29 Nov Nearing the Edge of a Fiscal Cliff?
The term “fiscal cliff” means different things at different times in different economic environments. The single definitional consequence upon which there is universal agreement, however, is that it’s a bad thing to fall off that cliff … or even to skate too closely to its edge.
When a government runs an operating deficit year-after-year – that is, when the amount of government spending consistently exceeds its revenue –, debt builds up, as does the cost of servicing that debt. The built-up debt increases the pressure on spending and, unless spending is cut or revenue is increased (through increased taxes), at some point the debt becomes impossible to repay (because of the accruing of interest (which creates a multiplier effect) and/or the sheer size of the debt). At the point when holders of that debt realize that they cannot be repaid, they dump their debt-holdings. That’s when the value of the government’s debt “falls off a cliff.” As economists have pointed out, risk dawns on people slowly … until it reaches a point when it spurts rapidly (a concept that owes its brevity to a dialogue from Hemingway’s The Sun Also Rises: “How do you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly”). A good many debt bubbles in history have led to precisely that sort of Acapulco-like cliff-dive – some of which have become well-known panics.
“Fiscal cliff” had a different meaning way back in 2012. The end of that year marked the “fiscal cliff date” when both (1) tax cuts enacted by the Bush administration some 10 years earlier were scheduled to sunset and (2) legislated spending cuts were programmed to kick-in. Upon expiration of the Bush tax-cuts, taxes would automatically have increased (with ratcheted-up tax rates applying to married couples having incomes of over $450,000 and to estates of over $5 million, increasing Federal revenue by more than 19%) and spending cuts would have automatically reduced non-essential expenditures (pursuant to a 2011 mechanism known as “sequestration”). Earlier Congresses, you see, had recognized the inability reluctance of the Federal government to exercise fiscal conservatism restraint prudence by building into their taxing and spending authorizations fail-safe mechanisms [sic] that were intended to prevent the government from over-spending and under-taxing … and thereby running-up unrepayable debt. What those fiscally-conservative restrained prudent Congresses of the early 21st Century had failed to recognize was that future Congresses would ignore their fail-safes and spend like drunken sailors authorize ever-higher debt ceilings, enact ever-lower tax rates, and increase spending in order to cement their time in office without consideration for the welfare of future generations whether the resulting debt could be repaid. The effect of the automatically-triggered tax increases and budget cuts was to prevent precisely that kind of fiscal mischief.
It didn’t work.
Subsequent Congresses ignored the potential horrors shocks of a far-off-in-the-future “fiscal cliff”… that prudent fiscal management could avoid through sensible government mechanisms (that could be enacted by means of a tax simplification such as that described in https://blog.thelonelyrealist.com/disrupting-americas-taxes/) and spending restraint. To the contrary, in 2013 Congress enacted only small tax increases (that the succeeding Administration more-than reversed), repealed the 2011 sequestration legislation, and raised America’s debt ceiling. In other words, Congress in 2013 blinked …, and subsequent Congresses have continued blinking. There now is a “debt ceiling” only in words, not deeds – Congress simply raises the amount of national debt that the U.S. government is authorized to borrow whenever the existing debt level is threatened. Raising the debt ceiling has become so commonplace that the media barely cover the process. America’s spending therefore continues to rise. It (and its related earmarking) has no apparent limits. No consensus is being sought to rationalize its tax system. Partisan politics, rather than the interests of Americans, is the only game in town. And America’s debt therefore steadily rises such that, today, it exceeds $27 trillion … with total national debt expected to exceed $80 trillion by year-end.
A similarly dire situation exists with respect to America’s States’ debt obligations. Pre-Covid, New Jersey had the largest deficit (with many analysts viewing it as unrepayable without Federal assistance), followed by Illinois, Massachusetts, Hawaii, Kentucky, Maryland, New York, Connecticut and Delaware (etc., etc., etc.). Covid-19 both exacerbated those deficits and their resulting debt, many of which currently are unrepayable without Federal assistance, and decimated the budgets of others, including Nevada, Alaska, New Mexico, Texas and Wyoming (etc., etc., etc.). The debts of America’s States inevitably will become a Federal government fiscal burden (whether through bail-outs of insolvent States and their pension obligations, or Federal unemployment payments and other benefit outlays, or a national economic slowdown that impacts Federal revenue … or all three). In 2019, the national per capita debt of Americans exceeded $69,000. It has since grown significantly (see https://blog.thelonelyrealist.com/coronanomics-201/).
There’s a substantial difference between an individual’s fiscal cliff and that of a country …, and an enormous difference between the fiscal cliff America is may be facing and those faced by other countries. Unlike national governments, individuals cannot print money to pay their creditors. Countries’ printing presses can fend off creditors for longer periods of time and more successfully, especially since there are international agencies, such as the International Monetary Fund, that stand ready, willing and able as lenders of last resort to prevent national debt defaults. However, although a number of countries other than America can print their own currencies, only America prints the world’s Reserve Currency. The advantage that provides is profound (see https://blog.thelonelyrealist.com/the-fracturing-us-dollar/) .
