A Sensible and Comprehensive Plan for Reducing Debt and Inflation

As I have been saying for many weeks on this blog, see here, here, and here, the closely related problems of inflation and national debt are by far the biggest and most urgent problems facing our country.

Finally, there is a sensible and comprehensive plan to address these problems put together by the Committee for a Responsible Federal Budget (CRFB).  It should be looked at carefully by everyone who realizes how dangerous our current fiscal situation now is.  The Plan is actually modest in that it doesn’t expect miracles.  But even to stabilize our current public debt (the $24 trillion on which we pay interest) at 98% of GDP over the next decade will require roughly $7 trillion in budget savings!

The Plan is a combination of revenue and spending changes – with savings from health care, tax reform, discretionary spending caps, energy reforms, and Social Security solvency, among other things.  Without major reforms such as these, our public debt will grow from 98% of GDP in Fiscal Year 2022 to 116% of GDP by FY 2032.  Here is a rough outline (to begin with!) of the CRFB Blueprint:

  • Stabilize and reduce the debt as a share of the economy. Failing to do so means leaving us at increased risk of higher interest rates and slower growth with fewer tools to address future needs and crises.  A comprehensive plan should prevent debt from rising as a share of the economy.
  • Support the Federal Reserve’s efforts to fight inflation. While the Fed is charged with fighting inflation, also using fiscal policy to help the Fed ensures that all policy is moving in the same direction, spreading the impact of inflation reduction across the economy, and reducing the likelihood and/or severity of recession.
  • Secure the major trust funds to prevent insolvency. The major trust funds, Social Security, Medicare Hospital Insurance (Part A), and the Highway Trust Fund are all headed for insolvency within the next 12 years, which would require abrupt cuts in benefit spending.  A budget plan should restore long-term solvency to these funds.
  • Promote long-term economic and income growth. Lower debt can help to grow the economy and specific policy reforms can further support work, promote investment, and reduce distortions.
  • Support fairness and efficiency throughout the tax code and budget. A budget plan should consider how to structure the budget and tax code more efficiently to better target resources where they are needed and can do the most good.

The above-outlined fiscal policies help to fight inflation by tempering demand, boosting supply, and lowering prices. 

Conclusion.  We now have a very serious inflation problem and our national debt is growing rapidly.  These two problems are intimately related.  While the Federal Reserve has the primary responsibility of fixing inflation, Congress and the President can help immensely by implementing serious fiscal restraint.  That’s what the CRFB blueprint plan, as described above, is proposing. More details will follow soon!

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How Do We Solve Our Inflation Problem?

By far the biggest problem in our country right now is inflation, which reached an annual rate of 9.3% in June and is now at 8.2%.  I have been devoting a lot of time with this blog in discussing various aspects of this problem, see here, here, and here.

Let’s summarize the fundamentals of inflation, and how to fix it, as explained by the economist John Cochrane in the Wall Street Journal.  They are:

  • Loose Fiscal Policy is the proximate cause of inflation, i.e. the most immediate cause. The government spent $5 trillion on Covid relief stimulus during 2020 and 2021 and thereby created huge spending deficits in those years (see chart).  These huge deficits created far more demand in the economy than could be quickly met and so prices started to increase.

  • The Federal Reserve has only a blunt tool to reduce inflation, namely raising interest rates to slow down the economy which, of course, risks causing a recession. So far, the Fed has raised short-term interest rates by 3% and will almost certainly continue raising rates for many months to come, to get inflation back down to the desired rate of 2%.
  • Interest Payments on our enormous $30 trillion accumulated debt have already started to increase rapidly because of the higher interest rates. This will, of course, make our already high annual deficits just that much worse.

