and economic calamity, with the Republican and Democratic candidates offering no viable plans to restore full employment, Mosler, an expert in monetary operations, is uniquely qualified to quickly move America back to full employment and prosperity. He knows the American economy works best when people working for a living have enough take home pay to buy the goods and services they produce, with business competing for those consumer dollars.

Mosler congratulated candidates McMahon and Blumenthal on their convention victories, and looks forward to public debate on the urgent economic issues facing our nation and the world.

“We have seen Republicans and Democrats overseeing the devastatingly tragic loss of over 8 million jobs. And while lower income people working for a living struggle to survive, elites who contributed to our problems rake in billions from bailouts,” said Mosler. “It’s time the government focuses on getting its hand out of the pocket of the hard working Americans who make this country great.”

See www.moslerforsenate.com for details of Mosler’s ‘Right on the Money’ proposals and his $1 Million Challenge.

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EU lends to itself to bail itself out – ECB remains sidelined

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“While each component makes sense in its own narrow terms, the EU policy as a whole is madness for a currency union. Stephen Lewis from Monument Securities says Europe’s leaders have forgotten the lesson of the “Gold Bloc” in the second phase of the Great Depression, when a reactionary and over-proud Continent ground itself into slump by clinging to deflationary totemism long after the circumstances had rendered this policy suicidal. We all know how it ended.”

Ambrose Evans-Pritchard

The meeting took 14 hours and produced numbers large enough and rhetoric credible enough to trigger today’s short covering that might continue at least through half of tomorrow.

But all the actual announced funding comes from the same nations that are having the funding issues. There is no external funding of consequence of national govt borrowing needs coming any source other than the euro governments, nor can there be, as the the funding needs are in euro. And the ECB, the only entity that can provide the euro zone with the needed net financial assets, remains limited to ‘liquidity’ provision which does not address the core funding issue.

Yes, the funding needs have been move evenly distributed among the national governments. But even the financially strongest member, Germany, is structurally in need of continually borrowing increasing quantities of euro to roll over existing debt and fund continuing deficits, with no foreseeable prospects of even stabilizing its debt to GDP ratio or debt to revenue ratio. Adding this new financing burden only makes matters worse, and do the austerity measures now under way in all the member nations.

The one bright spot is the ‘whatever it takes’ language that presumably includes the only move that can make it work financially- actual funding of national govt. debt by the ECB either directly or indirectly through guarantees. But there can be no assurance, of course, that it’s just another bluff to buy time, hoping for a large enough increase in net exports which would be evidence of the rest of the world deciding to reduce its euro net financial assets via the purchase of goods and services from the euro zone.

And with a meaningful increase in exports likely to happen in a meaningful way only with a much lower euro, the terms and conditions of today’s announcements introduce conflicting forces. The austerity measures work to strengthen the euro to the extent they succeed, and to weaken it to the extent they result in increased national govt debt and changes in portfolio preferences.

My best guess is that market forces will soon be testing this new package and its core weaknesses.

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Goodhart Says Greek Deal May Collapse as Crisis Tests Euro

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I like the way he puts it below:

“…if they actually cut back the deficit as fast as is being required they’re just going to go into appalling deflation.”

Goodhart Says Greek Deal May Collapse as Crisis Tests Euro

By Svenja O’Donnell and Andrea Catherwood

May 4 (Bloomberg) — Greece’s bailout “might collapse” and the nation’s debt crisis makes it “hard to see” how the euro will survive in its current form, former Bank of England policy makerCharles Goodhart said.

“If this financing deal should collapse, and it might for one reason or another, then there would be a question of what the Greeks could possibly do,” Goodhart said in an interview with Bloomberg Television in London today. “Default would be totally disastrous for them and leaving the euro would equally be disastrous.”

Euro-region ministers on May 2 agreed to a 110 billion-euro ($145 billion) bailout with the International Monetary Fund to prevent a Greek default, after investor concern sparked a rout in Portuguese and Spanish bonds last week and sent stock markets tumbling. The Greek crisis shows the need for more integration within the euro as a common currency, Goodhart said.

“It’s very hard to see how this is going survive this particular test,” he said. “The euro system has either got to have much more integration or parts of it will fall by the wayside.”

