Avoiding U.S. Fiscal Ruin - David Romer in 2007

Washington’s Out-of-Control Budgets - Notes on a Lecture by Prof. David Romer. (The following report is abbreviated with his permission from notes on the lecture taken by Bill Batt, staff political scientist in the New York State Assembly's Legislative Tax Study Commission, 1982-1992.)

On October 25, 2007, Scranton University held its 22nd Annual Henry George Lecture  and Romer was the Lecturer. [Henry George was a self-taught, widely read economist who favored taxing land rather than labor; he ran with labor support for the mayoralty of New York City in 1886, coming in second, ahead of Theodore Roosevelt, and again in 1897, dying at the height of the campaign. - JTM] The city of Scranton, Pa. itself was wild that day, as it played host to fans of the NBC hit serial, "The Office", set in Scranton. 

David H. Romer is the Herman Royer Professor of Political Economy at the University of California, Berkeley. He is a member of the American Economic Association Executive Committee, co-director of the Program in Monetary Economics at the National Bureau of Economic Research, and a member of the NBER Business Cycle Dating Committee – the so-called “wise men” who decide when national business cycles begin and end.

The lecture title was "Avoiding Fiscal Ruin: Failed Strategies and New Approaches to US Budget Policies." Professor Romer posed three questions: (1) How did we get here? (2) What are the likely consequences? and (3) What are some possible solutions? He showed simple PowerPoint bullets and graphics describing the past history and looming fiscal crises the nation faces in the next few decades:

History of the U.S. Budget

• The United States ran a small budget surplus throughout the years 1791-1929, except for support of the Civil War and World War I.
• The U.S. budget had an annual surplus in the early 1950s, and a deficit every year since then except for the final years of the Clinton administration.
• We are now running a $200 billion deficit, some 2 percent of GDP, which will grow enormously in the next two decades if most assumptions are borne out about health care, social security and other demographic trends. (He did not comment on the budgetary impact of the wars in Afghanistan and Iraq.)

The nation got into this position because we have in recent years stopped thinking of taxes and spending as going hand-in-hand. Moreover, beliefs about appropriate budget policy have changed. The prevailing view in the 1950s was that budgets should be in balance, at least averaged over a few years. Truman, in this regard, was a fiscal conservative, even though he favored government support of services. In the 1960s, a view took hold that balancing the budget was less important than maintaining economic growth. Hence deficits were sometimes necessary as a stimulus at certain points in the economic cycle. Nixon remarked, in 1971 [quoting Milton Friedman in 1965 - JTM], "we are all Keynesians now."

Reagan, in the 1980s, wanted to shrink government, as he believed that "government is the problem." It was possible, he argued, to do so according to a strategy of cutting back on domestic programs, called "starving the beast" [the original use of the term is attributed to David Stockman, Reagan's first budget director - JTM]. It followed to his adherents that cutting taxes would lead to a fall in government spending.

Cutting taxes doesn't have much impact on expenditure levels. Revenues, he argues, change for many reasons, and by tracing the history and motivation for tax changes, he has shown that the cause and effect relationships are very complex, and that correlation and causation should not be confused. He has looked at speeches, news conferences, reports, votes, and events such as wars and recessions, and concluded that it might even be that invoking "starve the beast" rhetoric actually leads to increases in tax and expenditure. Moreover, so many factors are involved in tax policy changes that there is typically shared fiscal responsibility – blame and credit for any policies are quite diffuse.

Problem. When the two sides, revenues and expenditures, are not viewed together it becomes difficult to focus policy. All indications are that U.S. taxes will soon need to increase, but little attention is being given to revenue designs.

With baby-boomers retiring, medical expenses increase, debt service increases, infrastructure renewal demands grow, and so on. Some leaders are already calling for such increases. But all the forecasts are necessarily based on existing law, which will need to be changed. The phase-out of tax measures in the year 2010 will lead to new initiatives, and these will call for new assumptions.

