The First Cut is the Deepest(???)…Rod Stewart

The day of reckoning for sequestration has come and gone and the small cuts have started to go into effect. To hear some of the rhetoric coming from the President and some of our other political leaders, you would have thought  that we are now facing an economic Armageddon. I believe these fears amount to “inside the beltway” exaggerated concern over the importance of government spending to the economy. After all, the cuts of $85 billion (and only $43 billion this fiscal year) are still very small relative to the amount of federal spending (only about 2 percent of total federal spending in 2013) and only about 0.5% of total US GDP. More importantly, they pale in comparison to what will be needed to ultimately to balance the budget which will require budget cuts below current levels ( not the “fake” future cuts below inflated future levels that are often cited by many politicians as if they were “real” cuts) of on the order of $500 billion per year.  (See “Let’s Get Fis-i-cal” post and early last year posts for more info on what we need to do.)

But somehow the thought of the ghastly sequester has had many leaders in Congress pretty confused. Consider the following dim-witted remarks in the past couple of weeks:

“It’s almost a false argument to say we have a spending problem” …Nancy Pelosi(D-CA)

” Is it a spending problem? No” …Senator Harkin (D-IA)

So since we seem to have two senior members of Congress having a “senior” moment, let me make this crystal clear . Our federal spending hasn’t just grown rapidly, it has literally exploded. In 2007, we spent $2.7 trillion and by 2011 we have spent $3.6 trillion or an eye-popping 30 percent growth in federal spending in only 4 years in a period when personal income growth was flat and inflation was very low.  And in the spirit of bipartisanship, we have been growing the federal budget almost as fast during the Bush years from $1.7 trillion in 2000 to $2.7 trillion in 2007. The only good news seems to be that we actually cut outlays slightly (by $60 billion) between 2011 and 2012 ( the limited “real” cuts that occurred as a result of the 2011 budget deal plus lower interest costs due to the Fed’s huge monetary stimulus). However, by and large, this has been an aberration in a very long-term pattern. Spending also has grown across the board. Discretionary non-defense spending has grown 31 percent between 2007-11 , with defense growing 28 percent during the same period. Between 2000-07, defense spending grew the most rapidly due to the Iraq war and new homeland security expenditures, but discretionary non-defense spending also rose rapidly by about 54% during this period.

The consequences of these large spending increases is well documented. Tax revenues grew enough prior to the 2008 recession to keep the deficit from growing much (i.e. in fact, we managed to get the deficit down to about $200 billion in 2007). However, after the recession and the major increase in government stimulus, the annual deficit exploded and reached $1.3 trillion in 2010 and 2011. As a result, we are now saddled with more than $16.5 trillion in federal government debt which is more than 100% of the US GDP, an already dangerous level. And this doesn’t even count on the order of $100 trillion of unfunded liabilities for social security and medicare and other government pensions.

The complete denial of the magnitude, scope and real danger associated with the US debt on the part of some of our politicians means we are in more serious trouble than even I realized. Further, the complaining and moaning on the part of many politicians over a tiny cut in the federal budget does not bode well for the future where we will need to do much more to get our fiscal house in order. Unfortunately, we also have enablers of this fallacy such as Paul Krugman, Ben Bernanke and other Neo-Keynesian economists who insist that we should postpone any further cuts far into the future, allowing politicians to “kick the can down the road” in good conscience. We also have the supposedly unbiased, Congressional Budget Office issuing projections for the future which even though they show continued large deficits, use ridiculously optimistic assumptions such as more than 4 percent real GDP growth between 2014-17, interest rates that don’t really rise significantly until 2016 (and remain moderate throughout the period) and inflation remaining at 2 percent virtually forever.  (and “forever” is a very long time!). These assumptions drive a very rosy picture of tax revenues almost doubling in just the next 5 years, while expenditures grow by only a bit more than 20% in the same period.

PUH-Leese! ….I went thru the CBO estimates and adjusted the costs for higher likely inflation and interest rates as well as lower likely growth in the economy. These more realistic assumptions suggest that we will continue to have deficits of about $0.8- $1 trillion per year or more and that our debt will swell to close to $25 trillion by the end of this decade. And probably several years before that, the US will learn what REAL ECONOMIC ARMAGEDDON means. Just remember, if we don’t cut our spending substantially (along with really reforming tax code to make it more revenue efficient) and really close our annual deficits to near zero, the markets will eventually come to the conclusion that the “full faith and credit” of the US no longer means much. Foreigners will sell their holdings of US treasuries, and the dollar will tank. To make matters worse, this will occur at the same time inflation and interest rates and interest costs are rising significantly (Thanks to the Fed’s policy of the last 4 years). As a result, we will probably go into default (though we won’t call it that) and there will very large layoffs in the government, along with massive cutbacks in social security and medicare payments when the government can no longer effectively borrow. You think it can’t happen? If we continue down our current path, I am quite confident it WILL happen.

So Rod Stewart didn’t really have it right after all, the first cut may seem like the deepest to some but it probably will be the “last” cut that is the deepest.

Next blog post, I will be more upbeat. I promise! But our not so fearless leaders, gave me no choice this time.