Standard & Poor’s last week cut Greece’s credit rating to the junk level of BB+, lowered Spain’s grade by one level to AA and downgraded Portugal by two steps to A-. Greece has now agreed to budget-cutting measures worth 13 percent of gross domestic product.

‘Appalling Deflation’

“If the current bailout is put in place, it will be enough to meet their immediate financing problems not only this year but for the next year or two,” Goodhart said. “The problem is that it doesn’t meet their adjustment problems. It doesn’t deal with the problem the Greeks, in part from having too large a deficit and too large a debt ratio, are very uncompetitive and if they actually cut back the deficit as fast as is being required they’re just going to go into appalling deflation.”

Greek 10-year bonds yielded 8.7 percent, about 566 basis points more than German bunds, as of 11:32 a.m. in London. That spread is down from as high as 800 basis points last week, the biggest gap since the euro’s introduction 11 years ago.

Should the deal fail, Greece “might do a kind of dual currency in which they use their scarce euros to meet their external commitments and in the meantime use an internal IOU, rather as Californian and some of the Argentinian states did, in order to meet their internal commitments” Goodhart said. “It would be a dual currency and the internal currency would fluctuate compared to the euro.”

Such an exercise would be “very messy,’ he added.

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The USA is broke and something needs to be done NOW

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Yet Another ‘Innocent Fraud’ Attack On Social Security And Medicare

The Future of Public Debt

By John Mauldin

For the rest of this letter, and probably next week as well, we are going to look at a paper from the Bank of International Settlements, often thought of as the central bankers’ central bank. This paper was written by Stephen G. Cecchetti, M. S. Mohanty, and Fabrizio Zampolli. ( http://www.bis.org/publ/work300.pdf?noframes=1)

The paper looks at fiscal policy in a number of countries and, when combined with the implications of age-related spending (public pensions and health care), determines where levels of debt in terms of GDP are going. The authors don’t mince words. They write at the beginning:

“Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable.

Solvency is never the issue with non convertible currencies/ floating exchange rates. The risk is entirely inflation, yet I’ve never seen a manuscript critical of deficit spending that seriously looks at the inflation issue apart from solvency concerns.

Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability.”

The negative consequences are always due to the moves presumed necessary to reduce deficits, not deficit spending per se.

Drastic measures is not language you typically see in an economic paper from the BIS. But the picture they paint for the 12 countries they cover is one for which drastic measures is well-warranted.

That would mean a hyper inflation scare, not solvency fear mongering.

I am going to quote extensively from the paper, as I want their words to speak for themselves, and I’ll add some color and explanation as needed. Also, all emphasis is mine.

“The politics of public debt vary by country. In some, seared by unpleasant experience, there is a culture of frugality. In others, however, profligate official spending is commonplace. In recent years, consolidation has been successful on a number of occasions. But fiscal restraint tends to deliver stable debt;

Stable public debt means stable non govt nominal savings with economies that require expanding net financial assets to support expanding credit structures and offset institutional demand leakages.

rarely does it produce substantial reductions. And, most critically, swings from deficits to surpluses have tended to come along with either falling nominal interest rates, rising real growth, or both. Today, interest rates are exceptionally low and the growth outlook for advanced economies is modest at best. This leads us to conclude that the question is when markets will start putting pressure on governments, not if.

Govts with non convertible currency/floating fx are not subject to pressure from markets with regards to funding or interest rates.

“When, in the absence of fiscal actions, will investors start demanding a much higher compensation for the risk of holding the increasingly large amounts of public debt that authorities are going to issue to finance their extravagant ways?

Investors have to take what’s offered, or exit the currency by selling it so someone else. And floating exchange rates continuously express the indifference levels

In some countries, unstable debt dynamics, in which higher debt levels lead to higher interest rates, which then lead to even higher debt levels, are already clearly on the horizon.

Only countries such as the euro zone members who are not the issuer of the euro, but users of the euro. They are analogous to us states in that regard, and are credit sensitive entities.

“It follows that the fiscal problems currently faced by industrial countries need to be tackled relatively soon and resolutely.

