I'll explain the mysterious looking graphic above a little later in this post. For now, I need to spend some time talking about deficits. Wow, they sure are huge, aren't they?
Republicans, unsurprisingly, are already playing the deficit card:
“Who among us would ask our children for a loan, so we could spend money we do not have, on things we do not need? That is precisely what the Democrats in Congress just did. It’s irresponsible.”
—Bobby Jindal, Feb. 24, 2009
President Obama apparently saw that coming:
"With a $787 billion stimulus package in hand, President Barack Obama will pivot quickly to address a budget deficit that could now approach $2 trillion this year. He has scheduled a 'fiscal responsibility summit' on Feb. 23..."
—Wall Street Journal, Feb. 14, 2009
The only problem with the Republicans' and Democrats' concerns about the federal deficit and debt is this: deficits don't matter. Worrying about deficits is barking up the wrong tree — at what is possibly the worst time in our nation's history to be making that mistake. The time our politicians and ideologues are wasting on the deficit debate is preempting a national debate on the only real solution to our economic problems: returning to robust economic growth. The unimportant, time-wasting deficit drivel could end up being extremely costly to our kids and grandkids.
Before going further, I should cover three falsehoods about deficits. Each deserves a lengthier explanation, but for now, I'll be as concise as possible.
Deficit falsehood #1
"Our kids and grandkids will eventually have to pay off the federal debt. Deficits increase the debt, saddling future generations with a bigger number to pay off."
Rebuttal: Anyone who believes falsehood #1 does not understand debt rollover. Bill O'Reilly is one among millions who don't; unfortunately, O'Reilly has a bigger microphone than most, and he has been using it to peddle false fear. What a pinhead.
Deficit falsehood #2
"Deficits cause inflation."
Rebuttal: Unanticipated inflation higher than about 2.5% is undesirable, that's true. But fiscal deficits rarely if ever contribute to inflation. Fiscal deficits are funded by borrowing dollars that already exist; deficits by themselves do not create inflation pressure. Controlling inflation (and deflation) is the responsibility of monetary policy, not fiscal policy.
Deficit falsehood #3
"Interest on the debt buys us nothing."
Rebuttal: That's simply false on its face. Steady, uninterrupted interest payments buy us our nation's creditworthiness — which in turn buys us the ability to supplement tax receipts with dollars from willing lenders — which in turn prevents us from having to cut back on government purchases such as aircraft carriers, weather satellites, levees, border guards, border fences, bullet-proof vests for our troops, and (last but not least) intelligence systems for preempting such things as the infiltration and simultaneous detonation of suitcase nukes in eight or ten of our large cities. Deficits supplement our government's ability to protect us; surpluses diminish it. (That's the main reason I prefer deficits to surpluses, by the way.) In short, falsehood #3 ("interest buys us nothing") is about as far from the truth as it's possible to get.
The real problem, and the only solution
What if interest on the debt consumed more and more and more of our federal budget? It took 15-16% of the budget in the Clinton years, and 8-10% of our budget during the GW Bush years. But what would happen if paying the interest took a far larger portion of the budget - say, 30% or 40%+ of the budget?
Answer: Well, now THAT would be a problem; it would diminish our government's ability to protect us, regardless of which party was in charge. We DEFINITELY need to keep that from happening, or else we will be sentencing our grandkids to a disaster. So, that begs the question, How do we keep it from happening?
History holds the clue. For at least two centuries, we've been rolling the debt principal over and over. We've also been paying the interest out of the federal budget, and we've never missed a single payment — even though both the debt and the interest payments have grown tremendously in those two centuries. How did we manage that? More importantly, how might we continue that practice for a few more centuries?
The reason we were able to afford it was economic growth. The mix of available jobs kept getting better and better — as did the paychecks, the things those paychecks would buy, and the overall standard of living. The debt grew and grew, we ran deficits far more frequently than surpluses, but it didn't matter because our economy was growing. Bigger paychecks meant more gross pay, more tax dollars paid to the government, and more take home pay. We could afford more and more of everything, including interest payments to the savers who were happy to keep funding our federal borrowing.
Bottom line: Growth not only raised our standard of living, it enabled us to pay the interest, and to roll the debt principal over. That formula has been working for two centuries (eight generations); why can't it continue working for another two centuries or more? To ask that a different way: What growth rate would we need in order to ensure that we'd remain in good shape indefinitely?
