The Precarious Fiscal Position of the U.S.

Our most serious national problem is inflation and several of my recent posts have been devoted to this topic.  I believe that the Federal Reserve is serious about bringing down the rate of inflation to the desired level of 2%.  Getting this done has major implications for our economy.

The only way the Fed can lower inflation is to slow down the economy, perhaps causing a severe recession, by raising short-term interest rates.  But higher interest rates mean much higher interest payments on our enormous national debt.  Consider:

  • National Debt. The national debt held by the public (on which we pay interest) is now about $24 trillion, almost 100% of GDP, as high as it was at the end of WWII (see chart).  And it will likely continue growing rapidly in the years ahead.

  • Federal Spending could soon be dominated by just three different items, healthcare programs, social security, and interest payments on the debt (see chart).

  • Interest Payments on the Debt. Estimated at $400 billion for Fiscal Year 2022 (which ends on September 30), interest payments on the debt are projected to reach $1.2 trillion in 2032, just ten years from now (see chart).

  • 30-Year Debt Projection. From about 8% of total federal revenues in 2022, interest payments on the debt could easily spiral up to 40% of federal revenues by 2052, 30 years from now (see chart).

  • Alternatively, interest payments on the debt, at 1.6% of GDP in 2022, are projected to increase to 7.2% of GDP in 2052, 30 years from now (see chart).

Conclusion.  These projections about how fast interest rates, and thus interest payments on the debt, are likely to grow, are conservative and depend on how aggressive the Federal Reserve is in raising short-term interest rates.  If more persistent inflation requires the Fed to raise interest rates even higher, then interest payments on the debt will grow even faster than projected above.
If nothing is done in the meantime, a severe crisis will likely occur before interest payments on the debt reach $1 trillion per year (projected to occur in just 2030, eight years from now).
In other words, the President and Congress have only a few years to adopt strong fiscal restraints (i.e. dramatically reduce annual deficit spending) before a very serious crisis occurs.  Let’s hope that our national leaders are up to this arduous task!

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The Fed Chair, Jerome Powell, Is Serious about Beating Inflation

“Our responsibility to deliver price stability is unconditional.  We are committed to doing that job”                                                 Jerome Powell. Jackson Hole. August 26, 2022

Last week I wrote that we should be optimistic about the future of our country.  I discussed several major trends that are going in the right direction.  But, of course, we do have one big problem right now which may get worse before it gets better.  I’m talking about price inflation.

What Mr. Powell basically said by implication at Jackson Hole is that “inflation must be beat, and it won’t be pretty.”  The problem is made more difficult because the Fed is fighting several headwinds at the same time.  Consider:

  • Globalization. In the 1990s multinational companies constructed global supply chains focused on driving down costs by finding the cheapest place and workers to produce products.  After the pandemic and the Ukraine war disrupted supply chains, many business leaders adopted new processes to increase reliability even if they cost more, such as by moving production closer to home or buying from multiple suppliers.  In other words, globalization is now on hold (see chart). This means higher prices for many items.

  • Labor markets. The U.S. labor force has roughly 2.5 million fewer workers than since the pandemic began compared with what it would have been if the pre-pandemic trend in workforce participation had continued, and after accounting for the aging of the population (see chart).  This means that labor costs are rising faster than usual.

  • Energy, commodity prices. For various reasons, energy and commodity firms haven’t heavily invested in new production over the past decade, creating risks of more persistent shortages when global demand is growing.  This, of course, also raises prices.
  • Fiscal policy. As I have previously discussed, President Biden’s spending policies, including the so-called Inflation Reduction Act, in the past year alone, have increased deficit spending in the short term.  And this doesn’t take into account the inflationary effects of the student debt forgiveness plan, which will cost roughly $500 billion over a ten-year period, as well as driving up the costs of higher education and loans going forward.

Conclusion.  The $5 trillion Covid stimulus spending tripped off the latest inflationary spiral which has now reached 8.5% as of July 2022.  So far, the Fed has raised short-term interest rates 2.5 percentage points and will have to raise them much higher in order to bring inflation back down to the desired 2% level.  Each 1% sustained increase will increase interest payments on our national debt by over $200 billion per year which will make our annual deficits, currently running at about $1 trillion per year, that much worse.  This is a huge problem that must be urgently addressed.  It can be solved, of course, but it will take a great deal of fiscal responsibility (i.e. cost cutting) to get the job done.  Are we up to this major challenge?

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Americans Should Not Be So Gloomy about the Future

I am optimistic about the future of the United States, as I have explained many times on this blog.  But pessimism is much too prevalent in the media.  A list of current problems: the botched Afghan pullout, urban crime waves, easily foreseen inflation, mayhem at the southern border, a self-generated energy crisis, etc.