Agreed, except fiscal drag needs to be removed to restore private sector output and employment. They have this backwards.

Failure to do so will raise the chance of an unexpected and abrupt rise in government bond yields at medium and long maturities, which would put the nascent economic recovery at risk.

Like Japan? Triple the ‘debt’ of the US with a 1.3% 10 year note? And never a hint of missing a payment. And Japan, the US, UK, etc. all have the same institutional structure.

It will also complicate the task of central banks in controlling inflation in the immediate future and might ultimately threaten the credibility of present monetary policy arrangements.

Yes, inflation is the potential risk, which is mainly a political risk. People don’t like inflation and will topple a govt over it. But there is no economic evidence that inflation is a negative for growth and employment.

“While fiscal problems need to be tackled soon, how to do that without seriously jeopardising the incipient economic recovery is the current key challenge for fiscal authorities.”

Yes, exactly. Because they have it wrong. The fiscal problem that has to be tackled soon is that it’s too tight, as evidenced by the high rates of unemployment.

They start by dealing with the growth in fiscal (government) deficits and the growth in debt. The US has exploded from a fiscal deficit of 2.8% to 10.4% today, with only a small 1.3% reduction for 2011 projected. Debt will explode (the correct word!) from 62% of GDP to an estimated 100% of GDP by the end of 2011.

Yes, and not nearly enough, as unemployment is projected to still be over 9%, and core inflation is what is considered to be dangerously low.

Remember that Rogoff and Reinhart show that when the ratio of debt to GDP rises above 90%, there seems to be a reduction of about 1% in GDP. The authors of this paper, and others, suggest that this might come from the cost of the public debt crowding out productive private investment.

Can be true for fixed exchange rate regimes/convertible currency, but not true for today’s non convertible currency and floating fx regimes. And today, deficits generally rise due to slowdowns that drive up transfer payments and cut revenues ‘automatically’ (automatic stabilizers) so it’s no mystery that rising deficits are associated with slowing economies, but the causation is the reverse RR imply.

Think about that for a moment. We are on an almost certain path to a debt level of 100% of GDP in less than two years. If trend growth has been a yearly rise of 3.5% in GDP, then we are reducing that growth to 2.5% at best. And 2.5% trend GDP growth will NOT get us back to full employment. We are locking in high unemployment for a very long time, and just when some one million people will soon be falling off the extended unemployment compensation rolls.

Nothing that a sufficient tax cut won’t cure. There is a screaming shortage of aggregate demand that’s easily restored by a simple fiscal adjustment- tax cut and/or spending increase.

Government transfer payments of some type now make up more than 20% of all household income. That is set up to fall rather significantly over the year ahead unless unemployment payments are extended beyond the current 99 weeks. There seems to be little desire in Congress for such a measure. That will be a significant headwind to consumer spending.

Yes, backwards policy. They need to work to restore demand, not reduce it.

My first proposal is for a full payroll tax (fica) holiday, for example.

Government debt-to-GDP for Britain will double from 47% in 2007 to 94% in 2011 and rise 10% a year unless serious fiscal measures are taken.

Or unless the economy rebounds. In that case the deficit comes down and the danger is they let it fall too far as happens with every cycle.

Greece’s level will swell from 104% to 130%,

Yes, and they are credit sensitive like the US states.
This is ponzi.
Ponzi is when you must borrow to pay maturing debt

The US, UK, Japan, etc. Have no borrowing imperative to pay debt, the way Greece does.
They make all payments the same way- they just mark up numbers on their computers at their own central banks:

(SCOTT PELLEY) Is that tax money that the Fed is spending?
(CHAIRMAN BERNANKE) It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

Bernanke didn’t call china to beg for a loan or check with the IRS to see if they could bring in some quick cash. He just changed numbers up with his computer.

so the US and Britain are working hard to catch up to Greece, a dubious race indeed.

Confused!

Spain is set to rise from 42% to 74% and “only” 5% a year thereafter; but their economy is in recession, so GDP is shrinking and unemployment is 20%. Portugal? 71% to 97% in the next two years, and there is almost no way Portugal can grow its way out of its problems.

