Fiscal Cliff Madness
by Benjamin Studebaker
Sneaking up on the US government, slowly but surely, is the fiscal cliff–the agreement congress made to cut spending across the board in many sensitive areas if a bipartisan deficit reduction plan could not be agreed to. This was a bad idea from the outset, but you wouldn’t know it from listening to the Democratic Party, and that’s both a problem, and the topic of today’s post.
Recently, former chairman of the Democratic National Committee Howard Dean had this to say about the fiscal cliff:
This is every bit as misleading and wrongheaded as anything anyone on the right has said in the last week. The key problem is that it feeds into the right wing paradigm that there is a debt problem when in fact there isn’t one. Investors still trust US public debt, as established by the still bottom-feeding rates on 10-year bonds. Here’s the Federal Reserve’s data on that:
As of August 24, 2012
As I’ve said before, the rate of inflation is just about even with the 10 year rate, meaning that US debt is reducing in inflation-adjusted value as fast or faster than it is accruing interest–this was one of Paul Krugman’s better observations. When Dean says that we all have to make sacrifices or we’ll end up like Greece, he is equating debt that currently costs under 2% interest to Greek debt, which currently costs the Greek government a 23% interest rate. That distortion is on level with any of the loose claims made in Paul Ryan’s budget.
Even more insidious than the sheer distortion of US government’s fiscal situation is the reality of what “driving over the fiscal cliff” will do to the American economy and to the millions of people who depend on it. Here’s what the Congressional Budget Office projects:
What Policy Changes Are Scheduled to Take Effect in January 2013?
Among the policy changes that are due to occur in January under current law, the following will have the largest impact on the budget and the economy:
- A host of significant provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312) are set to expire, including provisions that extended reductions in tax rates and expansions of tax credits and deductions originally enacted in 2001, 2003, or 2009. (Provisions designed to limit the reach of the alternative minimum tax, or AMT, expired on December 31, 2011.)
- Sharp reductions in Medicare’s payment rates for physicians’ services are scheduled to take effect.
- Automatic enforcement procedures established by the Budget Control Act of 2011 (P.L. 112-25) to restrain discretionary and mandatory spending are set to go into effect.
- Extensions of emergency unemployment benefits and a reduction of 2 percentage points in the payroll tax for Social Security are scheduled to expire.
What Is the Budget and Economic Outlook for 2013?
CBO’s Baseline: Taking into account the policy changes listed above and others contained in current law, under CBO’s baseline projections:
- The deficit will shrink to an estimated $641 billion in fiscal year 2013 (or 4.0 percent of GDP), almost $500 billion less than the shortfall in 2012.
- Such fiscal tightening will lead to economic conditions in 2013 that will probably be considered a recession, with real GDP declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013.
- Because of the large amount of unused resources in the economy and other factors, the rate of inflation (as measured by the personal consumption expenditures, or PCE, price index) will remain low in 2013. In addition, interest rates on Treasury securities are expected to be very low next year.
Essentially, in order to achieve a fall in the deficit of $641 billion during a time of high unemployment when spending needs to rise to serve as stimulus, during a time in which interest rates on government debt are below 2%, often lower than the rate of inflation, essentially during a time in which reduced spending is unnecessary and undesirable, the government is going to raise taxes on poor and working people via higher payroll taxes, cut unemployment benefits, reduce discretionary spending. The CBO projects the consequences to be a recession and a hike in unemployment, with vast amounts of economic infrastructure going unused. That is unacceptable in time when the economy is weak and the level of government debt is sustainable.
The democrats have played into the mythology of the debt crisis and all of the spending cuts that the imaginary debt crisis supposedly demands, and are nearly as willing as the republicans to hurt American workers in service to this false ideological idol. Dean’s assertion that this is worthwhile in order to obtain the expiration of the Bush tax cuts and defense spending cuts is both cowardly and cruel. It is cruel to punish the unemployed and the working poor, to further reduce already weak demand and push the weak recovery back into recession, just to obtain pet policy gains. It is cowardly to cave in and abandon the very important debate over what is actually going on in the economy and what should be done to fix it, to offer no opposition to the false narrative running rampant. It is also bad political strategy for the democrats, because, should the fiscal cliff be driven over and the economy slide back into recession, it will be the Obama stimulus policies and the expiration of the Bush tax cuts that will be blamed.
