According to Stockman, $700 billion to $1 trillion in structural deficit reduction is needed and that cannot be done by spending cuts alone. Politically, he is correct. The Democrats and many of the Republicans do not want to cut anything and the Republicans are against any tax increase.
Tax increases without dramatic spending cuts will accomplish nothing and would probably make things worse.
Misapplied tax increases will hurt economic growth and will reduce the revenue available to the government.
Governmental spending cuts will reduce somebody's income by an amount equal to the cuts. That will be deflationary and increase unemployment. There is no painless or simple way to get out of this mess. It is not going to spontaneously disappear.
As an aside, the Democrats are back in town to save governmental union jobs with $20 Billion more in new debt.
Beware the light at the end of the tunnel
Commentary: It's a debt train about to collide with federal obligations
By David Stockman
David Stockman served in the House of Representatives and was President Reagan's budget director. He was a founding partner at The Blackstone Group and now runs Heartland Industrial Partners, a private-equity fund. This article first appeared on Minyanville.com .
GREENWICH, Conn. (MarketWatch) --
The federal deficit is no longer an abstract long-term problem; it's a financially critical freight train hurtling down the track at alarming speed.
Here's a dramatic way to look at it: Nominal GDP is only $100 billion higher than it was back in the third quarter of 2008. That means it has been growing at only $4 billion per month, while new federal debt has been accumulating at around $100 billion per month.
Yes, this period represents the worst of the so-called Great Recession, but never in history has the federal debt grown at a rate of 25 times GDP for two years running! See "The Road to Recovery: Are We There Yet?"
This time is markedly different in terms of the business-cycle impact on the budget. During the past three quarters of "recovery" -- with real growth of 5.0%, 3.7%, and 2.4%, respectively -- nominal GDP growth has averaged only about 4%. This is steeply below the figure for past cycles when we had 7-10% nominal GDP growth due to higher real growth and much higher inflation.
Consequently, nominal GDP -- the true driver of federal revenue since they tax our "money" income, not the statistical "real" income confected by the Bureau of Economic Analysis and the Commerce Department -- has only grown at $50 billion per month during the last three quarters. In other words, the federal debt still has grown at two times the rate of GDP during what looks to be the strongest phase of the recovery.
Further, if we're in a period of sustained debt deflation, it's extremely likely the GDP deflator will shrink toward zero and real growth will struggle to make 2-3%. Hence, nominal GDP growth is almost certain to be even slower in the quarters ahead -- say 3% or $40 billion per month -- than it has been since last summer. This "realistic" outlook compares with the Office of Management and Budget forecast, which assumes double this level of nominal GDP growth of a 6% annualized rate, or about $75 billion per month.
At the same time, there's virtually no chance unemployment will drop much below 10% in the context of a deflationary "recovery," meaning that budget costs for unemployment, food stamps, etc. will remain elevated, not come down by hundreds of billions as currently projected, either.
Consequently, under the current policy baseline and including extension of the Bush tax cuts -- at a cost of about $300 billion per year -- and with even mildly deflationary economic assumptions, it's not possible for the baseline deficit to drop much below $1.5 trillion any time before 2015.
Triple the debt
So we have baked into the cake a rather frightening scenario: monthly federal debt growth upwards of $125 billion, or three times the likely nominal GDP growth of $40 billion per month -- as far as the eye can see. See "The Main Event: Inflation vs. Deflation."
The publicly held federal debt will be about $9 trillion when the fiscal year ends in September, and since it now is growing at 3 times that of GDP, it should reach $12 trillion at the next presidential inauguration in January 2013. Adding in state and local debt, we'd be at $15 trillion, or a Greek-scale 100% of GDP before the next cabinet is picked.
Every reason of prudence says not to tempt the financial gods of the global bond and currency markets with this freight-train scenario: Do something big to close the deficit, and do it now.
Also, there's no possibility in either this world or the next of obtaining the needed $700 billion to $1 trillion in structural deficit reduction by spending cuts alone. We've had a rolling referendum since the first Reagan budget plan in 1981, and progressively over these three decades the Republican party has exempted every material component of the budget from cuts, including middle-class entitlements, defense, veterans, education, housing, farm subsidies and even Amtrak!
Like Casey, the GOP has been in the anti-spending batter's box for 30 years, and has never stopped whiffing the ball. The final proof is that the one GOP spending cut plan with any integrity -- the "roadmap" of Congressman Paul Ryan -- has the grand sum of 13 co-sponsors, and I dare say half would call in sick if it ever came to a vote. Therefore, tax increases are now needed because it's too late and too urgent for anything else.
Plus, both the Keynesians and the supply-siders are wrong about the alleged detrimental impact on the business-cycle recovery of a big deficit reduction package, including major tax increases. The reason is that both focus on GDP flows, with Keynesians pointing to a subtraction from consumer "spending" and the supply-siders emphasizing a detriment to output and investment.
Blocking the flow
Under present realities, though, the problem isn't the flows; it's the massive, never-before-seen stock of combined public and private debt that's depressing the economy, which overwhelms any "flow" effects from fiscal policy. Specifically, at $52 trillion, credit-market debt today is 3.6 times that of GDP, compared with 1.6 times that of GDP when the original argument of supply-side versus Keynesians opened up back in 1980.
Moreover, this 1980 total economy "leverage ratio" hadn't fluctuated appreciably for 110 years going back to 1870. So I call it the "golden constant," and note that had the total economy-leverage ratio not gone parabolic after 1980, credit-market debt today would be $22 trillion at the 1.6 times ratio.
In short, the economy is freighted down with $30 trillion in excess debt. The process of liquidating the household and business portion of this -- about $24 trillion -- will swamp the normal cyclical recovery mechanisms for years to come. And it's insane to keep adding the mushrooming public-sector portion of the debt or order to artificially juice the GDP numbers for a few more quarters.
Finally, in the context of secular debt deflation, the overwhelming priority is public-sector solvency, not conventional growth. So policy needs to be geared to long-term balance-sheet repair, not short-term flows. In every sector -- household, government, business -- the numbers are awful, and far worse than the bullish mainstream seems to recognize. See "Why Government Spending, Public Sector Jobs Are Burden to Society"
Let me close with one example: At least once a day someone on CNBC talks about the $1.5 trillion in corporate cash on the sidelines and how healthy business-sector balance sheets are.
That's pure baloney. If you peruse the flow of funds, and you'll see that corporate-sector cash assets have increased by $279 billion since the December 2007 peak, and now total $1.72 trillion. According to the same data, non-financial, corporate-sector debt has increased by $480 billion and now stands at $7.2 trillion. Corporate debt net of cash has actually increased by $200 billion during the Great Recession.
Stated differently, corporate debt net of cash was $5.3 trillion or 36.7% of GDP at December 2007 and is now $5.5 trillion or 37.6% of GDP. There's been no de-leveraging in the business sector either -- especially when its noted that tangible assets have also declined by 20% on a market basis and are flat on a book basis during the same period.