The Lessons of Today’s Troubling Report on GDP

The Lessons of Today’s Troubling Report on GDP

January 30, 2013

This morning’s disappointing report that GDP actually declined by 0.1 percent in the fourth quarter of last year is a lesson in how government and serendipity can shape our economic path, especially in the short-term. The basic elements of economic prosperity are in place. To begin, Americans are spending again: Personal consumption accelerated from a 1.6 percent increase in the July-August-September quarter to 2.2 percent in October-November-December. Even better, spending on durable goods — autos, appliances, and so forth — increased at nearly a 14 percent rate. That should be no surprise, since disposable personal income rose at a strong and healthy 8.1 percent rate in the fourth quarter. Firms looking to the future are spending, too: Business investment expanded more than 8 percent, and investments in equipment and software were up more than 12 percent, a rate reminiscent of near-boom times. Housing is back as well, with residential investments growing at a rate of more than 15 percent.

How does all this good news translate into a flat quarter? For one thing, our exports fell faster than our imports. One reason for that was the economic slowdown in the huge European and Japanese markets. The other was Hurricane Sandy, which disrupted shipments in and out of the huge, New York and New Jersey ports. The hurricane also disrupted inventory purchases, which slowed by two-thirds compared to the preceding quarter. But the biggest single drag on the economy was Washington: Federal spending fell 15 percent, led by defense which declined at the fastest quarterly rate, 22 percent, in 40 years. Those declines were fueled entirely by politics, especially planning for the spending sequesters threatened for January 1.

We cannot influence the weather, but we can control the impact of government on the economy. This report should remind us that the economy remains vulnerable to precipitous, additional budgetary austerity. And given the progress we’ve already made on deficits — $1.2 trillion in cuts over 10 years enacted in 2011 and $700 billion in new revenues enacted late last year — we can now proceed in a very measured way with the final stage of long-term entitlement reforms and additional revenues. And to assure everyone that grown-ups who understand the economy are in charge again in Washington, Congress should cancel the sequesters and enact a clean, long-term increase in the debt limit.

The New Nihilism in the Debate over the Debt Ceiling

January 8, 2013

For decades, fiscal conservatives have used congressional debates over raising the debt limit to vent their frustrations with big government. But no one seriously questioned the need to do so, not until a band of Tea Party uber-conservatives in 2011 resolved to use the debt limit as a bargaining chip in budget talks. They ignored the fact that raising the debt ceiling does not in any way determine future spending or taxes. It simply allows the Treasury to borrow the funds to finance spending that past Congresses and Presidents already have undertaken. Raising the debt limit, in short, is a ministerial act that grants the government the technical legal authority to maintain the full faith and credit of the United States. And since the Treasury securities that comprise that credit underpin much of the operations of the American economy, withholding that technical authority could have devastating economic effects.

To understand how and why, start with the basics. When Washington runs a deficit, the Treasury has to borrow from investors not only to fund the deficit, but also to cover the interest on the government’s existing debt and to refinance much of that debt, all on a continuing basis. A failure to raise the debt limit, as many Tea Party denizens in Congress propose, therefore could force the Treasury to default on those obligations. Sovereign debt defaults have many well-known and very unpleasant consequences. Interest rates spike, stock and bond markets fall sharply, the value of the currency declines dramatically, and the country quickly falls into a deep recession. Given those consequences, no government with sane leadership would ever default voluntarily. Rather, the only reason any country has ever found itself unable to pay the interest on its bonds or issue new government debt is that domestic and foreign investors won’t lend it the funds to do so.

If, beyond all reason, Congress effectively forces our own government to default on our national debt, the results would be particularly nasty. Trillions of dollars in U.S. Treasury securities are held by financial institutions here and abroad, so the default would quickly freeze capital markets around the world. In other words, private lending to businesses and households here and in many other nations would halt. The reserves held by many of the world’s central banks include more trillions of dollars in U.S. Treasuries, so a U.S. default also would quickly bring on a global financial crisis that could dwarf the chaos of late-2008. In fact, even if the debt-limit debate merely increases the concerns of investors that a U.S. debt default somehow might occur, their heightened apprehension could have serious effects on interest rates, the dollar, and the stock and bond markets.

Even before a technical debt default could set in, however, the government would be forced to drastically cut current federal spending. Federal borrowing today covers between 35 and 40 percent of all federal spending. If Congress prevents the Treasury from legally borrowing any more funds, the government will be forced at once to slash spending by 35 percent to 40 percent. Such truly unimaginable cuts — more than ten times those contemplated under the sequester provisions of the 2011 budget Act — would force the President to shut down many parts of the federal government, including some national security operations, and even cut income support programs for tens of millions of retired Americans. And since the President and the Treasury would determine the distribution of these cuts, failure to raise the debt ceiling would effectively shift the power of appropriations from Congress to the Executive.