But consider:

  • The pandemic is well under control, at least in the U.S.  The latest wave of daily new infections is shrinking (see chart) and the CDC has relaxed its safety guidelines.
  • The Ukrainians are holding their own against the Russian invasion of their country. They want freedom and democracy and are willing to fight and die to achieve it.  The U.S. and its NATO allies are providing Ukraine with weapons and military supplies which are being used effectively by the Ukrainian military forces to slow Russian advances to a standstill.  The whole world sees how the West is helping Ukraine defend itself.  This is a big boost for democracy around the world.
  • American democracy is in good shape.  In fact, democracy is thriving in the U.S.  The 2020 presidential election was a stress test but democracy came through in excellent shape.  Since there were, however, pandemic-related voting irregularities in 2020, red state efforts to tighten up voting procedures for mail-in and absentee voting are simply a common sense approach to maintaining election integrity.
  • Inflation really is, of course, a big problem.  We are already in a mild recession that is likely to get worse if the Federal Reserve continues to act aggressively in raising interest rates in order to bring inflation back down to the desired 2% level.
  • Deficits and Debt. Our rapidly growing national debt, now in the vicinity of $30 trillion, as well as Federal Reserve bond holdings (quantitative easing), in the vicinity of $9 trillion, have become a loaded time bomb of loose fiscal and monetary policy.  The $5 trillion in Covid-related stimulus spending essentially blew the cork out of the (debt) bottle and tripped off our current bout of inflation.  The FED can lower the inflation rate back down to the 2% level by acting aggressively.  But, to keep inflation under control in the future, we must rapidly reduce our annual spending deficits.  Hopefully, our national leaders will now be able to much better appreciate the need for real fiscal responsibility and have the political will to get this job done!

Conclusion.  The U.S. is in good shape in a general sense in spite of several particular problems as mentioned.  Inflation is, however, very urgent and serious and must be dealt with firmly by the Federal Reserve.  Since inflation was tripped off by excessive stimulus spending, Congress and the President will now have to act in a far more fiscally responsible manner to keep inflation under control.

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Does the Biden Agenda Really Help Reduce Inflation?

The United States has serious problems to address at the present time such as the Ukraine War and Climate Change.  But, as I have recently discussed, the most serious and urgent problem of all is inflation.

Our enormous national debt of $30 trillion, plus the trillions of dollars in bond holdings by the Federal Reserve (Quantitative Easing) have created far too many trillions of dollars sloshing around in the U.S. monetary system.  It is not surprising that another $5 trillion in Covid stimulus spending in 2020 and 2021, especially the last $1.9 trillion after Joe Biden became president, has now tripped off a sharp increase in inflation.

The current issue of Barron’s warns that inflation is worse than it looks and harder to solve.  This is because of three shortages: labor, energy, and trust in government which have resulted in structurally higher inflation than most people realize. The U.S. workforce has shrunk 12% since the beginning of the pandemic and the transition to green energy means consuming more resources for similar output.  Furthermore, inflation is inversely proportional to the level of public trust held by a country’s citizens, with trust in institutions scarce in high-inflation countries.

The Biden Administration’s Inflation Reduction Act (IRA) purports to address inflation by reducing the deficit by $300 billion over ten years.  But, as pointed out by the Concord Coalition, the deficit reduction is back-end loaded and so may never actually occur.

But more generally, as pointed out by Greg IP in the Wall Street Journal, the IRA is only one of several major pieces of legislation signed by Mr. Biden in the past year.  For example, he signed a bill that vastly expands benefits to veterans exposed to toxic burn pits which adds an estimated $278 billion to deficits over the coming decade.  The infrastructure law from late last year adds $257 billion over a decade and the semiconductor manufacturing and scientific research law adds $79 billion.  This all adds up to a net increase in the deficit by $300 billion, not a $300 billion deficit decrease.

Mr. Biden is thus clearly not giving priority to deficit reduction. His priorities are expanding the social safety net, narrowing social and racial inequities, and combatting climate change.

The deficit reduction in the IRA (see chart) mostly takes place from 2027 – 2031.  But the time to help the Federal Reserve is now, with inflation running above 8%.  The immediate spending on the Internal Revenue Service and healthcare subsidies increases the deficit in the short term.  Again, incentives to invest in green energy, domestic semiconductor manufacturing, and public infrastructure only boost the economy’s supply side in the long run.  In the short term, such investment adds to demand.