  • The Federal Government will be tempted to spend even more money to help people pay their bills during the recession which may have already started. This will, of course, just make deficit spending that much worse.
  • Economic Growth is required for a favorable long-term outcome. This is what happened in the 1980s after the inflation of the 1970s.  Economic growth increases taxable income, and therefore taxes collected, which can be used to shrink annual deficit spending.  Along with economic growth is needed spending restraint, especially in the form of entitlement reform.
  • The Good News is that our inflation problem can be solved by fiscal (congressional), monetary (Federal Reserve), and regulatory (Presidential) policy working together, if these three branches of government are committed to working together.

Conclusion.  We are now faced with a very serious inflation problem.  It can only be solved by the Federal Reserve, Congress, and the President working together, as described above.  We can be confident that the Fed will do its part.  Are President Biden and Congress up to doing their own parts?  Only time will tell if we come out of our current predicament in a relatively comfortable way (with only minor economic pain), or whether we have new, and much worse, fiscal and debt crises to deal with along the way.

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The Biden Contradiction: Where He’s Right and Where He’s Very Wrong

My two favorite topics recently on this blog are 1) our fundamental strengths as a nation, and 2) my great concern about the damaging effects of high inflation.  In short, we’re doing a good job of providing leadership in the free world, but poorly in letting high inflation get such a strong grip on our economy.

More specifically, our current President Joe Biden is doing a good job on foreign policy but a very poor job on the economy.  Consider:

  • World Leadership. The Biden Administration’s new National Security Strategy Plan clearly identifies the challenges and opportunities facing the U.S. in dealing with our principal adversaries around the world: China, Russia, Iran, and North Korea.  In fact, the U.S. has many strengths to build on in dealing with these rogue countries.  U.S. companies are now, for example, responding to government incentives to withdraw from the Chinese Chip market.  In short, the Biden Administration is defending and further building on our strong record of supporting democracy and freedom around the world.
  • The U.S. Economy. Here the situation is the reverse of the above.  When President Biden took office in January 2021, the U.S. inflation rate was 1.4% and the economy was already recovering strongly from the Covid lockdowns and their consequent unemployment.  Nevertheless, despite strong warnings from many prominent economists, including Larry Summers, Congress passed, and President Biden signed, the $1.9 trillion American Rescue Plan in March 2021.  Inflation immediately took off, reaching a high of 9.3% in June 2022 and now sitting at 8.2% for September 2022.  Based on our experience in the 1970s and 1980s, the Federal Reserve will have to keep raising interest rates for many months to come, in order to force inflation back to the desired 2% level.  In the meantime, inflation has spread around the world, and hundreds of millions of people will be feeling the pain of higher prices and slowing economies.  Understanding that there are many contributing factors to inflation, see here and here, by tripping off the current inflationary spiral, the Biden Administration and fellow Democrats are largely responsible for inflicting this pain, not only on the U.S., but on the rest of the world as well.

Conclusion.  Giving credit where credit is due, President Biden is strongly supporting U.S. interests, broadly construed, around the world.  But his economic policies have been disastrous, tripping off a huge surge of inflation at home and abroad.  The answer is to elect a Republican Congress next month to put the brakes on excessive federal spending, in order to help the Fed bring the inflation rate back down to normal levels.

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The U.S. Has Huge Strengths in the Struggle for World Leadership

In recent posts, I have written that I am optimistic about the future of the U.S., but I am also quite concerned about the effects of the high inflation we are now experiencing.  In other words, we’re in overall good shape but there is going to be pain involved in getting inflation under control.  But compare our own strengths with the weaknesses of our main adversaries.

  • U.S. strengths. Our fundamental strength is a free and open society and a democratic form of government.   A free society like ours will always have urgent problems to address.  But our democratic form of government assures that the people will ultimately decide, with free and fair elections, how to resolve our differences and move forward.  Another huge strength is the superiority of a free enterprise economy (see chart) which will always out-compete the socialist alternative.  Yet another enormous strength is our good relations with the many other democracies around the world.  Stable democracies work out their differences peacefully rather than through war.

