Congress has now passed, and President Biden has signed, the Fiscal Responsibility Act of 2023.  It suspends the debt limit until January 2025, after the next presidential election, as well as setting an overall budget for FY 2024, beginning on October 1, 2023.  According to the Congressional Budget Office (CBO), it will reduce deficit spending by $1.5 trillion over the next ten years, which is quite modest, given our very large and rapidly growing national debt of $31.4 trillion.

It is generally well understood that the entitlement programs of Social Security and Medicare are the biggest drivers of our exploding national debt.  Social Security needs some relatively modest tweaks (raising the eligibility age and/or income caps).  But Medicare’s future solvency is a much larger problem, which will have to be addressed soon.

Nevertheless, the just-enacted Fiscal Responsibility Act has several excellent features:

• It reduces non-defense discretionary spending from the 2023 level of $744 billion to $704 billion for 2024, although not quite to the 2022 level of $689 billion, see here and here.

  

• If the House and Senate fail to enact the required 12 appropriations bills for FY 2024 by the end of this calendar year, all discretionary accounts are subject to a 1% cut. In other words, a strong incentive is created for returning to “regular order” where spending amounts are debated and voted on by the various appropriations committees in both the House and Senate, rather than Congress passing an omnibus spending bill at the last minute.
• The important principle of work requirements for welfare programs is reinforced even though only small improvements are included in the new legislation.
• The fulcrum of the nation’s political mood appears to be moving to the right, on such major issues as spending, crime, the border, and parental rights. The Fiscal Responsibility Act, resulting from negotiations between President Biden and House Speaker McCarthy over the House Limit, Save, Grow Bill, establishes the Republican House as the prime mover of political change in the current highly polarized national environment.

Conclusion.  The new Fiscal Responsibility Act, passed by Congress and signed by President Biden, achieves only modest deficit reduction over the next ten years, but nevertheless is consistent with the somewhat conservative political mood of the American people and therefore could well lead to other valuable changes and improvements in national policy in the near future.

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The House Limit, Save, Grow Act has set the stage for the U.S. to achieve fiscal responsibility and return to a long-term path of sound money and growing prosperity. Here is how I understand what is now going on:

• House Republicans are now negotiating with the Biden Administration over the FY 2024 budget and an increase in the debt ceiling. The main element of the House budget plan would return discretionary spending in FY 2024 to 2022 levels and then limit increases to 1% per year, achieving savings of $3.5 trillion over 10 years.  According to CBO, this would stabilize our debt at 110% of GDP (see chart below).

  

• Also, according to the CBO, a budget cut of this size will reduce economic growth in 2024 by about .5%, thereby slowing down inflation. This means that the Fed will be able to reduce interest rates more quickly, thereby boosting business growth and investment.  In other words, significant budget cuts will help the Fed fight inflation, which is critical for restoring economic health.
• As the House/Biden Administration negotiations proceed, default on our debt need not be a live option. Tax receipts are continuously coming into the U.S. Treasury. “There is no month of the year when interest on the debt will outstrip federal tax receipts.”  In other words, we can achieve a budget agreement to restore fiscal responsibility without an unnecessary, and artificial, debt ceiling deadline.

  

Conclusion.  The House Budget Plan not only makes a major contribution to fiscal responsibility, by stabilizing the national debt, but also will significantly help the Fed fight inflation.  President Biden’s latest approval rating is a low 37% because inflation is still so strong.  This means that the House Budget Plan, while highly beneficial for the country as a whole, will also help President Biden’s approval rating!  It should be considered a win-win for both sides!

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The House has passed a bill, the Limit, Save, Grow Act, to both set a budget for FY 2024 and simultaneously raise the debt ceiling by $1.5 trillion.  This is the way things are supposed to be done, i.e. in “regular order.”  Ideally, the Senate would then adopt its own proposed budget for next year (as well as a debt ceiling proposal) and then the two bodies would meet to come up with a common bill to send to President Biden for his signature or veto.