Conservatives have serious and sincere differences with progressives over certain federal programs and functions. Whether Republican leaders recognize it or not, putting at risk the government’s legal authority to issue new bonds as a lever to press their policy preferences is a form of political nihilism. It easily dismisses the costs of wrecking the operations of government, because it places so little value on government itself. As such, the new political nihilism is as far from genuine conservatism, which seeks to preserve traditional political arrangements, as it is from a progressivism that uses government to reform those arrangements. Nevertheless, by vowing to block any increase in the debt limit until the administration accedes to their budget demands, congressional conservatives have embraced this new nihilism.

Nor, as some Tea Partiers would have it, should a failure to raise the debt limit be seen as a “preemptive default” intended to head off a real one. Global investors continue to lend the United States whatever funding we require — and judging by the low interest rates they accept, they are eager do so. We also are one of only two countries in the world (Denmark is the other) that places a legal limit on the debt its government can issue. So, now a handful of radical members would have the Congress refuse to raise that limit, knowing that the country will face another recession as government programs are slashed, followed by the chaos of a sovereign debt default. Republican leaders have no reasonable alternative but to join the President in rejecting such nihilism

Modest Progress on the Deficit Is Just What the U.S. Economy Needs

January 2, 2013

One argument nearly entirely absent in the debate over the fiscal cliff issues is the effect on the economy. True, some diehard conservatives warn that without drastic steps to privatize part of Social Security and much of Medicare, our national debt will soon make us pariahs in global capital markets, on the Greek model. But there was never any economic evidence or reasoning behind their feverish scenario. In fact, throughout our long fiscal debate, worldwide investors have been eager to lend the Treasury virtually unlimited funds in 10-year tranches and accept annual yields of less than 2 percent.

Based on that, some diehard liberals insist that we do not have to cut spending at all, especially when there are plenty of well-heeled Americans around who can afford to pay higher income taxes. Their position ignores economic history — namely, that whenever our deficits have climbed and the national debt has threatened to soar, we earned the confidence of global investors by addressing those problems in measured ways. The only genuine economic imperative in this entire dismal fight is not that we should raise taxes on the wealthy or cut domestic spending, but simply that we once again have to take care of our fiscal business in a reasonable manner.

Despite the protestations of partisan economists, the economy is largely indifferent to whether we address these imbalances by cutting spending or raising taxes. The first stage of this effort, in 2011, brought $1.2 trillion in spending cuts over 10 years. The verdict of the markets was, “well done”; and, despite the heated rhetoric of last year’s campaign, the 2011 deal was followed by a generally strengthening economy. Stage two was resolved in this week’s agreement to raise nearly $700 billion in new revenues over 10 years, including substantially higher taxes on capital income. The markets are satisfied with that, too, and the economy almost certainly will continue to strengthen.

Stage three will come in a few months, when the President and Congress will likely agree to modest entitlement changes in exchange for additional revenues raised through some version of corporate tax reform. The economy will be fine with that resolution as well.

In fact, this process has been a quiet refutation of the slash-the-deficit chorus. That includes those of the Paul Ryan variety who would upend entitlements to finance more tax cuts, and “responsible budget” types who would hike taxes and slash spending as much as possible to reduce the cost of business borrowing in years to come. The truth is, the economy does not usually respond to drastic measures that confound the expectations of investors and consumers. For all of the complaints that rather than make a meal of the deficit, we take a nibble here, another nibble there and then a third nibble somewhere else, this tortured course allows businesses and households to adjust little by little. And that is the best course for the economy.

So, setting aside politics and social policy, the economic imperative remains that Washington must manage to take care of its fiscal business in measured and reasonable ways, whether through taxes or spending cuts of almost any variety. Looking ahead, this means that the debt limit can never again become a negotiating chip in fiscal politics. The last time that House and Senate hyper-conservatives went down that path, it cost the U.S. government its triple-A rating from one of the three major credit-rating agencies. A government capable of letting lapse its own legal authority to issue new debt and pay interest on its existing debts is one that, by definition, cannot take care of its basic business. And that is especially so in the current circumstances, when there are no market pressures on the government to default and when the government’s debt securities comprise much of the reserves of most of the world’s central banks.

Global investors would be anything but indifferent to such contempt for predictable economic consequences. A technical sovereign debt default triggered by a debt-ceiling stalemate would be a calamity for the U.S. and world economies. Any political leader or party that helps to bring about such a catastrophe will prove themselves unfit to govern for a very long time.