  • China’s weaknesses. China is basically a socialist country even though it has aspects of a free market.  It is not really free because the government arbitrarily controls its tech sector as well as its overbuilt real estate market.  And its zero-Covid policy is now creating huge economic problems at the same time as our own (democratic) decentralized response to Covid has pulled us out of the two-year pandemic.  China also has a huge demographic problem (its working-age population is shrinking) because of its previous one-child-per-woman policy.
  • Russia’s weaknesses. Russia’s President, Vladimir Putin, has been a worldwide trouble maker for many years, and has now made the huge mistake of invading Ukraine.  With the help of the U.S. and its European allies, Ukraine is defending itself heroically and even starting to repel the Russian forces.  There is growing opposition to the Ukraine invasion and to Putin, himself, even within Russia.  However the Ukrainian war plays out in the end, Russia has been diminished as a superpower.

  • Iran’s weakness. Starting with a young woman’s arrest and death over a head scarf, Iranians are protesting in droves fueled by middle-class anger over the country’s collapsing economy.  The mullahs running Iran are unwilling to enter a “longer and stronger” agreement with the U.S. to assure that Iran does not develop nuclear weapons.  Iran is now suffering from severe economic sanctions imposed by the West.

  • North Korea. North Korea is a threat to the U.S. because it has nuclear missiles.  The best defense for the U.S. against North Korea is to keep improving our missile defense capabilities.

Conclusion.  The United States has huge underlying strengths in the struggle for world supremacy against our main adversaries of China, Russia, Iran, and North Korea.  We have a far superior economic and political system than our rivals.  We also outclass them in military strength.  We should be confident in our ability to remain the world’s leading power for many years to come.  At the same time, we should never become complacent about our advantages and let our guard down.  Especially right now, we must take very seriously our high rate of inflation, and exercise the necessary fiscal restraint needed to bring the inflation rate back down to the desired 2% level.

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The Harmful Effects of High Inflation

As readers of this blog know, I am optimistic about the long-term future of our country,  because of our many fundamental strengths.  But I am also quite concerned about the effects of the high rate of inflation we are now experiencing, which is, first of all, driving up the cost of everyday living.

In the near term, the next few years, inflation is going to cause even more pain for millions of Americans.  Consider:

  • What inflation costs workers.  In 2021 inflation reduced real wage gains by 2.4% (see chart).

  • Mortgage rates surge.  The average mortgage rate is now 6.7%, the highest level since July 2007 (see chart). This adds pressure to the already cooling U.S. housing market.  Many would-be home buyers have given up, while many existing homeowners have become reluctant to sell.

  • Likelihood of recession. According to the economist Larry Summers, there is a very substantial likelihood of a recession over the next two years.  This is suggested by the current inflation rate of 8.3%, along with the current low unemployment rate of 3.7%, and the clearly stated goal of Federal Reserve Chair Jerome Powell to raise interest rates as high as necessary to bring the inflation level back down to the desired 2% level.

  • Interest payments on the national debt.  Rising interest rates are already dramatically increasing interest payments on our public debt of $24 trillion.  They hit $63 billion in August 2022 which computes to $756 billion on an annual basis.  Soon interest payments on the debt will exceed $1 trillion per year from the current level (in Fiscal 2022) of $400 billion per year.  Because of inflation, social security payouts will increase from $1.2 trillion per year to $1.3 trillion.  Federal healthcare costs (Medicare, Medicaid, etc.) which amounted to $915 billion in fiscal 2022, will grow by $163 billion next year.  If we do fall into a serious recession, federal tax revenue will erode.

Conclusion.   Workers falling further and further behind in the cost of living, prospective home buyers unable to afford to buy a house, a serious recession substantially raising the unemployment rate, and finally, huge increases in financing our growing debt coupled with recession-induced shrinking tax revenue, all these events will be very harmful to the economy.  Will this likely combined scenario put us into a “doom loop” of decline or “just” mire us in stagflation, draining growth potential from the national economy?  Either way, the whole process will be painful for tens of millions of Americans.