Likely Scenarios. Only three scenarios are possible:

1. Lower national saving, which will mean less reinvestment, slower growth and a lower standard of living.
2. A national economic crisis in anticipation of what is in reality a "Ponzi scheme".
3. Pay off the debt, either by raising taxes or printing more dollars. His comparison with past experiences in nations in Latin America was not lost on the audience. Nor did he see the United States abandoning care for its elderly.

Solutions. Professor Romer argues that we need to:

• Educate the public to a level where a solution is politically possible. He said that we need to link taxes and spending together once again as was the case prior to the 1960s. The political appetite for such policies are not presently on the horizon, but he suggested that perhaps some kind of "mutual disarmament pact" could be devised such as was set up earlier to address the Social Security crisis in the 1980s, and as exists now for closing military bases.
• Improve accounting practices by the federal government and for the U.S. economy.
• Introduce strong "pay as you go" rules such as were attempted in the Gramm-Rudman approach two decades ago.
• More radically, introduce a stringently fashioned "balanced-budget amendment."
• In addition, or alternatively, create a separate agency, comparable perhaps to the Federal Reserve System, that would be granted powers to impose fiscal and budgetary requirements.

Professor Romer was not sanguine that any solution was within sight, even though we are on a "potentially ruinous fiscal path." He argued that we need to contemplate major changes to address the problem.

Chelsea Intersection Made Safer

Problems are global, politics is local. Earlier this year in May, an elderly Penn South resident was killed by a truck as she was walking across Ninth Ave. at the south side of 23rd St. Since I overlook this corner and have witnessed the aftermath of several fatalities resulting from speeding downtown cars at this intersection, I described it as the neighborhood’s “dead man’s curve” in an article in Chelsea Now by Al Amateau.

Something has now been done about it. Kernan Huttick and the Penn South residents' council lobbied three people: Traffic Commissioner Janette Sadik-Khan at NYC DOT, City Council Speaker Christine Quinn (who lives in London Terrace on the NW corner of the intersection), and State Sen. Tom Duane (a resident of Penn South, which starts at the NE corner).

Commisioner Sadik-Khan, who came from an engineering firm and has an explicit “green it up” agenda, devised an interesting solution that is a twofer. It puts an island in the middle of Ninth Avenue so that elderly people can make the trip across Ninth Avenue in two stages if necessary. At the same time it creates a bicycle lane, courtesy of DOT's Bicycle Projects Group, described as “awesome” by Amy Pfeiffer of Transportation Alternatives. Here's a DOT slide show on the twofer innovation - creating a bicycle lane and an island for Chelsea's senior citizens.

DOT gets great credit for taking an edgy action to deal with a real and persistent problem. The improvement will certainly make it safer to cross and the bicycle lane is in use. Now we watch to see how it works in practice.

More on U.S. Debt

In two previous blogs I have presented U.S. national debt data showing that it is high and growing relative to other countries. In The Growing Price of U.S. Debt, I estimated the debt at $67,000 per U.S. taxpayer, with the number about six times bigger if we add unreported U.S. liabilities. In The U.S. 10-Trillion-Dollar Debt Limit I noted that the debt limit has been raised an average of $500 billion per year since President George W. Bush came to office and noted that our state and local officials don't have the luxury of running deficits. NYC Mayor Bloomberg has assailed the continuing huge U.S. budget deficits as "lunacy" in a speech to British conservatives.

My concerns focus on the fact that the debt is (1) growing fast, (2) understated, because it does not include social insurance liabilities, and (3) leaves a legacy for our children of a burden of taxes (especially, as the U.S. tax system is now structured, payroll and income taxes) that will reduce their standard of living. The other concern I have is that continuing current-account deficits mean that the debt is being financed by overseas accumulations that could be de-accumulated under conditions that will tie the hands of the United States internationally.

Now I would like to add to the pile of evidence against current practice an interesting summary of the growth of the U.S. national debt since 1938 by Steve McGourty, who takes a partisan approach - he lays the blame for the bulk of the growth of the debt at the feet of tax-cutting Republican Presidents Reagan and George W. Bush. Actual reductions in the national debt occurred in the last 50 years only under under Presidents Kennedy and Clinton (adjusted for inflation). His charts are interesting. I would be interested in seeing (1) his numbers adjusted for inflation, (2) an addition for unfunded health and Social Security liabilities, and (3) a link between the current-account deficits and the budget deficits.

