From the December 20, 2009 Sunday Times (London)
December 20, 2009
by Irwin Stelzer
Reality bites. Well, not quite bites. Bares its teeth. And is ignored. During this holiday season President Barack Obama and his Democratic Congress feel entitled to an extra glass or two of bubbly now that healthcare “reform” seems certain to pass, the threat of financial collapse is past and the economy is in better shape than it was when Obama was inaugurated in January.
Enter Scrooge — or reality. Yes, the economy is on the mend. On the mend, but not quite mended. Job losses have abated and there is reason to believe that the next report will show modest hiring gains. Manufacturing production rose a healthy 1.1% in November, due in part to restocking. House sales and new construction rose smartly in November. Retail sales are coming in better than expected. On a trip to New York last week I couldn’t help noticing that the crowds in upmarket stores were often foreigners, feasting on the buying power conferred by the depreciated dollar.
Unfortunately, memories are short. The crisis was caused in part by excessive debt: mortgages that could not be repaid; credit-card balances that consumers could not cover; property loans based on inflated values. And the solution being proposed is more debt: huge government borrowing. The economy is floating on a sea of credit, with government deficits topping $1 trillion, more than 80% of the mortgage market supported by the government, and the Federal Reserve Board printing so many dollars that fears of deflation have been replaced with a gnawing worry that inflation will prove the enemy — although not a worry of investors who are stocking up on gold and gold-related assets. Wholesale prices rose last month by an unexpectedly large 1.8% (0.5% if we exclude food and energy, of relevance to those who neither eat nor drive nor heat their homes). Worse still, the president is urging banks to lend more freely to businesses that the bankers deem unlikely to be able to repay, and government agencies are financing mortgages at 97% of the value of the homes being bought. Those loans aren’t exactly of the highest quality.
To avert eyes from the mounting deficits, the president is attacking “fat-cat bankers”. Not without reason. Having called on taxpayers to save their hides, the banks have returned to profitability, in good part because they can borrow at low rates because of the loose monetary policy needed to prevent the economy from having a relapse. But instead of using the profits to shore up their balance sheets, the bankers are throwing a bonus-fuelled holiday party for themselves. To do that, of course, they had to escape government supervision by repaying the government’s loans. That meant selling shares to raise capital, diluting their existing shareholders. In short: the bank executives diluted their shareholders to raise money with which to buy out of government supervision of their bonuses.
So there will be blame enough for all when reality bites. And it will. The federal government deficit, $1.5 trillion, close to 13% of GDP, shows no sign of abating. The healthcare plan will cost well over $1 trillion, and since nobody really believes that half of this will come from eliminating waste, it will eventually add to the deficit. The House of Representatives, in a pre-adjournment spasm, voted $175 billion for what is in all but name a second stimulus: more infrastructure spending, more cash to the states. The president is stomping the country in support of still another spending programme — cash for insulating homes, and more support for green energy production. Then there is the $30-40 billion annual cost of the surge in Afghanistan, which has not yet been included in the budget or counted against the deficit.
Never mind that the rating agencies are warning even triple-A rated countries — notably America and Britain — that their ratings will be threatened if they do not get their balance sheets in order. The spending continues, the borrowing continues, the red ink flows.
Congress will undoubtedly hear from constituents during the recess. The vast majority want the deficits brought under control and oppose healthcare “reform”, which they know will drive up their insurance premiums. Diana Furchtgott-Roth, my colleague at the Hudson Institute think tank, estimates the increase at more than 40% for families who get healthcare insurance through small businesses.
There is talk in Washington of a bipartisan commission to review the entire fiscal situation, including the looming bankruptcy of the Medicare and social security systems. Traditionally, Democrats want to keep spending and cover deficits by raising taxes on high earners, while Republicans favour cutting spending. So far, there isn’t much talk of compromise, perhaps because both parties are waiting to see how Obama plans to implement his pledge to bring the deficit down to about 4% of GDP by 2019, which will still be high by historic standards.
The assumptions underlying the president’s deficit-reduction programme are, to put it mildly, questionable. His forecasts assume an annual growth rate of 5.1% in 2011 and very low inflation. Believe that the economy can achieve those goals only one year from now and I will get you a date with the tooth fairy.
My own guess is that this deal will eventually be cut by a bipartisan commission. Democrats will accept some limits on net, new spending and Republicans will accept some increases in taxes. Most likely America will join almost all other countries and impose a value added tax. Democrats, especially the president, like any idea that makes us more like Europe, and know that Vat is an easy tax to raise; it has champions in house speaker Nancy Pelosi and key Democratic adviser John Podesta. Republicans like a consumption-based tax, the adoption of which would ease the pressure to raise marginal income tax rates. Besides, by waiving Vat on exports, as Britain and other countries do, we will be able to provide a covert subsidy to exports without running foul of World Trade Organisation rules.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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