Conclusion.  Helping veterans, lowering the cost of healthcare, and encouraging domestic semiconductor manufacturing are worthy goals but they increase deficits, and therefore inflation, in the short run.  The Federal Reserve will have a difficult time reducing inflation on its own. It needs help now!  The Biden Administration should be putting far more emphasis on immediate deficit reduction.

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The U.S. Greatly Needs a Sustainable Climate Policy

I have discussed global warming on this blog many times, most recently here.  Global warming is real and serious but it is not an emergency.  We know that the temperature has risen by 2 Fahrenheit since preindustrial times.  Arctic sea ice is receding.  The ocean is rising at the rate of one foot per century.  Miami could, theoretically, be flooded in a hundred years, but it has lots of time to adapt to rising sea levels.

The greatest threat to the decarbonization of energy sources comes from unsustainable energy policies, especially those proposed by the current U.S. administration.  America’s announced climate goals seek a transition to 100% clean electricity by 2035 and net-zero carbon emissions by 2050.  Such aggressive timelines are at odds with three hard realities: economic, geostrategic, and political.

  • According to the federal Energy Information Administration, global demand for energy will rise nearly 50% by 2050, with fossil fuels still accounting for roughly 75% of the world supply.  A McKinsey & Co. report shows that achieving net-zero carbon emissions globally by 2050 would require $6 trillion in new spending every year for the next 30 years, clearly a practical impossibility.
  • It is increasingly clear that both Russia and China view aggressive Western climate commitments as an opportunity to increase their power and influence.  We have already witnessed what Europe’s reliance on Russian natural gas has wrought: unacceptable dependence on one of the world’s vilest governments.  Meanwhile, China continues to increase its use of fossil fuels as it tries to catch up to and surpass the U.S. as the world’s largest economy.
  • Without committed action by the Group of Seven nations – the U.S., Canada, France, Germany, Italy, Japan, and the U.K. – there is little hope for real climate progress in the coming decades.  And these are the world’s leading democracies, accountable to their public.  The voters in these countries could easily rebel against energy policies that ramp up energy prices, hinder economic growth, and even lead to rationing and blackouts.  According to a July NYT/Siena College poll, only 1% of U.S. registered voters rank climate change as the country’s most important issue, far behind inflation and the economy.

The U.S., which sits atop massive natural gas reserves and has the world’s most innovative economy, is perfectly positioned to lead a realistic green transition.  The administration should announce that U.S. natural gas will become the world’s vital bridge to an eventual carbon-free future.  The U.S. should also strongly support research in carbon capture and storage, the development of lightweight, high-capacity lithium batteries, and next-generation nuclear reactors.

Conclusion.  A transition to clean energy will be more effective and happen more quickly if it is based on sustainable policies and makes full use of America’s vast resources and well-known capacity for innovation.

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What Is Our Most Urgent Problem at the Present Time?

The United States, and the rest of the world, are facing three major problems at the present time: the War in Ukraine, Global Warming, and Inflation.  I have written about all of these problems separately in the recent past, see here, here, and here.

These three problems are, in fact, highly interrelated.  Consider:

  • The Ukraine War. Ukraine wants to be free and independent.  Russia invaded Ukraine to keep it in its own orbit.  The brave Ukrainians are willing to fight and die to expel the Russian forces.  The U.S. and its European allies are helping Ukraine defend itself by supplying military armaments.  This should be continued as long as Ukraine is willing to resist.   But Europe is dependent on Russian gas and Russia is now threatening to cut off gas exports to Europe. This puts huge pressure on Europe to find alternative sources of energy.
  • Global Warming. Global warming is real and serious.  But we need to keep things in perspective.  Yes, the average world temperature has risen 2 degrees Fahrenheit since pre-industrial times.  Although half a million people die each year from heat, 4.5 million perish each year from cold.  Cheap and reliable energy is needed to afford air conditioning in the summer and heat in the winter.
    Rising fuel prices are also making food more expensive.  Low-cost synthetic fertilizer, made from natural gas, is one of the greatest technologies mankind has invented for feeding the world.
    The world gets almost 80% of its energy from fossil fuels.  Instead of sending energy prices sky-high by trying to force a premature transition to renewables, we should focus on funding research to decarbonize traditional energy sources, such as carbon capture and storage, that are affordable and reliable.

  • The annual inflation rate has now reached 9.1% and the Federal Reserve has just raised interest rates again by .75 percent, for a total increase this year of 2.25%, not nearly as much as the 7% increase in inflation during the past year.  Such a modest plan for fighting inflation is based on the optimistic outlook that Pandemic- related supply problems will quickly resolve themselves.
    But focusing on supply issues only does not take into account the enormous buildup in national debt as well as Fed bond holdings (quantitative easing) in the past decade.  This has created an enormous amount of money sloshing around in the economy which has caused way too much artificial stimulation.
    A more aggressive Federal Reserve, aided with fiscal restraint by Congress, will get our inflation rate back down to a reasonable level more quickly and with less pain in the long run.