Why the Safety Net Collapsed for WTC Rescue Workers

[My friend Peter F. Rousmaniere during the past nine months has been studying the problems of World Trade Center rescue and emergency workers in obtaining compensation for illnesses they contracted that may be attributable to the conditions under which they worked. I am interested in this subject because, as Chief Economist for the NYC Comptroller, I was asked to assess the economic damage of the WTC attacks for purposes of obtaining State and Federal aid. I have maintained, then and now, that there would be a longer tail than some have asserted to the economic effects of 9/11. As a risk management professional who writes frequently on occupational risks (last year I posted an interview with him on workers comp in NY State), Peter has been researching how the system has worked out for WTC workers. Peter lives in Woodstock VT, and can be reached at 802-457-9149; email pfr@rousmaniere.com.]

The health problems of World Trade Center rescue, recovery and cleanup workers have been in the news. Now Peter F. Rousmaniere has produced the most comprehensive analysis to date of what actually went wrong. He says there were three independent failures at the local or state levels:

One, the City’s safety enforcement at Ground Zero was poor, well below recognized standards, and inexcusable notwithstanding the scale of the challenge.

Two, employers, insurers, the City and state regulators failed to monitor the health condition of these workers, even though it was well known that these workers were vulnerable to slowly emerging diseases. This failure greatly increased the uncertainty today about the health status of tens of thousands of workers.

Three, New York state’s workers compensation system effectively collapsed as a provider of adequate medical and disability support, thereby inflaming demands for support from the Federal Government and through the courts.

Risk & Insurance Magazine, a leading business publication, is publishing Rousmaniere's articles about his investigation. The first three installments may be downloaded. The fourth and final installment will be published on November 1.

Within a few days after the WTC towers’ collapse, it was clear that those overseeing ground zero had to implement a safety program without delay, using the best resources available in the country. But the City and its contractors in 2001 were failing to enforce basic standards of worker protection. It took well after September 2001 for officials to formalize even a basic safety plan.

It is axiomatic that workers exposed to high levels of toxic materials should be monitored regularly for their health status. The only workers who were monitored carefully were New York City firefighters. Tens of thousands of workers were allowed into ground zero without any check for their existing health status, and there was no attempt to check up on them later. Confusion today about the actual health status and prognosis of these workers can be directly linked to the absence of medical surveillance from the start.

The workers compensation system of New York was created in part out of reaction to the 1911 Triangle Shirtwaist fire. Since then, the system has restricted access to persons who acquire diseases at work, such as lung conditions and posttraumatic stress disorders. Substantial numbers of World Trade Center workers have symptoms of these diseases. Workers compensation law is expressly designed to frustrate claims arising from disasters except from those whose full time work is emergency response. It took the legislature until 2006 to amend the law to give these workers fairer access to benefits.

The lessons from this experience start with the urgent need to place disaster site control in the hands of organizations and leaders who are up to the challenge. A threshold needs to be set above which the Feds should by default be placed in charge of managing a disaster at the earliest feasible moment. The fires currently raging in southern California would be below the threshold, in part because Californian fire fighting agencies have over the years become a national model of emergency response.

Also, the Federal Government should fund and install quickly a medical monitoring system in any disaster in which it is involved. We cannot trust employers, insurers or state regulators to take on this task.

Third, because legal barriers to benefits from the workers compensation system exist in most states, the federal government should assume responsibility of administering workers compensation benefits for disaster workers. There is a sorry history of Washington having to assume workers compensation responsibilities for workforces struck by disease.

If we fail to apply the lessons from these failures, Rousmaniere concludes, we may pay the price in vastly greater death and disability among workers, for instance in responding to a pandemic in the future.

We may also find it harder to recruit emergency workers.