Yes, they are in Ponzi

Japan will end 2011 with a debt ratio of 204% and growing by 9% a year. They are taking almost all the savings of the country into government bonds, crowding out productive private capital.

Nothing is crowded out with non convertible currency and floating fx. Banks have no shortage of yen lending power. The yen the govt net spends can be thought of as the yen that buy the jgb’s (japan govt bonds)

Reinhart and Rogoff, with whom you should by now be familiar, note that three years after a typical banking crisis the absolute level of public debt is 86% higher, but in many cases of severe crisis the debt could grow by as much as 300%. Ireland has more than tripled its debt in just five years.

Ireland is in Ponzi as they are users of the euro.

The BIS continues:

“We doubt that the current crisis will be typical in its impact on deficits and debt. The reason is that, in many countries, employment and growth are unlikely to return to their pre-crisis levels in the foreseeable future. As a result, unemployment and other benefits will need to be paid for several years, and high levels of public investment might also have to be maintained.

“The permanent loss of potential output caused by the crisis also means that government revenues may have to be permanently lower in many countries. Between 2007 and 2009, the ratio of government revenue to GDP fell by 2-4 percentage points in Ireland, Spain, the United States and the United Kingdom.

Again, failure to recognize the critical differences between issuers and users of the currency.

It is difficult to know how much of this will be reversed as the recovery progresses. Experience tells us that the longer households and firms are unemployed and underemployed, as well as the longer they are cut off from credit markets, the bigger the shadow economy becomes.”

Yes, responsible fiscal policy would not have let demand fall this far. The US should have had a full payroll tax holiday no later than sept 08, and most of the damage to the real economy would have been avoided.

We are going to skip a few sections and jump to the heart of their debt projections. Again, I am going to quote extensively, and my comments will be in brackets [].Note that these graphs are in color and are easier to read in color (but not too difficult if you are printing it out). Also, I usually summarize, but this is important. I want you to get the full impact. Then I will make some closing observations.

The Future Public Debt Trajectory

“We now turn to a set of 30-year projections for the path of the debt/GDP ratio in a dozen major industrial economies (Austria, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Portugal, Spain, the United Kingdom and the United States). We choose a 30-year horizon with a view to capturing the large unfunded liabilities stemming from future age-related expenditure without making overly strong assumptions about the future path of fiscal policy (which is unlikely to be constant). In our baseline case, we assume that government total revenue and non-age-related primary spending remain a constant percentage of GDP at the 2011 level as projected by the OECD. Using the CBO and European Commission projections for age-related spending, we then proceed to generate a path for total primary government spending and the primary balance over the next 30 years. Throughout the projection period, the real interest rate that determines the cost of funding is assumed to remain constant at its 1998-2007 average, and potential real GDP growth is set to the OECD-estimated post-crisis rate.

[That makes these estimates quite conservative, as growth-rate estimates by the OECD are well on the optimistic side.]

Yes, future liabilities are always quoted in isolation from future demand leakages including growth of reserves in pension funds, insurance companies, corps, foreign govts, etc.

And they are always used to imply solvency issues. No actual calculations are ever done regarding inflation.

Debt Projections

“From this exercise, we are able to come to a number of conclusions. First, in our baseline scenario, conventionally computed deficits will rise precipitously. Unless the stance of fiscal policy changes, or age-related spending is cut, by 2020 the primary deficit/GDP ratio will rise to 13% in Ireland; 8-10% in Japan, Spain, the United Kingdom and the United States; [Wow!] and 3-7% in Austria, Germany, Greece, the Netherlands and Portugal. Only in Italy do these policy settings keep the primary deficits relatively well contained – a consequence of the fact that the country entered the crisis with a nearly balanced budget and did not implement any real stimulus over the past several years.

Yes, this is big trouble for the solvency of the euro zone members, but not the rest.

“But the main point of this exercise is the impact that this will have on debt. The results plotted as the red line in Graph 4 [below] show that, in the baseline scenario, debt/GDP ratios rise rapidly in the next decade, exceeding 300% of GDP in Japan; 200% in the United Kingdom; and 150% in Belgium, France, Ireland, Greece, Italy and the United States. And, as is clear from the slope of the line, without a change in policy, the path is unstable. This is confirmed by the projected interest rate paths, again in our baseline scenario. Graph 5 [below] shows the fraction absorbed by interest payments in each of these countries.From around 5% today, these numbers rise to over 10% in all cases, and as high as 27% in the United Kingdom.

