deficits

"Reagan proved deficits don't matter."
Dick Cheney
2002

JPMorgan Chase has held up through the financial crisis better than most of its rivals. Its CEO, Jamie Dimon, was quoted in the Financial Times this morning saying, “The worst of the economic situation is not yet behind us. It looks as if it will continue to deteriorate for most of 2009.” That’s consistent with the consensus of economists – things are going to get worse before they get better and don’t expect a lot of good economic news in 2009.

While some bloviating shills in the right-wing media have taken to blaming Obama for the current state of the economy, most Republicans have been holding back until he actually takes office. But you can bet that as of next Tuesday they will attribute every fresh piece of bad economic news to his remedial efforts. So it is useful to take note of the where things stand as of January 2009.

When Barack Obama steps into the White House next week the US government will already be almost four months into the current 2009 fiscal year, which began October 1. Last week the Congressional Budget Office forecast the 2009 deficit at nearly $1.2 trillion, swamping the previous record of $455 billion set in 2008. (Bush already owns the five largest federal budget deficits of all time, not including 2009, after inheriting the largest budget surplus in US history.) The CBO assumes the US economy will decline by 2.2% in 2009. But the CBO estimate doesn’t include spending for the wars in Iraq and Afghanistan (which the Bush administration has treated every year as if it was some kind of surprise that couldn’t have been anticipated). And it doesn’t take into account any economic recovery program – no tax cuts or spending increases to stimulate the economy. So add another $500 billion or so to the deficit number -- $1.7 trillion.


[click to enlarge]

This is not wild conjecture. It was announced earlier this week that the federal budget deficit for just the first three months of fiscal 2009 was $485 billion. Not an annualized projection – that is actual amount for just three months. That means that even if the year ended even before Obama took office next week, the 2009 budget deficit would already have set a new record. That is on pace for a $2 trillion deficit. It is sort of like Bob Beamon’s world long jump record at the 1968 Olympics when he became the first person to jump over 28 feet and 29 feet in the same jump. We are sailing right over $500 billion, past $1 trillion, and almost certainly exceeding $1.5 trillion as we approach a $2 trillion deficit. Not bad considering that the record budget deficit before Bush took office was a mere $290 billion run up by his dad in his last full year in office.

That’s what you get when you cut taxes multiple times while fighting two wars and abandoning all control over spending.

Why it was only eight years ago, in January 2001, when then-Fed chairman Alan Greenspan testified to Congress in favor of Bush’s first round of massive tax cuts. After having been a fiscal hawk during years of Democratic government, Greenspan had a change of heart. His logic? We risked paying off the Federal debt altogether too soon. The horror!

[T]he Fed head said, "the most recent projections, granted their tentativeness, nonetheless make clear that the highly desirable goal of paying off the federal debt is in reach before the end of the decade."

And that could be a bad thing.

Running surpluses without a debt, Greenspan warned, would result in the "longer-term fiscal policy issue" of a government paying off its debt, particularly long-term Treasury bonds, before the bonds mature — costing it extra money by buying back those securities from private investors before they mature.

Buying back Treasury bond in the public markets is only costly if prices go up, which means interest rates are going down. How is that a bad thing? It’s called “capital formation” – savings being recycled as private sector investment. Conservatives used to consider that a good thing.

The Bush tax cuts, Greenspan testified, would put us on a “glide path to zero federal debt." He was also concerned that the federal government, in the absence of debt to pay off, would have to invest surpluses in the private capital markets. "The federal government should eschew private asset accumulation," he said (yes, Greenspan actually used the word “eschew”), "because it would be exceptionally difficult to insulate the government's investment decisions from political pressures." Of course, Greenspan didn’t raise this as a concern when Bush was peddling the idea of privatizing Social Security. Then, diverting Social Security dollars into private capital markets would be a GREAT thing – raining down riches on retirees (and, coincidentally, raining down fees on Wall Street).

