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Korfmann: The U.S. Debt; Why greener pastures have yet to be seen

August 9, 2011

Last week, almost everybody took a sigh of relief; the Democrats and the Republicans finally settled on a deal to raise the U.S. debt ceiling, supposedly restoring confidence in financial markets. After all America is now not going to default. Notice, however I did not include everybody in this “sigh of relief”, for I, just as the global markets themselves, sure didn’t feel any less insecure over American finances- and you shouldn’t either.

As was previously made quite clear; in order for our neighbours down south to retain their top-dog credit rating at AAA, two of the major international crediting agencies stated that $4 trillion would have to be cut. Only $2.1 trillion has been put on the chopping block (and this-technically- was coupled with an effective increase of $2.1 trillion in spending over the next few years). Starting with Beijing and then to S & P, international crediting agencies have begun downgrading the U.S. credit rating- as it stands whilst I write this article, the U.S.’s once perfect credit rating has been changed to AA+. Markets have taken a sharp turn for the worse in response.
Dagong Global Credit Rating commented on their downgrading of American credit scores from A to A- by stating “By raising the debt limit the U.S. temporarily prevents the government from debt default, but it does not improve the national solvency; rather the heavier debt burden on the government will cause the U.S. sovereign debt crisis to deepen further”.

This alone should make you all quiver in your boots, however there is more to this towering Pisa-style mess of a problem. The deal is only good enough to last them until 2013- increasing the ceiling by $900 billion and allowing them to accumulate more red ink in the process. This was a huge political success for Mr. Obama, and quite a humiliating defeat for the Republicans. Obama should not be exclaiming that he didn’t come out on-top, because he most certainly did. The GOP should not be running around toting the fact that their “we’re not going to raise taxes” bit was included either, because it will, sooner or later, bite them both in the proverbial. Most likely come election time.

Let’s be clear here for a second; the problems that America was facing to start this calamity are as follows; A-they were spending too much to begin with, B-they decided it would be a good idea to couple the increase in spending with tax-cuts, which would further decrease government revenue (desperately needed to PAY OFF their debts), C- they decided to elect a president (Obama) who’s main election promise was to spend MORE money, D- they refuse to cut back on the monstrosity of entitlement spending and E- they elected a Congress who are dead set against removing tax breaks, forget about raising rates(???)

The $14.2 trillion of debt talked about in the media and focused on by the general public over the past few weeks also only takes into consideration America’s public debt, and does not even include the money guaranteed for Medicare, Medicaid and Social Security, which according to government numbers totals a whopping $50 trillion. The real problems, which the most recent debt-deal fail to address lie in these “big three” entitlement programs; where the U.S. government, between the years 1985 to 2009, has seen an almost 9 percent average growth in Medicare per year, compared with only 5 percent growth in the gross domestic product [Kaiser Family Foundation]. Even with inflation, just ONE of the top healthcare programs alone already continues to grow at a faster rate than the GDP of the most powerful economy in the world .

Like health spending – debt too continues to spiral out of control. With more than 10 increases in the vaunted “debt ceiling” in the last 10 years alone. The fact that you can simply raise the limit of what you can borrow, at any time you like, utterly defeats the purpose of the ceiling in the first place. Why even have a debt ceiling if it just continually gets raised by the very people who implemented it in the first place? Recall, they put the cap in place with the goal being to NOT reach the cap, and instead they routinely BREECH the cap.

It is not just Obama that is to blame here though; I could probably go as far back as the FDR/Lyndon B. Johnson era of a “great society” and “The New Deal”-when government spending was seen as a remedy to all of the country’s ills. Post WWII saw a massive economic shift, indeed there was a significant increase in science due to the war-machine set-up by the winning countries; this is all common sense, if you put money into R&D, the economy will advance and become more efficient. The point that everybody failed to see though was that somebody had to PAY for it all- instead everybody assumed this “multiplier effect” would sustain itself and that the government spending would “pay for itself with the profits”. We don’t even know if the positive side-effects from government programs such as NASA could have been accomplished at a much cheaper and quicker rate- because it was effectively monopolized by the American Government and nobody else was even capable of trying.