“Seeing that the status quo is untenable, countries are embarking on fiscal consolidation plans. In the United States, the aim is to bring the total federal budget deficit down from 11% to 4% of GDP by 2015. In the United Kingdom, the consolidation plan envisages reducing budget deficits by 1.3 percentage points of GDP each year from 2010 to 2013 (see eg OECD (2009a)).

Why would anyone who understood actual monetary operations want to increase fiscal drag with elevated unemployment and excess capacity .

“To examine the long-run implications of a gradual fiscal adjustment similar to the ones being proposed, we project the debt ratio assuming that the primary balance improves by 1 percentage point of GDP in each year for five years starting in 2012. The results are presented as the green line in Graph 4. Although such an adjustment path would slow the rate of debt accumulation compared with our baseline scenario, it would leave several major industrial economies with substantial debt ratios in the next decade.

“This suggests that consolidations along the lines currently being discussed will not be sufficient to ensure that debt levels remain within reasonable bounds over the next several decades.

“An alternative to traditional spending cuts and revenue increases is to change the promises that are as yet unmet. Here, that means embarking on the politically treacherous task of cutting future age-related liabilities.

Here we go- this is too often the ‘hidden agenda’

It’s all about cutting social security and medicare.

Who would have thought!!!

Yes, the euro zone’s institutional arrangements that make member govt spending revenue constrained have it on the road to collapse, maybe very soon, and for reasons other than long term liabilities.

The rest of the world doesn’t have that issue, as govt spending is not revenue constrained, and the risk to prosperity is acting as if we all have the same revenue constraints as the euro zone.

With this possibility in mind, we construct a third scenario that combines gradual fiscal improvement with a freezing of age-related spending-to-GDP at the projected level for 2011. The blue line in Graph 4 shows the consequences of this draconian policy. Given its severity, the result is no surprise: what was a rising debt/GDP ratio reverses course and starts heading down in Austria, Germany and the Netherlands. In several others, the policy yields a significant slowdown in debt accumulation. Interestingly, in France, Ireland, the United Kingdom and the United States, even this policy is not sufficient to bring rising debt under control.

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Greece Bailout Plan Will Include Support Fund for Domestic Banks, EU Says…

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The size Greece ‘needed’ implies the others will need numbers beyond euro zone capacity, especially as the Greek deal used up euro zone capacity.

So this means Greece is the last rescue possible- the rest are on there own.

They wanted to stop the contagion, but that would have had to be done by showing they could save Greece without weakening themselves, and in a manner that shows they can help any and all.

They didn’t do that.

Instead they showed the effort necessary save Greece was so large that they don’t have the means to save anyone larger than Greece.

So now they are performing without a net.

And, as Marshall put it, the austerity measures are likely to increase rather than decrease deficits, making it all that much worse.

This euro zone problem is not going away.

From: Marshall
Sent: Sunday, May 02, 2010 8:23 PM


Well, it’s early, but euro is weakening again in early FX trading in Australia and US bonds are much stronger. Still early, but that’s very telling. And frankly, as good as the data has “looked” in the US, I don’t believe it myself. The gasoline consumption numbers in California that I saw last week were terrible and California is a good lead indicator. I started getting bullish on the equity markets (or at least less bearish) in Jan. 2009 when the California housing data started to pick up. And regardless of whether Greece is “saved”, the events of the past few weeks have been profoundly DEFLATIONARY for the entire euro zone. How can the global economy not be affected by the downturn in the second most important economic bloc in the world?


Combine that with a legal and political attack against Wall Street that gives every indication of INTENSIFYING and I think you have to say that things are definitely changing for the worst at the margin.

Hey, the data post the Bear Stearns rescue looked pretty good for a while as well until the whole foundation came tumbling down. The termites never look like their making much progress until the structure suddenly collapses.

Then again, I’m usually more bearish than Warren, so take what I say with a grain of salt.

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