The democrats were wrong to go into the fiscal cliff to begin with–it was intellectually dishonest and cowardly, and talk of driving over it and allowing the economy to slide back into recession compounds the error. The American left needs to defend factual economic reality, to make the case for more stimulus and pro-growth policies. Continuing to embrace policies based on a misunderstanding of economic realities out of convenience, simply because the general public has been convinced and it is easier to go with the current, makes the democrats complicit in the irresponsible austerity drive that has been dominating US politics since the 2010 mid-term election. It is shameful, both intellectually and ethically, for them to continue to do so.
Source list:
CBO on the Fiscal Cliff:
http://www.cbo.gov/publication/43539
Federal Reserve Economic Data (FRED):
http://research.stlouisfed.org/fred2/graph/?s[1][id]=DGS10
Paul Krugman is cited with in-post links.
Benjamin Studebaker 
Most politicians and many economists believe that it is possible to manage the sovereign debt by outgrowing it with the economy, even as we lose control of the debt. There is a great problem growing the economy as the debt becomes large and costly. There is no guarantee that interest rates will remain low, especially when external lenders cannot meet the expenses of their own debt problems. Inflation cannot be guaranteed under all circumstances and is likely to make debt more than unsustainable. Under this debt-based monetary system, growing the economy can only work by means of inflation but inflation alone does not suffice. The regular cycles of growth, excess debt followed by decline are a part of this problem. So, recessions are needed to bring down, deflate or deleverage the debt allowing the defaults that must occur. After the recession has done its job, then debt continues growing and the threat of another recession never ends. Fortunately, there is no need for permanent sovereign debt as we now have and even temporary debt is not going to remain temporary as long as we have greed and politicians.
Under our present monetary system, our money is created both by the Fed and the private banks as debt. So, as the economy grows, it demands a constant growth of the money supply and ergo, the debt. And because the debt grows exponentially with the interest it requires, then eventually the debt will always grow to become unsustainable. And it has done so. Debt cannot be outgrown or reduced by the economy under this system. The debt is always paid with debt-based money. In fact, debt slows the economy as debt grows more expensive. Artificial interest reductions only delay the defaults that must occur. So, recessions cannot be avoided and must happen to make debt more manageable.
This awful debt-based monetary system guarantees that the debt can never end, that inflation is required to manage it, that it will interfere even more as the economy grows more debt and that recessions will become more severe and periods of inflation much greater as the debt grows. Who would want such a messy system that regularly makes life so unbearable? Thank goodness this debt-based monetary system is unnecessary.
Fortunately, we can create money without using debt. And it would be much simpler to manage and without the such severe swings. Politicians would have to tax their spending and the people would then have a choice in the matter.
A new interest-free money supply would be exactly like the Greenbacks used by Abe Lincoln when he needed to finance the Civil War and lenders were overcharging him. Without these unnecessary debt service payments, we would save hundreds of billions of tax dollars each year paid to lenders that could then be spent on government’s needs. And the spending decisions would not be complicated by the corrupting influence of lenders placed upon our government.
I don’t think you’re differentiating between public and private debt. High levels of private debt were indeed a primary cause of the recent recession, but they were certainly avoidable if the financial system had respected the previously convention limits on credit-worthiness when passing out loans to home buyers. However, because banks were passing those mortgages on to other financial institutions and because the ratings agencies continued to triple A rate subprimes, there was no clear incentive to avoid loaning money to people who could not repay it or any major regulations preventing it. The private sector has, since the initiation of the recession, been deleveraging and paying down those unsustainable levels of debt. However, the wider recession is not, as you say, necessary, but is in fact avoidable.
This is because public debt does not work like private debt–the government can spend its way out of the recession and recoup the debts incurred by raising taxes during the subsequent boom and by running slightly higher rates of inflation, which eat into the real value of the debt. In emergencies, the government can have the Federal Reserve buy its debt by printing more money. In effect, a government default is always avoidable. The markets know this, and they also know that US treasuries are safe relative to the rest of the market, and as a result rates on US treasuries remain very low. They will only rise when the wider economy is improving and the market sees reason to invest elsewhere–precisely the goal of the recovery. The economy as a whole would be better off with more private investment and higher rates on treasuries, and in order to bring this about the Fed is presently trying to raise inflation above the rate on bonds so that there is a strong incentive to invest somewhere more profitable. The markets give the government far more room with regard to debt than they give to the private sector for these reasons.
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