But our fragmented and polarized political system makes regular order almost impossible to achieve.  As it stands right now, President Biden will meet with Congressional leaders on Tuesday, May 9 to try to come to an agreement on raising the debt ceiling and adopting a budget for next year.

Here is why it is so important for next year’s budget to include significant spending cuts as insisted on by House Republicans.

• The current FY 2023 budget has a deficit projection of $1.4 trillion and President Biden’s proposed 2024 budget of $6.9 trillion represents a big increase in spending over 2023. (see below). In addition, CBO estimates that federal spending will equal 23.7% of GDP this year, well above the pre-pandemic level of 21% in 2019.

  
  

• The House Republican budget proposal for 2024 stills allows spending to increase year-by-year as a percentage of GDP, but at a somewhat slower pace than does the Biden budget, thereby slowing the growth of annual deficits and accumulated debt.

  

• U.S. economic growth is very strong as indicated by the latest (April 2023) job growth, unemployment data, and job openings.  This puts strong upward pressure on inflation and makes the Fed’s job to bring inflation down that much harder.

  
  
  

• The CBO estimates that the House budget and debt ceiling proposal would reduce federal discretionary spending by $129 billion in FY 2024, enough to knock about half of a percentage point off economic growth. This would allow the Fed to reduce interest rates faster than otherwise while bringing inflation back down to the desired 2% level.

Conclusion.  The Fed can’t fix inflation by itself.  It needs fiscal restraint as well.  This is exactly what the House Republicans want to accomplish with their proposed spending cuts for next year.  Hopefully, the House, the Senate, and the President can agree on a plan to both raise the debt limit and cut spending simultaneously to put us back on track to achieve both sound (inflation-free) money and a prosperous (growing economy) future.

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The U.S. is now in a rough patch with out-of-control spending leading to growing annual deficits, massive debt, and stubbornly high inflation.  Furthermore, President Biden is virtually clueless on basic economic and fiscal policy, while the leading GOP presidential candidate for 2024, former president Donald Trump, is under one criminal indictment with more expected.

Although it is clear in a general sense what is needed to get back on track, how do we get started in the right direction?

The budget bill introduced by the House Republicans, the Limit, Save, Grow Act, is an excellent way to start.  It would produce savings of $4.5 trillion over ten years and improve our fiscal trajectory going forward (see charts below).  The main features are:

• Return domestic spending to the level of FY 2022 and then limit growth to 1% per year for the next ten years.
• Establish a 20-hour-per-week work requirement for all able-bodied adults, between ages 18 and 59, without dependents, who receive food stamps or Medicaid. There are an estimated 40 million Americans on food stamps and 55 million on Medicaid, roughly 10% of whom would now be required to work for their welfare benefits.
• Returning all unspent Covid funds to the Treasury since the pandemic emergency is over. Additionally, stopping the forgiveness of college loan debt for students from wealthy families will save hundreds of billions of dollars.
• Raising the debt limit by $1.5 trillion or until March 31, 2024, whichever comes first. This reflects the approximately $300 billion saving under the House plan for 2024 compared to what is in President Biden’s proposed 2024 budget. The 2024 Biden budget proposal produces a deficit of $1.8 trillion next year compared to $1.5 trillion under the House plan.
• Default on the debt should not be a big concern.  Enough tax revenue continuously flows into the Treasury to pay interest on the debt and also pay priorities like Social Security.  Other parts of the government might have to operate briefly at reduced capacity, but this has happened before.

Conclusion.  It is imperative to get federal spending under much better control to avoid a new and much worse financial crisis in the near future.  The House Republican plan represents an excellent place to begin budget and debt ceiling negotiations between the House, the Senate, and the Biden Administration.

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The U.S. is in a rough patch at the present time.  The long-term steps needed to restore sound money and prosperity are clear.  But how do we get started?