Slate Picks Up Turkey Recommendation

Slate in its Blog Roundup quoted this paragraph from my HuffPost blog on the Kurdish rebels: "[T]he best hope for calming this crisis," says John Tepper Marlin at the Huffington, is "a combination of a serious effort to contain the Kurdish rebels while joining the U.S. voice with that of the EU, which has also warned Turkey against violating Iraq's territorial integrity. The grave danger is that in the frayed international environment of 2007 Turkey will sooner or later respond to its very real domestic pressures and defy western wishes on the bet that they can continue to get away with going it alone."

Turkey and the Rebel Kurds: Next Move

This blog was posted earlier today on Huffington Post

President Bush's response to the Turkish Parliament's declaration of war against the 3,000+ rebels of the Kurdistan Workers Party (PKK) in oil-rich northern Iraq was muted because the United States needs Turkey. The Kurdish administration in oil-rich northern Iraq seems unable to control the small number of PKK separatists, while labeling in advance any Turkish forays to strike at PKK camps as a violation of Iraqi sovereignty. Such forays would immensely complicate the war in Iraq and destabilize the region.

Turkey's economic needs might give it pause. Prime Minister RecepTayyip Erdogan is as friendly a Prime Minister as the United States could hope for in a 99 percent Islamic country in the fifth year of an Iraq war that has allowed Kurdish rebels to build up in the north and to kill many Turks recently on the border. He was reelected handily this year because he has delivered strong economic growth.

When the United States invaded Iraq in 2003, the Turkish Parliament refused to allow U.S. troops to drive through to Iraq - a "low point" for U.S.-Turkish relations, although Turkey allows U.S. supplies through via Incirlik Air Base. For many Turks, the low point was months later when U.S. forces - from Turkey's perspective - dissed Turkish soldiers serving with the U.S. army in northern Iraq. These events were the basis for a hugely popular Turkish movie, "Valley of the Wolves Iraq," which stirred up anti-American sentiments.

Relations looked better last year when a U.S.-Turkish shared vision was mapped out. But the over-stretched U.S. military and The Kurds in Iraq are understandably concerned about having as a guest Turkey's half-million troops, the second-largest army in NATO and the largest army in Europe? No wonder a barrel of crude oil for November delivery hit a record price today of $90.07.

What might restrain Turkey is its ongoing need for full access to American and, even more, EU markets. Turkey would dearly love to become a full member of the EU, and many in the EU would like to see Turkey join. Turkey's textiles and apparel industry, which accounts for nearly 40 percent of Turkey's exports, is being squeezed by low-cost competition from the rest of Asia and by concerns of western, especially European, buyers about labor conditions in Turkish factories. The Turkish government has contributed to the problem by raising taxes on employment to levels well above its neighbors, where wages may be as low as one-fifth of prevailing Turkish wages.

So the best hope for calming this crisis would be a combination of a serious effort to contain the Kurdish rebels while joining the U.S. voice with that of the EU, which has also warned Turkey against violating Iraq's territorial integrity. The grave danger is that in the frayed international environment of 2007 Turkey will sooner or later respond to its very real domestic pressures and defy western wishes on the bet that they can continue to get away with going it alone.

DOWN DOWS | Cognitive Dissonance

Oct. 19, 2007–For the day, the Dow fell 367 points or 2.6 percent to 13,522. For the week, the Dow was down 4.1 percent. The other indexes fell by similar percentages. The day had little specific news to drive it. Initial news-service analyses didn’t make much sense, explaining the downdraft based on a few isolated weak earnings reports. The heavy buying of Treasury notes made clear that something more basic was going on – investors were worried and were looking for a safe haven, desperate not to be caught with what they were selling after the market closed on Friday.

Can we explain the week’s drop in the market? Here are two lines of thinking:

1. Investors applied rational expectations theory. The financial community has been providing a stream of information about the subprime loans and some of the information creates cognitive dissonance. Investors take into account all information available and some of the information doesn’t compute. The fact that the FOMC lowered the target interest rate preemptively by 50 points was initially seen as an effort to spur the economy. In retrospect, it can also be seen as an indication of worry on the part of the Fed about credit markets. After the major banks took heavy writeoffs for subprime loan losses, three of them got together to try to bolster the market for structured investment vehicles with a so-called Master Liquidity Enhancement Conduit. This $75 billion conduit raised more questions than it answered. Former Fed Chairman Alan Greenspan opined that the special fund might be counterproductive, contributing to rather than reducing worries about possible further losses. Further losses in the credit markets can be expected to exacerbate problems in the real estate arena, lowering values and discouraging new construction.