Conclusion.  The U.S. is handling the Ukraine War as well as it can.  But the war is putting Europe in a bind because Russia is threatening its energy supplies.  Trying to make a transition to clean energy too quickly is causing a lot of unnecessary pain and suffering around the world.  On the other hand, inflation is a more urgent problem than is recognized by our national leaders.  The Federal Reserve and Congress should be taking it much more seriously than they have so far.

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The Federal Reserve Cannot Fix Inflation by Itself

Inflation is now increasing at a 9.1% annual rate.  The Fed is likely to increase short-term interest rates by at least .75% (perhaps as much as 1%) at its July meeting in order to reduce demand by slowing down the economy.  Increasing interest rates is a blunt tool.  It could easily set off a recession and put a lot of people out of work, creating additional misery at a time when wage increases are already lagging behind price increases.

In my last post, I discussed the basic causes of inflation, namely irresponsible deficit spending by Congress over many years as well as the huge amount of quantitative easing carried out by the Fed in recent years.  These actions have enormously increased the amount of money floating around in the economy by many trillions of dollars.  On top of this enormous buildup of federal debt in the system, it was the $5 trillion in Covid relief stimulus funding in 2020 and 2021 which tripped off the current flare-up of inflation.

Of course, the Fed must now take the strong measure of raising interest rates.  But the Fed cannot fix inflation by itself.  It needs help from Congress on fiscal policy.  Here are a few things that Congress can do:

  • Stop digging, i.e. stop making the inflationary environment worse. This includes ending the remaining Covid relief – that is boosting price levels by 0.2 to 0.7 percentage points.  Avoid adding more to the deficit by such measures as a gas tax holiday, student debt cancelation, expanded veteran’s benefits, or new tax cuts.
  • Lower health care costs. Thoughtful healthcare reform, especially for Medicare providers, Medicare Advantage plans, and coverage of prescription drugs can significantly reduce the inflation rate.
  • Reform the tax code to raise more revenue. Tax increases can reduce demand in a distributionally desirable way, putting downward pressure on inflation.  Congress could also limit tax expenditures and subsidies which drive up specific prices in the economy.
  • Limit discretionary spending, reduce consumption-oriented spending, and shrink aid to states. Congress should reimpose discretionary spending caps and reduce spending on various programs from farm subsidies to Social Security benefits for high earners and federal aid sent to cash-flush states and local governments.
  • Promote work, savings, and investments. Congress could reduce barriers to work by eliminating the Social Security earnings test, allowing older workers to collect the Earned Income Tax Credit, and providing vocational training for disabled workers.
  • Lower energy, trade, and procurement costs. The government could reduce tariffs, end regulations that boost shipping costs, and encourage more extraction of fossil fuels.

Conclusion.  As described above, there are lots of things that Congress and the President can do to help the Fed bring inflation under control.  Such help would lessen the pain by speeding up the whole process, thus increasing the chance of achieving a “soft landing” with a shorter and milder recession than would otherwise occur.

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The Big Picture on our Inflation Problem

Inflation has now become a very serious problem for the U.S.  The annual rate is averaging above 8% (8.5% in March, 8.3% in April, and 8.6% in May).  The Hoover Institution’s John Cochrane has given an excellent analysis of the underlying fiscal and monetary policies related to inflation.  Consider:

  • The current inflation was sparked by fiscal policy – during 2020 and 2021 the government printed or borrowed $5 trillion and sent checks to people and businesses.
  • The Federal Reserve’s monetary policy tools to cure inflation are blunt. By raising interest rates, the Fed pushes the economy toward recession.  It hopes to push just enough to offset the fiscal stimulus boost.  But monetary brakes and a floored fiscal gas pedal mistreat the economic engine.
  • Higher interest rates will directly make deficits worse by adding to interest costs on the debt. Each percentage point interest rates are higher means $250 billion more in inflation-inducing deficit.
  • Many governments, including the Biden administration, want to address inflation by borrowing or printing even more money to help people pay their bills. That will only make matters worse.
  • Monetary policy alone can’t cure sustained inflation. The government will also have to fix the underlying fiscal problem.  Short-term deficit reduction, temporary measures, or accounting gimmicks won’t work.  Neither will a growth-killing high-tax “austerity.”
  • A favorable outcome requires economic growth, which raises long-run taxable income. The U.S. also needs spending reform, especially on entitlements.  And it needs to break the cycle that each crisis will be met by a river of printed or borrowed money, bailouts for the big financial firms, and stimulus checks for voters.
  • The good news is that inflation can end quickly, and without a bruising recession, when there is joint fiscal, monetary and economic reform. In the U.S. tight money in the early 1980s was quickly followed by tax, spending and regulatory reform.  Without these reforms, the monetary tightening might have failed.