• First, reduce inflation. Yes, inflation dropped to 5% annually in March 2023 from 6% in February.  That is progress but the Federal Reserve’s remaining job will be difficult.  If it continues raising short-term interest rates, it risks causing more bank failures.  If it stops raising interest rates, inflation will subside much more slowly.
• The analyst Andrew Puzder has a good discussion of what it will take to get back to strong economic growth.  Most basically, coming out of the pandemic, two things were clear. First, we knew that people had accumulated a lot of money.  The federal government handed out over $5 trillion during the pandemic and people had little opportunity to spend.  The second thing we knew was that fewer people were working.  These two factors combined to produce excess demand and less supply than normal.  In fact, the $1.9 trillion American Rescue Plan of March 2021 tripped off the ensuing inflation (see chart below).
• Believe it or not, we are still paying too many Americans not to work. A study from December 2022 shows that in 24 states unemployment benefits and ACA subsidies for a family of four with both parents not working are still the annualized equivalent of at least the national median household income.  Moreover, in 14 states (shown below), unemployment benefits and ACA subsidies are equivalent to a head of household earning $80,000 or more in salary, plus health insurance benefits.             

Conclusion.  The Federal Reserve has more work to do to bring down inflation to the desired 2% level.  And the recent banking crisis is making its job harder.  But the current labor shortage, which contributes to inflation by reducing supply, is unnecessarily worsened by paying too many people not to return to work.

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Last week I discussed the rough patch that our country is now in with still 6% inflation, out-of-control national debt, and fraught presidential politics.  But it is possible to turn things around; this has been done so far in American history.  Consider:

• Where we are right now.  Nonfarm payrolls increased by 236,000 in March and the unemployment rate dropped from 3.6% to 3.5%. There are still almost 10,000,000 job vacancies nationally.  Such a tight jobs market means that the March CPI (inflation) index is likely to be only slightly lower than February’s 6%.  Therefore the Fed will likely raise rates again when it meets in early May.  In other words, bringing inflation down to the desired 2% level will take longer than anticipated.  (Added on April 13: since the  latest inflation number,5%, is lower than I expected, I now expect that the Fed is less likely to raise rates in May.  This means that inflation may linger longer).
• How do we get back to sound money and long-term prosperity? Paul Singer, the founder of Elliot Management and one of the world’s most successful hedge-fund proprietors, has predicted all of the financial crises in the last 15 years.  He warned about the dangers of subprime mortgages, the excesses of the Dodd-Frank Act of 2010, and the expansive monetary policy ever since.
  He is afraid that short-term declines in inflation will deceive policymakers and that they’ll quickly go back to their easy money playbook.  If so, inflation will likely come roaring back, and interest rates will have to go higher for longer.
  He worries that the current market trouble is only the beginning.  Likely is an extended time period of jagged moves as people come to grips with the excesses in the financial system.
  His optimistic scenario going forward “would entail pro-growth reforms across the board, including tax reductions, entitlement reforms, regulatory streamlining, encouraging energy development including hydrocarbons … cutting federal spending, and selling the asset holdings on central bank balance sheets.”
  In other words, let us assume that Jerome Powel’s Federal Reserve can get inflation subdued soon as Paul Volcker’s did in the 1970s and 1980s.  Then we will still need a president like Ronald Reagan to implement the pro-growth reforms referred to by Mr. Singer above.  This is what happened in the 1980s and, with some luck, it will happen again.

Conclusion.   We are in a rough patch, a fiscal, economic, and political mess.  Mr. Singer is right on track for how to turn things around.  If we are fortunate, American exceptionalism will assert itself and lead us back to the promised land of sound money and long-term prosperity.

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As I have said many times on this blog, I am optimistic about the long-term future of the U.S.  The U.S. is not only the strongest country in the world economically and militarily, but the strength of the U.S. and its democratic allies together far surpasses the combined strength of our major adversaries: China, Russia, Iran, and North Korea.

