Lessons from the Other ‘Fiscal Cliff’

The infamous morning of Black Sunday, April 14, 1935 began as a bright sunny day filled with the hope that a three-year drought was finally coming to an end, but by evening, one of the most damaging dust storms in American history charged through the open landscape like a raging bull removing over 300 million tons of topsoil from the prairies, causing economic and agricultural devastation across the Midwest. It came at a low point during the Dust Bowl of the ‘30‘s when food and jobs were already scarce. By 1935 Congress initiated policies, incentives, and legislation that helped the economy to bounce back and its farmers to develop preventive measures that would save the Nation from what was then considered ‘the end of the world’. 

Nearly 77 years later, another bowl of devastation is heading our way loosely referred to as the ‘Fiscal Cliff of 2013’.  Its similarities to the Dust Bowl are truly striking, with one exception. the Dust Bowl of the 1930‘s was a natural phenomena caused by Mother Nature while the ‘Debt Bowl’ of today will have been self-inflicted by the US Congress.

During a recent PBS Documentary, the narrator quoted one of the families who had lived through the Dust Bowl era as saying that despite their efforts to plug every crack in their home, the dust still managed to get in. I could not help but think how, for the past decade, easy credit had similarly crept into every household in America the same way that dust had during the Dust Bowl. No matter how frugal one chooses to live today, Americans will be liable for not only their collective personal debt, but also their share of the rapidly growing National Debt. Like dust, our National Debt has infiltrated every American household for generations to come.

Washington Ideas Forum
Recently, The Atlantic Magazine, a political/business/entertainment publication, held their fourth annual Washington Ideas Forum at the Newseum in Washington DC where they conducted a series of live interviews with a Who’s Who list of Washington politicos including Senator Marco Rubio, Sheila Bair, Chris Matthews, Gene Sperling, and David Rubenstein. When asked to comment on the ‘Fiscal Cliff’, their combined assessments were bleak.  All of them agreed on the need to avoid the ‘Fiscal Cliff’, if at all possible, but like the example from the Dust Bowl era, they could not see any sure way to avoid the inevitable. The following is a recount of what they had to say.

Sheila Bair on the true Amount of Debt
Sheila Bair, the former head of the FDIC during the economic crisis of 2009, clocked the unsustainable size of US private debt at 160% of GDP, which she claimed was twice the size of the US public debt (80% of GDP). She noted that the size of the private debt had become a quiet secret that no one in Congress seemed eager to discuss. The private debt that goes unpaid, as we are seeing today with the recent unraveling of unpaid FHA loans, will eventually wind up on the US Government’s balance sheet and become every citizen’s concern. When added together, the aggregate public and private debt is truly astounding.  Bair has always preferred a ‘rip- off the band-aid quickly’ approach to the crisis and reminds her colleagues that banks should have taken a full hit early on to allow for a faster economic recovery. According to her intended strategy, banks that received government loans were expected to use the funds to realign their portfolio of home mortgages.  Instead they used the borrowed funds to increase their reserves and improve their capital ratios leaving home-owners with ‘underwater mortgages’ to their own devices.

Gene Sperling on Preserving a Tax Revenue Framework
Gene Sperling, one of Obama’s economic advisers, focused on the greater potential damage that could result from a surge in negative investor sentiment if Congress waits too long to act. Also present, David Rubenstein, a billionaire philanthropist, agreed.  Rubenstein felt that political uncertainty can create far more economic damage by holding businesses back from investing in their business and hiring new employees.

Sperling went on to defend the Democratic position of extending all tax cuts prior to the Holidays for those earning less than $250k/year, while hitting the remaining 2% of taxpayers with a hefty tax bill.  Republicans countered his proposal with a $50k tax deduction cap citing that the amount of tax revenues raised would match Obama’s plan ($750 billion/year).

Sperling’s response offered a glimpse at the intensity of the debate between both parties.  He felt that a tax deduction cap would discourage future donations to charities and non-profits, while encouraging the use of crafty lawyers to find tax loopholes for their rich clients.  Skeptical that the Republican plan would raise sufficient funds, Sperling noted that in principle the Republican plan would have ‘frozen the tax revenue framework’ by locking out the option of raising revenues at a time when voters today are willing to accept higher taxes.  If sufficient revenues were not raised using the Republican plan, Sperling points out, the onus of closing the revenue gap would fall on the middle class.

Senator Marco Rubio on Building a Middle Class
One could make a case that the Republicans may not have thought through their plan as thoroughly as the Democrats, but that is unlikely. Senator Marco Rubio, a young Republican hopeful for the 2016 Presidential elections, felt that Mitt Romney had failed to convince the American people how limited government and free markets can create a thriving middle class – a cornerstone in Republican ideology.

Rubio began his analysis by asking how the ‘fiscal cliff’ would reduce the national debt, if it also ‘wiped out’ small businesses through higher fees and taxes.  In his opinion any plan that does not include a comprehensive formula to stimulate growth is unsustainable and foolish.  The economy must produce something for it to service its debt, otherwise, its debt levels will continue to rise.  The products and services it produces will require jobs with new skills and those jobs can only be filled if the government invests in its workforce by, for example, making student financial aid accessible to anyone in need of proper training. Rubio notes from his Hispanic background that tomorrow’s workforce will depend upon a comprehensive immigration reform policy that balances the supply and demand for jobs as baby boomers continue to retire.