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Americans Are Too Gloomy about the Future III. The Partisan Divide

One of the themes recently on this blog is that Americans are too gloomy about the future. Yes, we have problems. Inflation is making daily life more expensive.  Political polarization is rampant.  Global warming is real.  China and Russia are trying to gang up on us.  But things are much better than they seem.

I consider myself fortunate to be an American because this is such a great country to live in.
I am amazed by the partisan breakdown of people who agree with me.  Consider:

  • Most Republicans, 91%, think that America is the greatest country in the world, while only 61% of Democrats agree. See the chart below.

  • Furthermore, 85% of Republicans think that if people work hard, they are likely to get ahead, while only 53% of Democrats agree. See the chart below.

  • Far more Democrats than Republicans think that the U.S. is worst or near the bottom in such issues as income inequality, acceptance of migrants and refugees, minority rights, religious tolerance, and LGBTQ rights. See the chart below.

  • These issues which exhibit such a partisan divide are as much cultural as economic in nature. Wokeness refers to the left-wing cultural program which represents the tastes and worldview of an insular class of white progressive elites, who sit to the left of non-white Democrats on social issues such as white supremacy, systemic racism, LGBTQ rights, and self-responsibility.

Conclusion.   It is remarkable how our two political parties differ with respect to the quality of life in America and the role and stature of America in the world.  Republicans are much more optimistic about our country than are Democrats.  Of course, we should all try to be realistic about our problems and how to solve them.  But I would rather have optimists than pessimists in positions of responsibility.

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Americans Are Too Gloomy about the Future II. Things Are Better than They Seem

Americans are too gloomy about the future of our country.  Inflation is appearing to be stubbornly persistent.  The political parties have a difficult time cooperating.  Covid just won’t go away.  Our super-power status is challenged by the rise of China.  Is there any good news?  Well, yes there is.  Consider:

  • Democracy is thriving at home. The two political parties are almost evenly matched in strength at the national level.  There is vigorous competition for the control of both the House and the Senate in the upcoming November 2022 elections.  The two big issues are the rise of inflation and abortion restrictions in some states.  Which issues will weigh most heavily with the voters?  We will soon find out!
  • Democracy is also thriving abroad. Ukraine wants to be free and independent and the Ukrainians are willing to fight and die to resist the Russian invasion.  The whole world is watching as the Ukrainians repel the Russians with the help of military supplies from the U.S. and its allies.  The Russian leader, Vladimir Putin, has become an international pariah.  This strengthens the forces of democracy around the world.
  • China is stumbling.  China’s zero-covid strategy has led to massive lockdowns in cities including Shanghai.  And China has additional huge economic problems resting on Mr. Xi’s pivot to the state by unleashing a crackdown on the property and tech sectors.  If China is foolish enough to invade Taiwan, the U.S. and it’s allies will again come to the rescue of democracy.
  • Global warming. The world temperature has risen 2  Fahrenheit since pre-industrial times and this means more evaporation into the atmosphere and more rainfall around the world.  This is likely the reason for the massive current flooding in Pakistan.  Global warming can be addressed effectively by focusing on de-carbonization rather than de-fossilization.
  • Inflation and debt. The annual inflation rate in the U.S. is now hovering above 8%. The Federal Reserve is serious about raising interest rates as high as necessary to bring inflation back down to the desired level of 2%.  This may cause a recession as well as dramatically increase interest payments on our massive and out-of-control national debt.  There is only one good solution to this problem: fiscal restraint by our national leaders.  This will cause some pain for Americans and require courage from our elected officials to accomplish.
  • Conclusion.  There are always serious and urgent issues in a free and open society like ours.  Right now our biggest problem is the high rate of inflation and the economic pain which will be necessary to bring it back down to a comfortable level.  As we begin to experience this pain more directly, I believe we will begin to take the steps necessary to solve this problem.
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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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