Politics & Policy

The Specter of Default

We need to restore sanity to national economic policy.

The core of the tumult in current public discussion is the whipsaw between those who dread inflation and those who fear a relapse into economic decline and are aroused about health care. It took the former administration (but the same Federal Reserve chairman, Ben Bernanke) an unconscionable length of time to “break the glass” and pull the fire alarm, in former Treasury secretary Hank Paulson’s words. Then there flooded out from the Federal Reserve an unprecedented 100 percent one-year increase in the money supply, 30 or more times what is normal, as the Treasury bought hundreds of billions of dollars’ worth of “troubled” or “toxic” assets.

This total monetary immersion staved off the feared collapse into depression, which the fearmongers, especially on the pre-Reagan left, were excitedly bandying about. But unemployment has continued to rise, the economy has not really revived, and the United States, which had been encouraged by its fiscal and monetary guardians for over a decade not to save anything, but to binge on unaffordable housing and non-essential goods whose production had been outsourced to China and Japan and paid for with borrowings from China and Japan, has rediscovered the virtues of savings. Banks, heavy-laden with the taxpayers’ money, are still too shell-shocked to lend, and the public is too shaken to spend. Personal and corporate loans are being sensibly paid down, to a large extent with money created for the occasion by the Federal Reserve.

#ad#Within this deepening vortex, the vast and unedifying battle of health care has raged and stormed, as the ambition to ensure that all have health insurance has been overtaken by the debate about costs. Medical care in the U.S. costs $3,000 per capita more than in other advanced countries. Switching course in mid-tempest, the administration claimed that it would reduce medical costs by taking over the insurance of those already covered. The cost-conscious didn’t believe it, and those concerned about covering the uninsured were unimpressed.

Until the risks of being awash in newly created money were finally recognized as the 800-pound self-inflating tiger in the room, the administration and congressional leadership were hinting at a new stimulus package. As was widely seen at the time, the $787 billion stimulus bill was a disaster, a riot of children left to ransack the candy store and gorge themselves. It stuffed money into the districts of prominent Democrats in Congress, on a delayed trip-wire to coincide with upcoming elections, as less than a quarter of the money has been spent; but it has been a very inefficient job-creator. The whole concept of stimulus is bogus, as the borrowing of the money consumes at least as much stimulus as it generates.

There was no excuse for such a bumbling program by this administration. The procedural playbook, if not all the substantive policy, was written by Franklin D. Roosevelt 75 years ago: Prepare a precise program, round up public support for it, send completed bills to Congress and ram them through, alleviate unemployment with low-paid conservation and infrastructure workfare, and solve banking problems with investments in the banks, not in their worst assets. Instead of that, we have witnessed a bunch of grumpy boy scouts trying to put up a pup tent in the dark.

With Social Security, Medicare, and the FDIC (totalling $125 trillion of obligations) as well as the Federal Reserve itself now confronting appalling debt scenarios (the Fed’s loans and other advances, some of them vulnerable, are backed by hard assets of only about one half of 1 percent of the obligations), the administration projects trillion-dollar annual deficits for ten years. Obviously, the Chinese and Japanese are not going to go on buying this debt, and have already moved much of what they hold to short-term Treasuries, to translate into U.S. assets at knock-down prices. To sell on any real market any serious amount of this debt in the next decade would require torqued-up interest rates, which would be steroids for bulging debt, while strangling economic growth. It would be the 30-year-old bugbear of stagflation. And most is already being bought by the Federal Reserve: a straight open-faucet addition to the money supply, future inflation, and the reduction of the dollar’s value.

The present health-care bills include large tax increases. The proposed cap-and-trade bill to reduce carbon emissions would pile increased heating and air-conditioning costs on homeowners and employers, but would neither reduce emissions nor raise government revenues. The whole program is based on the unproved eco-terror arguments that have made Al Gore a Nobel Prize laureate centimillionaire, and the bill is ill-conceived if not insane.