But we have now clearly hit a rough patch. Consider:

• Inflation is still high at 6% (as of February 2023). The Federal Reserve is determined to bring it down by continuing to raise interest rates as high as necessary.  But now bank failure has become a problem precisely as a result of the rapid rise of interest rates.  If the Fed slows up on raising interest rates to save more banks, inflation will take much longer to subdue.
• The national debt has reached $31.4 trillion and the House Republicans (rightly) insist on big budget cuts in return for agreeing to raise the debt ceiling.  Hopefully, the Biden Administration will come to agree that a strong emphasis on fiscal restraint is imperative in the fight against inflation.

  

• Donald Trump has now been indicted for campaign finance violations dating back to 2016.  Since he is an announced candidate for reelection in 2024, this throws a wrench into the Republican primary process leading up to November 2024.  His indictment will probably unite Democrats and divide Republicans.  It makes Trump more likely to be nominated in 2024 and therefore more likely that President Biden will be reelected.
• Joe Biden is a disaster for the economy, with his strong support of massive new, deficit-financed, spending initiatives in the past two years.  His reelection in 2024 would likely continue this reckless spending blowout and put the U.S. at risk for financial default.

  

• Donald Trump and Joe Biden are both very poor choices for president. Trump had some policy victories in his previous term as president but he is too erratic and narcissistic to be a good choice for reelection.  Even though Joe Biden is doing a good job on Ukraine, he is economically incompetent and his reelection could easily lead to a new, and much worse, financial crisis.

  

• The one major event which is going well for the democratic world right now is the war in Ukraine. Russia’s invasion of Ukraine in February 2022 was a major miscalculation and is badly damaging the Russian economy.  Saving Ukraine from Russian domination would be a major victory for the free world.  It will make it far less likely that China will invade Taiwan anytime soon.

Conclusion.  Right now the U.S. is undergoing a rough period with the increased danger of prolonged inflation, a spending blowout by the Biden Administration and a more volatile U.S. presidential campaign in the offing.  But the U.S. and its democratic allies are very strong economically and militarily, which should enable us to ride out the current rough patch and continue to thrive for many years to come.  It would greatly help if neither Trump nor Biden is reelected in 2024.

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“No money shall be drawn from the Treasury but in consequence of appropriations made by law”                                        U.S. Constitution, Article 1, Clause 9, Section 7

The U.S. national debt now stands at $31.4 trillion, after enormous increases during the pandemic. The new Republican House of Representatives insists on significant spending cuts in return for agreeing to raise the debt limit.

The President’s budget proposal will be unveiled on March 9, a month later than normal.  Then the House and Senate Budget Committees mark up the President’s budget, pass their own individual budgets, and then come to an overall agreement through joint conference. (https://budget.house.gov/budgets/)

Finally, the House and Senate Appropriations Committees take over in May and pass individual spending bills for each of the various federal agencies.  Below are listed the Appropriations Subcommittees which do this work in the House of Representatives.   Finally, the separate House and Senate Appropriations Committees meet in conference to agree on overall spending levels for the federal agencies.

• Agriculture, Rural Development, Food, and Drug Administration
• Commerce, Justice, Science, and Related Agencies
• Defense
• Energy and Water Development, and Related Agencies
• Financial Services and General Government
• Homeland Security
• Interior, Environment, and Related Agencies
• Labor, Health and Human Services, Education
• Legislative Branch
• Military Construction, Veterans Affairs, and Related
• State, Foreign Operations, and Related Programs
• Transportation, Housing and Urban Development, and Related

Senator Joe Manchin (D, WV) is urging that Democrats work with Republicans on both short-term spending cuts for this year as well as a long-term plan to get entitlement spending under control.  This augers well for achieving real bipartisan cooperation.

Conclusion.  The U.S. has a very serious problem of huge spending deficits year after year.  The new Republican House has taken the lead n insisting that Congress return to traditional “regular order” in processing spending requests from each of the various federal agencies.  For now, it looks like our national leaders will be able to work together, across party lines, to begin a process to get the annual budgeting and appropriations processes under sustainable control.  A sound fiscal future depends on their success in doing so.