Conclusion.  A very serious inflation problem is facing the United States.  It is clear (as described above) what needs to be done to address it.  Does the Biden Administration have the political will to get the job done?   Or will Biden flounder like Herbert Hoover did after the stock market crash of 1929 and allow inflation to remain a damaging economic issue all the way into the next presidential campaign?

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The Difference Between Equity and Equality

I have devoted many posts on my blog, ”It Does Not Add Up,” to the topic of racism in America, one of the most contentious topics in the public domain today. For example, “Is There Structural Racism Still Remaining in the U.S?” concludes that the major form of structural racism still existing is the academic achievement gap between blacks and whites, and suggests specific programs for addressing this disparity.

The newest hot topic in race relations is the concept of equity which means equal outcomes achieved, if necessary, by unequal treatment, biased competition, and preferential judging.  Equality, on the other hand, means equal treatment, unbiased competition, and impartially judged outcomes.

The problem with the concept of equity is that it challenges America’s bedrock principle that people should be treated equally and judged as individuals, not as members of groups.

Americans are very generous and support some form of social safety net for the poor and disadvantaged.  The debate has always been about how extensive the social safety net should be and how long it should last for each recipient.  But most Americans don’t want to turn welfare programs into large and permanent entitlement programs, giving substantially different treatment to different groups, even if those groups have suffered historical wrongs.

The black policy expert, Shelby Steele, says that blacks don’t have to fight so much for freedom anymore, but have to do something more difficult: fully accept that they are free, and stop acting like victims.

The black linguist, John McWhorter, explains that the current version of antiracism, in its focus on an oversimplified sense of what racism is and what one does about it, is content to harm black people in the name of what can only be called dogma. It exploits modern Americans’ fear of being thought racist to promulgate not just antiracism, but an obsessive, self-involved, totalitarian, and utterly unnecessary kind of cultural reprogramming.

The black scholar, Ian Rowe, promotes the four-point plan F.R.E.E. (freedom, religion, education, and entrepreneurship) for all children to overcome the victimhood narrative and discover their pathway to power.

Conclusion.  The problem with equity is that it has the radical goal of re-engineering society through coercion.   Equity is just a new brand name for a very old program of achieving equal outcomes.  Its name is socialism and we know from long experience that it doesn’t work.

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The Enormous Achievements of Western Civilization

“Hey, hey, ho, ho, Western Civ has got to go”
Reverend Jesse Jackson, Stanford University, January 15, 1987

Americans, and other people growing up in the western world today, are among the luckiest people in human history.  We are lucky because men and women before us worked hard to make it so and performed feats extraordinary and mundane to see that luck was what we got.  A luck that much of the world still wants to take part in.

Douglas Murray, in his new book, “The War on the West,” describes very clearly why westerners are so lucky.

Consider:

  • The west has given the world a disproportionate number, if not most, of the things that the world currently benefits from.
  • They include almost every medical advancement that the world now enjoys. They include almost every scientific advancement that the world now benefits from.
  • The west led the world in the invention and promotion of the written word. Westerners founded most of the world’s oldest and longest established educational institutions.
  • Western peoples happen to have also developed all the world’s most successful means of commerce, including the free flow of capital.  The system of free-market capitalism has lifted more than one billion people out of extreme poverty just in the twenty-first century alone.
  • It is the western people who developed the principle of representative government of the people, by the people and for the people. The western world has developed the principles and practice of political liberty, of freedom of thought and conscience, of freedom of speech and expression.  It evolved the principles of ‘civil rights,’ rights that do not exist in much of the rest of the world.
  • Western achievements have led to a footfall that is entirely one-directional. There is today no serious movement of peoples in the world struggling to get into China or Russia, as they are, at great personal risk, trying to move to America.  The migrant ships across the Mediterranean go in only one direction – north.  In spite of everything that is said against it, America is still the world’s number one destination for migrants worldwide.
  • The culture which is now so fashionable to deprecate remains the only culture in the world that not only tolerates but actively encourages a dialogue against itself.

Conclusion.  For all the above reasons and many more, Americans and other westerners have the highest quality of life that has ever been achieved in human history.  It is truly amazing that so many people in the West today apparently cannot see this.  Most of the rest of the world wants the same prosperity as well as the personal freedom and security that we enjoy in such great abundance.

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