An individual faces a fiscal cliff when his debts exceed his assets and he has insufficient cash to pay interest and principal when due. Should that occur, he defaults, proverbially falling off an economic cliff. Perhaps he declares bankruptcy, his creditors accede to his assets, and he’s tossed onto the street … where he perhaps joins angry others (for example, during a depression or a major recession) in voicing dissatisfaction with the economic system … which is why that system works differently with respect to a government debt default. Countries cannot allow their citizenry, wholesale, to be tossed onto the street … nor can other countries risk the turmoil such an economic dislocation might create …, which is why developed countries have created international bailout mechanisms. An archetype for those bailouts is Argentina, a fiscally-imprudent country that has defaulted on its national debt twice since 2000 … and a total of 9 times since it declared independence in 1816. Blessed with abundant resources and a favorable climate (much like the United States), Argentina nevertheless has experienced regular bouts of bungled economic policymaking and inflation largely due to unstable and inconsistent governments. From being the world’s 10th wealthiest country on a per capita basis 100 years ago, Argentina today is 114th. It provides a sobering set of lessons in government mismanagement.
America’s per capita debt differs significantly from Argentina’s … and every other country’s … because America can repay its debt obligations by printing US Dollars. This “exorbitant privilege” (a principle discussed in https://blog.thelonelyrealist.com/the-fracturing-us-dollar/) enables the U.S. to run sustained budget deficits. With the Dollar as the world’s Reserve Currency, central banks in other countries are compelled to hold significant quantities of Dollars and Dollar-denominated debt in order to engage, and enable their countries’ businesses to engage, in international transactions. America therefore can continue over-spending and under-taxing forever for a lengthier period of time than other countries … or, at least, until its creditors start wondering whether America’s pieces of paper truly are worth the paper they’re printed on. The timing of that realization obviously will depend on the quantity of America’s debt, the interest rate payable on that debt (which depends in large part on the rate of inflation), the strength of the U.S. economy and, most importantly, the confidence of debt-holders in the stability and proper management of America’s economy.
There is widespread agreement that the economic strength of the U.S. has been fortified by the tax changes enacted in the “Tax Cuts and Jobs Act” of 2017. Among other things, the TCJA lowered individual tax rates, reduced corporate taxes and expanded business deductions. All of its provisions, however, will sunset on December 31, 2025. That creates uncertainty that drains confidence in America’s economic stability.
A far shorter sunset applies to the Covid-19 stimulus enacted by Congress in March 2020, the incentives having gradually faded until they end on December 31st. Treasury Secretary Mnuchin apparently believes that the economy already has fully recovered. In concluding that no further economic stimulus is needed, he announced the termination of the Covid stimulus’ remaining emergency lending programs and instructed Federal Reserve Chairman Powell to return the unused portion of a $454 billion account approved by Congress that gave the Fed $4.5 trillion of lending power that has had an enormously positive effect on market confidence. Senator Patrick Toomey, the expected chair of the Senate banking committee, agreed, adding that emergency credit facilities were no longer needed and that there is ample liquidity in the American economy. Chairman Powell (joined by a number of leading economists) disagreed, saying that while economic activity and employment have made some gains, they “remain well below their levels at the beginning of the year.” He added that, “Obviously, it’s for Congress to decide the timing, size and components of further fiscal support for the economy. I will say that the support provided by the CARES Act was absolutely essential in supporting the recovery that we’ve seen so far … and I do think it’s likely that further support is likely to be needed from monetary policy and fiscal policy.” America’s Federal Reserve has been a consistent booster of America’s economy … and a necessary one (see https://blog.thelonelyrealist.com/the-fabulous-federal-reserve/ and https://blog.thelonelyrealist.com/what-if-there-were-no-more-recessions/). The pernicious effects of the Financial Crisis of 2008-09 have been ongoing and those effects, together with the even more damaging economic fallout from Covid-19, have been successfully addressed, thus far, by the joint actions of the Fed and America’s government. These efforts have required the Fed to utilize unique and extraordinary financial engineering tools, and to use them in ways and on a scale that the world never before imagined. Those tools have now been withdrawn. They can be replaced only by new Congressional legislation. The message Treasury Secretary Mnuchin, Senator Toomey and Senate Majority Leader McConnell have sent, respectively, in terminating Federal lending programs and balking at Democratic Party proposals to enact further Covid-19 stimulus is that the U.S. economy can stand on its own, that the fiscal cliff is beyond the horizon. One can only hope they’re right … and that the withdrawal of Federal economic stimulus and Fed lending doesn’t tip-over the U.S. economy.
Finally (from a good friend)
A farmer had 5 female pigs. Times were hard, so he decided to take them to the county fair and sell them. At the fair, he met another farmer who owned five male pigs. After talking a bit, they decided to mate the pigs and split everything 50/50.
The farmers lived 60 miles apart, so they decided to drive 30 miles each and find a field in which to let the pigs mate.
The first morning, the farmer with the female pigs got up at 5 A.M., loaded the pigs into the family station wagon (which was the only vehicle he had), and drove the thirty miles.
While the pigs were mating, he asked the other farmer, “How will I know if they are pregnant?”
The other farmer replied, “If they’re lying in the grass tomorrow morning, they’re pregnant. If they’re lying in the mud, they’re not.”
The next morning the pigs were rolling in the mud, so he hosed them off, loaded them into the family station wagon again and proceeded to try again.
This continued each morning for more than a week and both farmers were worn out.
The next morning, the farmer with the female pigs was too tired to get out of bed. He called his wife, “Honey, please look outside and tell me whether the pigs are in the mud or in the grass.”
“Neither!” yelled his wife. “They’re in the station wagon. And one of them is honking the horn.”