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Our biggest national problems at the present time are inflation and debt.  The annual rate of Inflation now appears to be stalled in the mid-6% range (6.5% in December and 6.4% in January) and our national debt is sitting at $31.4 trillion.  The Federal Reserve is determined to bring inflation back down to the 2% range.  Already short-term interest rates have been boosted by 4.25% and are likely to have to go up much further.  The problem is that the economy is not responding like it was expected to.  Consider:

• The economy has been very strong in the past year.  The $5 trillion in Covid fiscal stimulus has a long tail. Years of low-interest rates have transformed debt dynamics for the overwhelming majority of U.S. households, leaving them largely shielded from the current high-interest rates.
• The changing debt profile has allowed consumers, still cash rich from the flood of fiscal stimulus unleashed in the wake of the pandemic, to keep up their high levels of spending on services, especially as Americans have shifted away from the goods they had been buying during Covid shutdowns.
• With over 10 million unfilled jobs in the economy, a hiring surge of 517,000 new employees in January 2023, and a very low 3.4% unemployment rate, wages are increasing rapidly.  An undersupply of housing, in combination with fresh federal investment in infrastructure, has kept the construction industry in business.
• Some Covid spending programs, such as expanded nutrition aid, are only now winding down, while federal spending on green infrastructure initiatives, is just beginning to flow out.
• This positive economic data has fueled hopes of a “no landing” scenario – rather than a hard or soft landing – in which the economy continues to expand. But a more realistic outlook is less benign: interest rates are likely to stay higher for longer to tamp down stubborn price growth, probably forcing at least a mild downturn along the way.
• A no-landing scenario, in other words, is simply a delayed landing because the central bank will keep policy tight until inflation falls. And whether it will be a contractionary crash or a smooth glide back to 2% inflation remains to be seen.  Thus, even unprecedented economic strength so far isn’t enough to ensure that the Fed can avoid a painful outcome.

Conclusion.  The Federal Reserve is committed to reducing our current high rate of inflation back down to the normal 2% range.  But the Fed can’t fix inflation by itself.  It needs fiscal restraint from Congress and the President.  And it’s not getting it from the Biden Administration.  This is making the Fed’s job much harder and more likely to have painful side effects for the overall economy.

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Last week I pointed out that President Biden is being fiscally irresponsible by downplaying our massive national debt, high rate of inflation and rapidly increasing interest payments on the debt (because of rising interest rates).  All of this, and more, has now been carefully documented by the Congressional Budget Office.

Consider:

• The pandemic is over but federal spending in 2022 still rose to 24.8% of GDP from an average of 21% of GDP from 1973-2022. It is predicted by the CBO to continue to be 24.9% of GDP, ten years from now in 2033.

  

• Although revenues were up to 19.6% of GDP last year, this still amounts to a deficit of 5.2% of GDP. Again, the CBO predicts an even higher deficit of 6.9% of GDP in 2033.
• The inflation rate fell from 6.5% in December 2022 to 6.4% in January 2023, in other words, just barely. This means that the Federal Reserve will have to keep raising interest rates aggressively for much longer to get inflation back down to the desired level of 2%.
• The higher the rate of inflation and the higher that interest rates must go to bring it down, the more likely the chance of a hard “recessionary” landing.
• The Treasury has to roll over 30% of our $31 trillion of debt, more than $9 trillion, in the next 12 months at interest rates now approaching 5%. This, of course, makes the debt that much worse.

  

• Amid the fiscal mess now being made worse by the Biden Administration, the Republican House wants the federal government to adopt a plan to reduce federal spending!  What could make more sense?
• “The bottom line is that the President and the Democrats have built a much larger federal government that is taking nearly a quarter of all national income, up from about a fifth over the last fifty years.”

Conclusion.  In our dangerous fiscal climate of massive debt, high inflation, and rising interest rates, the Biden Administration has dramatically increased federal spending.  This is highly irresponsible and speeds up the inevitable day of fiscal reckoning which can’t be postponed forever.  It should be opposed as strenuously as possible.

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