The pickle that we are in now was not the product of a year or two of misunderstood economic thought; it was the product of more than half a century of policies created back under the presidencies of FDR and Lyndon B. Johnson, and in Canada’s case; Pierre Elliot Trudeau. What I am meaning to say is this; at the time, there was quite a bit of money floating around the economy, and subsequently just as much in public purses. This all led to governments, believing that they were doing good (and receiving great amounts of public support in the process),, spending their way into an oblivion. But this oblivion took a while to manifest, and it didn’t fully settle in until after their terms in office concluded. Yes, investment of that sort will change the economy, and it did. But at what long-term cost?

The creation of American Medicaid under Johnson and the New Deal under FDR set the foundations for an increased government, with increased influence, over an increased number of lives. This very system has now set-up a whole generation, and now society with expectations that cannot possibly be upheld under reasonable financial circumstances. What these Presidents and Prime Ministers failed to see was that borrowing money means higher interest payments (and more of them), and promising pension increases and welfare cheques to people means that the number of recipients will grow with the population and costs would increase as said population ages, and the economy (as we have learned over recent years), won’t always be as prosperous as it was in the early days of the post-war boom- leaving nobody with the funds to pay for it all.

The trickier part is this; since we have let this build up for so long, people have grown old while working these entitlement programs and grants into their every-day expenses and long-term financial plans. So much that, if we were to massively cut the amount owed to recipients, quite a lot of people would suffer economic hardship. America has raised a nation once founded upon equality in the sense that all men are people earning what they work for and have just as many opportunities as the next person, on a different notion of equality; where everyone has the right to receive what their fellow countrymen do, without necessarily working as hard or in the same manner. I, by no means blame individuals for this mess, I blame the short-sightedness of political elites and the American culture for succumbing to the initial successes of their economic past. I really do hope that their case does not follow the same fate as that of the United Kingdom’s (just after the first world war, when they began to succeed as the major economic and diplomatic force of the world), but this cannot quite be ruled out at this point.

In terms of governments funding R&D programs, as much as investment works, if it is all taken out of public debt- it will not likely be the case. To put it into perspective; if you wanted to invest in something to increase your net worth, but didn’t have the funds on hand, you’d take a hike to the nearest financial institution and apply for a loan. First they’ll ask you if you have solid employment, and if you were the United States, you’d most likely respond with “well, not really, you see I’m only partly employed and most of it is part-time or temporary work” [current unemployment rate of 9%, coupled with an increase in part-time and temporary government employment in those with jobs], then they’ll ask you about income and current financial debts of which you’d respond “you see, my debt is 95% of what I earn (debt to GDP ratio), so I still have some room to “invest” some more, right?”. If you were the loans officer, what would your reaction be?

You would start laughing.

Any other response is not very likely to come from anybody with a shred of common sense.

So why is the United States an exception? Well actually, they’re not, and the fact that they’ve been able to stay afloat for this long is rather surprising. What surprises me more, however is that even though we hear the talk about fixing it, we still have yet to see the walk. Even the great Ronald Reagan that the Republicans (and even President Obama) seem to quote so much on this topic raised the debt ceiling 17 times.

But what the American government has succeeded in doing (and has succeeded in doing 103 times since the inception of the first debt ceiling in 1917), is just put-off the problem until the next generation and/or politician has spent too much and needs to figure out a way out of the problem.

Why does nobody get it?

Just like an individual borrower, it doesn’t make sense to keep giving money to someone who cannot pay it back, where is the common sense here?

But perhaps there is a reason to keep lending them cash – they are too big to fail! As we heard over and over again in the past few weeks, if the United States decides they can no longer pay for all these loans and over-spending, their economy will take a tumble and with them will go most, if not all of the other economies around the world. Economies rely on Americans to keep making their minimum debt payments, and to keep buying stuff. Economies that, without the Americans, would see poverty spike across the board..