That's what I was asking myself when I read through the assumptions in President Obama's budget. Some have called the assumptions a "rosy scenario." I can't agree with that yet, because I think robust growth is still possible. What I have heard are two things I cautiously agree with: Obama's budget is (1) full of stimulus spending that is supposed to cease once the economy has been stimulated back to the growth path, and (2) full of investments, investments, investments. (Successful investments yield a better future; unsuccessful ones don't. In the private sector, we were careful to vet the proposed investments ahead of time, approve only the ones that seemed to meet the hurdle criteria, then move ahead on those that did. Subsequently, we would enjoy the fruits of the successful investments, and just as important, cut our losses on the ones that didn't deliver.)
The reasons I'm cautious about Obama's budget: (1) I'm not so sure the Democrats, including Obama, have the discipline to stop "stimulating" their constituents after the private sector returns the economy to the growth path; and (2) I'm almost certain that the government lacks the discipline or the incentive to kill the loser projects — and there will be losers.
In any case, Obama has laid down the results his budget is expected to produce each year for the next five years. I've placed those assumptions into a financial model that starts now and goes out several generations into the future, to answer the question we defined above: What portion of the federal budget will be required to pay the interest on the debt, assuming we get the deficit down to 3.5% of GDP, and hold inflation steady at 2.5%, both continuing indefinitely?
Well, that depends on the real growth rate the economy achieves. It goes without saying that the current downward spiral (negative 6.2 percent), if it continued, would quickly lead to catastrophe. [Picture the streets full of angry unemployed people in our major cities; they wouldn't care one whit about who Friedrich Hayek was.] The downward spiral must be reversed. Republicans and Blue Dog Democrats, by opposing stimulus and rescue spending, are willing to take a gamble I am not willing to take.
So, I first loaded this financial model with the five-year Obama assumptions. Happily, his budget says we'll get back to 4.2% real growth by year 5. That's the dark green line below, and it's good news: interest on the debt would require a smaller portion of the budget versus the Clinton years, a larger portion versus the GW Bush years, and would remain level almost forever (even though the model assumes we run deficits indefinitely).
In short, 4.2% growth is very encouraging, if we achieve it. [Many of us will be watching the results closely, and expecting more accountability from government for achieving their advertised numbers.]
But what if steady-state growth turned out to be different from the Obama budget assumption of 4.2%? As you can see, I modeled those scenarios, too. Red lines are bad news, green and blue are good news. I hope these results make it clear that deficits don't matter. When the economy is plummeting, deficits are designed to help us return to growth. When the economy is humming along on a healthy growth trend, deficits are harmless, even desirable. Deficits don't matter, growth does.
A return to robust growth is the change we need. Private sector entrepreneurs are the ones who can deliver it — if we are wise enough to set up the proper incentives for them to decide to get moving.
President Obama and entrepreneurs
Does President Obama know what the word "entrepreneur" means? I'm not so sure. Here's the definition...
entrepreneur: One who starts a business or other venture that promises economic gain but that also entails risks.
—The American Heritage New Dictionary of Cultural Literacy
Does our president understand what types of policies encourage (or discourage) entrepreneurs? His speeches and his budget proposal are not encouraging along those lines. I found the word "entrepreneur" in exactly one of his campaign speeches (June 5, 2008; he used it to describe Senator Mark Warner). His budget only pays lip service to "entrepreneurs" in a few obscure places. It's discouraging that entrepreneurs don't seem to be top-of-mind for our president, even though they are the ones who would conceive and create the higher-paying jobs of the future, the real jobs (as opposed to government jobs) it will take to grow the economy. They'll be the ones employing our grandkids at higher wages and salaries, if only we understand, and set up, the incentives that will reward them for success. [Obama's call for higher taxes on successful Sub-S corporations does not incentivize entrepreneurs, by the way.]
Mark Cuban sounds unsure about Obama as well:
...Obama needs to have the counsel of those who will take the real risk inherent in creating companies and jobs. Those who put their money and lives on the line with their business. Without it, the rules of unintended consequences of any economic policy could hit you in the mouth in ways you never expected. Things like forcing companies from being taxpayers to the underground cash economy, or forcing new hires to be independent contractors to avoid having to pay their insurance or higher matching social security amounts. [His] current group has no one with 100pct of their networth on the line. I promise you that the possibility of losing it all will provide a completely different perspective than any of the “knowledge” the esteemed, learned members of his current advisory team offer.
I hope this isn't a bad omen. We'll see, soon enough. The economy's growth, and the size of government (as a share of the economy) will tell the story within two or three years. Real growth of 4.2% would not only be commendable, it is the change we need; but without entrepreneurs, it's a fantasy. Government "experts" don't have a clue about how to grow a $14 trillion economy at a 4.2% annual pace. I certainly hope Mr. Obama catches onto that before it's too late to meet his budget targets.