(It’s too bad we didn’t turn over Social Security to the “Masters of the Universe” on Wall Street, isn’t it? According to the 2008 Social Security Trustees report, the system will only be able to pay 100 percent of forecast benefits through 2041 – and then only 78% thereafter in perpetuity. If only Democrats had let Wall Street do to the Social Security system what it has done to your IRA – the “Final Solution” to the “Social Security problem.” Maybe it would have prolonged the financial bubble long enough for Bush to leave office before the inevitable burst.)

Economists have a concept called fiscal space, defined as room in a government´s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy. It is actually not a complicated concept. It’s pretty intuitive. For example, if you are running large budget surpluses during a time of healthy economic expansion, the budget can take a hit during a downturn without it doing serious damage to the country’s finances. On the other hand, if you are already running record budget deficits during an unsustainable credit bubble (for example), and the economy subsequently plunges into the worst economic crisis since the Great Depression, there isn’t much slack in the budget for an accommodative fiscal policy without completely blowing the budget apart. The boost to demand required to arrest the downward spiral risks damaging the value of the country’s currency and its terms of access to the capital markets. To take a more concrete example, in fiscal 2000 the US ran a budget surplus of $236 billion (the largest in history). When the economy experienced a mild recession (but a big drop in taxes from capital gains) in 2001, Clinton was still able to bequeath to Bush a budget surplus of $128 billion that year. But when Bush, in turn, hands Obama a $485 billion deficit – in only the first quarter of 2009 – in the face of a full-blown economic crisis, policy options are more constrained.

But Bush is just following in the footsteps of his role model, the Republican saint Ronald Reagan. Bush has almost doubled the national debt on his watch, but Reagan almost tripled it. In Reagan’s first address to Congress in February 1981. He said:

I've been trying ... to think of a way to illustrate how big a trillion is. The best that I could come up with is that if you had a stack of $1000 bills in your hand only four inches high you would be a millionaire. A trillion dollars would be a stack of $1000-dollar bills 67 miles high.

Reagan's speech-writers missed an opportunity. Most Americans have never seen a $1000 bill because they were discontinued in 1969. Using $20 bills, a trillion-dollar stack would be an impressive 3150 miles high. The national debt nearly tripled on Reagan's watch, from $993 billion to $2.6 trillion, a stack of Jacksons soaring 8450 miles high. But Reagan was frugal. When George W. Bush wandered into the White House on January 20, 2001, the national debt had climbed to $5.7 trillion. When he leaves next week, it will be pushing $10.8 trillion, a stack of twenties 34,000 miles high.

Using inflation-adjusted dollars, in the past 28 years, since Reagan took office, the national debt has risen $800 billion during Democratic administrations, and a staggering $7.5 trillion during Republican administrations. Or, looked at another way, it has risen $100 billion a year during Democratic presidencies and $375 billion a year during Republican administrations. In the Cheney-Bush administration, it has averaged over $500 billion a year (adjusted for inflation and including “off-budget” increases to the debt).

But now isn’t the time for short-term deficit concerns. To paraphrase Donald Rumsfeld, “You confront a depression with the budget you have, not the budget you might want or wish to have at a later time.”

Even conservative Republican economists are urging a two-year economic recovery package in the general range of $1 trillion. That includes Martin Feldstein, Ronald Reagan’s economic advisor and a conservative stalwart, who has endorsed a major fiscal stimulus, saying, “We're down to fiscal policy, which pains me a bit, more than a bit, but I don't think we have a choice.” He even took the stage with Clinton labor secretary Robert Reich to endorse plans along the lines being proposed by Obama. "It pains me to say that because I am a fiscal conservative who dislikes budget deficits and increases in government spending,” Feldstein said in Congressional testimony. “Reviving the economy requires major fiscal stimulus …”

So now we are hearing a lot of belly-aching from Congressional Republicans about the deficit. It might have been nice to have heard that when we were running record budget deficits during an unsustainable credit bubble. But that might have constrained their tax cuts. In the meantime, well ...

Reagan proved deficits don’t matter. Right?

[click to enlarge]

The numbers are understated – this cartoon is from April 6, 2008. But the concept is more relevant than ever.