2. The madness of crowds and the power of superstition. Today is the 20th anniversary of Black Monday, when the Dow fell 22 percent. The Armenian genocide resolution in the House of Representatives started up a round of international hand-wringing that has raised difficult questions of alliances and allegiances. Turkey is an important friend of Israel as well as the United States. New sabers are rattling in Turkey and Iraq, including a threat by the Kurdish rebels (the PKK) to destroy pipelines carrying oil into Turkey. Add that to a seemingly endless series of U.S. current-account deficits, U.S. budget deficits, declines in the value of the dollar, and a new shifting out of dollars by Asian central banks and it would be easy to see how fears might begin to mount.

Austin today - Albany tomorrow?

Information delayed is information denied. Texas has opened up its spending to public scrutiny. By logging onto the Texas Comptroller's window on state spending, individuals can monitor where the money goes. Sunlight is a great disinfectant, and with thousands of potential observers of the details of public spending, major abuses are less likely. Austin has a lot of techies who considered the opening up of government books a challenge. New York's reform-minded Governor Eliot Spitzer or Comptroller Thomas DiNapoli might want to emulate this. New York has techies who can do this job.

Yay PATH - Better Signals=Faster Service

PATH (i.e., its parent the Port Authority of New York and New Jersey) is upgrading its signals. Great news. New York City depends acutely on its rail transit links, both within the City and between the City and its suburban communities. The tracks can carry a lot more traffic and they will have to if fewer people are to bring their cars into Manhattan.

Better signals make possible more efficient travel - reducing headway times safely and making better use of NYC's enormous investment in the rail tunnels. NYC's subway system needs the same makeover.

The Mayor's Management Report - Raising the Bar

Glenn Pasanen has a good review on the Gotham Gazette web site of Mayor Bloomberg’s Mayor’s Management Report (MMR). He is critical of the lack of links between numbers and explanatory information. He is right.

I have been so happy to see positives and negatives more even-handedly reported than under Mayor Giuliani (who only stressed the good news) that I have looked no further.

The full potential of the MMR, however, is not being exploited. It should be linked to the budget. We call it the Office of Management and Budget, but the Mayor's Office of Operations (MOO) is not milked (sorry) enough for management information - at least in what is given to the public.

Some years ago when I was Chief Economist at the City Comptroller's Office I worked with the Chief Accountant to see if we could develop a prototype of a budget that would correspond to the categories of the MMR. We did it. So it can be done. I'm sure I can find this prototype if anyone is interested.

NYC | Congestion Pricing

Traffic congestion is a costly problem for New York City residents, workers and visitors. The problem originates from inadequate pricing mechanisms for the use of roadways and railways in NYC. It is an aspect of the Tragedy of the Commons.

A new report on Alternatives to Traffic Congestion Mitigation in the Manhattan CBD, by the Committee to Keep NYC Congestion Tax Free, provides a list of alternative ways to use pricing to reduce congestion in Manhattan's three CBDs. The list is good and the opening up of options to the committee looking at these issues is even better.

A broad approach to congestion pricing and mitigation is provided in Professor William Vickrey's 12 Principles posted at http://tinyurl.com/29vz7n. Vickrey recommended maximizing use of railway tracks by upgrading signal systems to permit shorter headways between subways and using a skip-stop system for local trains to shorten travel times for most travelers with a minimum of inconvenience to a few travelers.

WEBSITES | Best Five City/County Sites

New York City's web site - http://www.nyc.gov/ - is by far the most popular local government web site in the United States, based on visits to the sites. As of August 2007, New York City's site had a 7.3 percent market share. It is more than three times as popular as the next-most-visited site, according to Hitwise.