Rubio exemplifies a modernized version of a member of the Republican Party that our founding fathers probably had in mind, but he is only one person in a party severely split over a slew of self-serving cronies.  Many older Republicans have sided with arguing for the sake of argument rather than seeking ways to work together toward a common goal.

Chris Matthews on Restoring Respect in Politics
Chris Matthews, a news anchor and political commentator for the popular TV talk show Hardball, reminisced over the Reagan era when politicians respected each other’s office and compared the then-to-now changes with Senate Minority Leader Mitch McConnell’s comment that his number one priority going forward was to ensure that Obama would become a one-term President. McConnell’s comment coupled with Romney’s ‘47%’ blunder including his ‘self-deportation’ remedy for immigration during a debate have demonstrated how out-of-touch the older leadership have become, offering an unprecedented opportunity for young Republicans like Senator Rubio to regain control of the Republican Party and its true ideology.

Summary Remarks
Historically crises such as the ‘Fiscal Cliff’ have a silver lining.  They can whip a complacent and divided group of leaders into line and force them to work together despite their differences. During the famous Dust Bowl, President Roosevelt was heard saying to an affected group of farmers that the US Government did not know how to remedy their desperate situations but that if a solution existed, ‘they’ were sure to find it.  The ‘they’ President Roosevelt referred to included every living person who could lend a hand, which amounted to just about everyone. Today, 77 years later, President Obama already knows what needs to be done to tackle the ‘Debt Bowl’ of 2013 but lacks the political will and the genuine respect on Capitol Hill that President Roosevelt and his constituents had taken for granted.

So as we gather around our respective Thanksgiving dinner tables, think for a moment what our world would be like if we respected each other as individuals and not just as stepping-stones for personal gain. As the liberal Democrat, Tip O’Neill, a former Speaker of the House, once told the staunch conservative Republican President Ronald Reagan, “We may agree to disagree, but after 6pm, we are always friends.”

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3 Responses to Lessons from the Other ‘Fiscal Cliff’

  1. MMT (Modern Monetary Theory) claims that the word “borrowing” is a misnomer when it comes to a sovereign government’s fiscal operations, because what the government is doing is accepting back its own IOUs, and nobody can borrow back their own debt instruments. Sovereign government goes into debt by issuing its own liabilities that are financial wealth to the private sector. “Private debt is debt, but government debt is financial wealth to the private sector.”

    This means that sovereign government is not financially constrained in its ability to spend; it can afford to buy anything that is for sale in currency that it issues (there may be political constraints, like the debt ceiling legislation). The only constraint is that excessive spending by any sector of the economy (whether households, firms or public) has potential to cause inflationary pressures. MMTers argue though that generally inflation is caused by supply-side pressures, rather than demand side.

    Realization that a sovereign government’s ability to spend is not limited by its ability to raise revenue has led to some rather unorthodox policy conclusions. Abba Lerner’s functional finance is an integral part of the MMT. This is the idea that a state uses its fiscal policy purposefully as a stabilizing mechanism for macro-economy. Warren Mosler put it this way: “for any given size government, there is a ‘right level’ of taxes that corresponds with full domestic employment”.

    Abba Lerner said that: “government should adjust its rates of expenditure and taxation such that total spending is neither more nor less than that which is sufficient to purchase the full employment level of output at current prices.”

    MMT also advocates replacing NAIRU unemployment (unemployment that is purposefully maintained to achieve price stability) with job guarantees that would achieve price stability by employing people in a labor buffer stock. That would get rid of involuntary unemployment, as well as achieve better price stability because employers like to hire people that are already employed. A job guarantee program would also be a powerful automatic stabilizer to the economy, expanding when private sector activity cools down and shrinking in size when private sector activity heats up. http://en.wikipedia.org/wiki/Chartalism

    • Tom Kadala says:

      Excellent comments!
      Regarding your first comment: Quantitative Easing is a fancy term for parking debt off the books. Money is printed to purchase the debt and parked for another day, another election, and another administration.

      Regarding your second comment: Germany has job guarantee program you mentioned. Rather than issue ‘pink slips’, German companies reduce the number of hours worked per employee, thereby keeping unemployment low and most important maintaining an employable workforce. In contrast, after 4 years with unemployment above 7%, US workers who have been unemployed for extended periods of time are less employable. These workers will more than likely have trouble integrating with a more advanced economy as it evolves. One might ask which policy is most effective in the short and long term, the US or German policies? If you subscribed to Republican idealogy for a free market, the US policy should outperform the German one. On the other hand of you follow Democratic values, the German policy would most likely prevail. Thoughts?

      • Yes, I agree the JGP is the optimal policy if it also includes a buffer stock provision which helps maintain price stability. See L. Randall Wray, “Employer of Last Resort.”

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