Why we seem content to hang upon this common precipice has baffled me; until now.

If we think about this for a second we’d be faced with the discovery of something rather frustrating, and perhaps something already known to some people-just not enough of them. We would discover that putting-off administrative worries that may or may not affect the every-day economic lives of individuals affects not just those looking up at the system from below; it most surely affects the policy makers and the politicians as well.

We’ve heard it before and we heard it again in this most recent debate over American finances; “It’s all a political mess”. This is actually dead on. What we have just experienced was the political jabbering from both ends of the American political spectrum; where one side wanted large spending cuts on over-funded entitlement programs coupled with zero tax increases, while the other side pushed for a sharp increase in taxes for different groups of the population, and little-to-no spending cuts in the aforementioned entitlement programs. Both might appear to be valid- however I would argue that (and this has been proven time and time again) tax hikes only marginally increase the amount of government revenue freed-up to pay-off debts compared to spending cuts. Yet those same hikes (especially ones to the rich, as was suggested by Obama), generally take out money from the economy and leave individuals with less to spend and save while only aggravating economic hardship. Spending cuts, especially in a situation like this, are the most effective way of staying on track. You just can’t go wrong with saving the money you are earning now, to pay-off debts you owe all while making sure you STOP spending on more frivolous things. We do it every day as households; if you are facing tough economic times, you take less vacations and eat out less. Remember what was said about exceptions? There are none. You can’t increase the amount of money you take from people while they are earning less; it’s trying to squeeze water out of a rock.

The one problem here-whether you agree or disagree with my choice of spending plan- is that put together, a mixture of both of these plans are DISASTOUROUS. Let me explain; with zero tax increases and a clause written-into the deal that doesn’t let anyone touch the current levels of spending on Medicare, Medicaid, and Social Security, we’re getting nowhere. And fast. If the major problems (i.e. the largest areas of government spending) are not allowed to be fixed, then this whole idea of not even raising taxes will turn ugly- fast. As mentioned before; if government entitlement programs are increasing faster than your GDP, IT’S A PROBLEM.  Can someone please tell me why this so-called “debt solution plan” won’t let us tackle this problem?

The ONLY reason this “deal” was made is because there are significant levels of political benefits to either side of the argument. They both WANT to fight this fight again next November. The Democrats can say “those heartless Republicans caused us to make that horrible deal back in July of 2011 and now we cannot let them win this election”. The Republicans will be doing just the same, but in reverse. I can hear it now: “Back in 2011, President Obama would not let us touch upon the real issues at stake, which are the overspending on Medicare, Medicaid, and Social Security entitlements. We cannot let Mr. Obama get re-elected and mess things up even worse.”

I really wish I was yanking your chain here, but it has already started!

Worse, Mr. Obama and Mr. Boehner (and their political allies, both moderate and maniac) believe they have successfully taken the global financial markets hostage for their own political gain. I will make this clear; no-one wins if Americans continue to spend more than they can afford, or are willing, to pay.

Unfortunately, the American political system is set up to ensure just that – too much spending and too little taxation. Incentives matter, and each and every one of the cogs in this massive political and administrative machine have incentives to not cut spending, to not reform government programs, and to not solve this debt issue. What will happen when the politicians of the stars and stripes nation can no longer raise the false ceiling they claim aids in their fiscal prudence?

Who knows.

But I can pretty much guarantee you one thing; it won’t be pretty.

This analysis was originally published on the official blog of the Atlantic Institute for Market Studies (AIMS). Andreas Korfmann is as economics policy intern at AIMS.

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One Comment leave one →
  1. Anon permalink
    August 14, 2011 7:23 am

    Lmao at ‘the great ronald reagan’, the bastard himself was responsible for a massive addition to the debt to pursue wars abroad and at home on its citizens (war on drugs). Mind you he’s certainly not the only republican who has aggressively spent the nations money fighting redundant wars. Military spending, in my opinion, is much less important and FAR more wasteful than any form of socialized healthcare

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