It is also mad to increase taxes when in, or just starting to emerge from, a recession. Contemplation of debt on the scale now envisioned, plus negligible interest rates, has driven up the price of gold, undermined the dollar, and pushed the stock market to unnatural highs of 17 times anticipated (tax-loss-increased) cash flow. It has also produced destabilizing flights of capital to Brazil, Canada, Australia, and China, all of which are coming through (provisionally in China’s case) the recession well. The first three are natural-resource exporters; China the low-cost exporter, saver, and lender; the U.S. the borrower and consumer, i.e. the chump. American leaders should embrace the prospect of an investment-based, rather than consumption-based, economy, rather than lamenting that people aren’t throwing their savings out of the windows buying mainly foreign-produced goods.

Currencies are only as strong as the economies they represent, and their values are determined by money supply and measured against one another. There is no reason to mourn the gold standard: The world’s currencies should not be dependent on the success of the world’s gold prospectors and mining engineers. But a little discipline goes a long way. The World Wars and the Great Depression have caused a century of accelerating inflation.

#page#Everyone should recognize that the issuance of trillions of dollars not representing any new production or value will generate inflation eventually, and there are no yardsticks of value except saleable assets and convertible currencies. When President Wilson set up the Federal Reserve in 1913, when President Roosevelt removed the gold convertibility of paper money in 1933, and when President Nixon removed the convertibility to gold in international transactions in 1971, there was noisy concern that the dollar was on a conveyor belt to worthlessness.

Although not unfounded, those concerns have been excessive, up to now. From 2004 to the present, U.S. federal unfunded liabilities increased by 50 percent, while revenue increased by 12 percent; and that unfunded obligation has increased by $9 trillion this year alone. The U.S. annual federal deficit is 13.5 percent of GDP, and the fact that most other advanced countries are in an only slightly less distressed condition by this measurement is no consolation. It just increases the vulnerability of the whole system. America has been terribly let down by all its economic leadership, political, institutional, corporate, and academic, and the damage to public and international confidence, naturally, is almost mortal.

What should happen — but there is little likelihood that much of it will — is the passage of a health-care bill that expands coverage for those not covered, caps malpractice awards other than in extreme circumstances, reduces the need for preemptive measures to avoid legal vulnerability, unites the consumer with the payer by providing a tax credit for anything beyond basic care, and taxes extensive employer coverage in the hands of the recipient. This would end the futile war of attrition between the inflation hawks and the militant health-care providers, but it would require the government to stand up to the lawyers and unions at the same time — an unlikely rush of political courage, especially for the Democrats.

The economic recovery is too soft to turn off the spigot now, but the 70 percent of the stimulus package that has not been spent should be scrapped and partially replaced with a payroll-tax cut. The president should be given stand-by authority to impose sales and services taxes on designated non-essential spending and to remove taxes on the income from savings, as a first line of defense against inflation before sharply raising interest rates, the traditional antidote, which is severe medicine.

Cap-and-trade should be dropped sine die, and tax increases should be confined to three measures. First would be a serious gasoline tax, with rebates to those who make their living in gasoline-intensive occupations like trucking. This would incentivize conservation, reduction of oil imports, and aggressive pursuit of new domestic sources of energy. Second, there could be a tax on securities trades and merchant-banking transactions, and related professional expenses. These activities have been horribly over-indulged and  scandalously over-compensated, have attracted too many talented people, and have led to too many bad deals that should not have been done. Mayor Bloomberg will have to stop living off the froth of Wall Street and curb the rapacious New York City public-service unions. Everybody loves Santa Claus, but he is out of season.

Third, a small, self-terminating wealth tax could be imposed on very large fortunes, to provide funds for those taxpayers to engage in legitimate anti-poverty projects they would devise themselves and have certified, like charities. The tax would decline as sensibly defined poverty declined, and would evaporate when poverty did. The greatest commercial minds in the private sector would have a vested interest in eliminating poverty and would produce a variety of imaginative methods of doing so.

The U.S. political process must stop its infantile wrangling and show cause for the world to believe that it will defend the financial integrity of the country, before discussion of U.S. default — which will otherwise become audible, soon — spooks the whole world.

— Conrad Black is the author of Franklin Delano Roosevelt: Champion of Freedom and Richard M. Nixon: A Life in Full. He can be reached at cbletters@gmail.com.

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