The next most popular was Miami-Dade County, with 2.2 percent. Next, surprisingly, is not the City of Los Angeles but rather its Sheriff's Department. The City of Chicago ranks fourth and the Maricopa County (Phoenix) court system is fifth.

Rank. Name of Locality - Web Site - Market Share
1. City of New York - http://www.nyc.gov/ - 7.32%
2. Miami-Dade County - http://www.miamidade.gov/ - 2.20%
3. Los Angeles Sheriff's Department http://www.lasd.org/ 1.65%
4. City of Chicago http://www.cityofchicago.org/ 1.62%
5. Maricopa County, Arizona - Superior Court of
Arizona - http://www.superiorcourt.maricopa.gov/ 1.52%
Source: Hitwise

NYC Speaker Quinn's Five Fiscal Reforms

The New York State Financial Control Board (FCB), created in 1975 to oversee New York City's finances, sunsets in less than a year. City Council Speaker Christine Quinn this morning addressed the City's fiscal reporting (full text here). She has a five-point fiscal-reform program. All of her points are good ones. She is making one of them effective on her own authority (#4) and is recommending the others to the Mayor, Governor, state legislature and her own City Council colleagues:

1. More accountable independent public entities. The Transit Authority, the Health and Hospitals Corporation, the Economic Development Corporation and the NYC Housing Authority have increased their reporting. Oversight should be even stronger.

2. More accountable budgeting. Short-term debt should be watched because in 1975 the City had $6 billion of it. Oversight over City borrowing should be the responsibility of the City Comptroller. In addition, the city’s tax collection and spending numbers should be reported by the Mayor to the City Council, City Comptroller and the Independent Budget Office.

3. A “rainy day fund.” Surplus revenues can be diverted in good times for use in leaner ones. years. State legislative approval is needed for this. (The averaging of property assessments over five years is in itself a form of rainy day fund. The problem with actual rainy-day funds historically is that they are tempting - they get used up fast at the first sign of morning dew. The criteria for adding to and drawing from the fund need to be automatic.)

4. Disclosure of sponsors of capital projects. Names of council members will now be disclosed along with the capital projects they sponsor. Speaker Quinn is introducing this reform on her own authority.

5. Program budgeting. Department budgets need to be informative and linked to the Mayor's Management Report. This fifth proposal is of particular interest to me. When I was Chief Economist at the NYC Comptroller's Office, I attempted a reorganization of the City's budget - with the help of the Chief Accountant - to conform to the categories of the Mayor's Management Report.

September Job Numbers

The stock market rose significantly today on the much-awaited September employment situation release from BLS, which said: "Nonfarm payroll employment rose by 110,000 following increases of 93,000 in July and 89,000 in August (as revised)." These figures are not such a drop from the first half of 2007 as was previously reported. The markets were pleased.

But the "as revised" parenthetical comment refers to a major swing in the August numbers. The BLS's August employment situation release had reported a decline of 4,000 jobs, and the revision is to a growth of 93,000 jobs. What happened?

Philip Rones, the Acting U.S. Labor Commissioner, in his accompanying statement reports the revision as follows: "The estimates of payroll employment change for July and August were revised upward. The July change rose from +68,000 to +93,000 and the August change from -4,000 to +89,000. After incorporating these revisions, average monthly job growth for June through September is 90,000,compared with an average of 147,000 for the first 5 monthsof the year. Nearly all of the August revision reflected an upward adjustment to government employment, particularly local education. As noted last month, employment estimates for local government education can be volatile, particularly during the summer months. Initial estimates of employment in local education typically are based upon a smaller percentage of survey responses than in other sectors. This lower initial response can make estimation more problematic in months when school sessions begin and end."

Agora Financial in its 5-minute report today isn't satisfied with this explanation and wonders whether the preliminary August numbers somehow landed on the weak side to help justify the September 18 cut in the Fed's target rate by 50 basis points. With such a large revision, the question is inevitable. Future revisions will surely be watched closely.

Predatory Credit Card Issuers?

Who's at fault for the high level of credit card debt and the high fees that are being charged? The credit card issuers, who make it so easy to borrow, or we American consumers who run up five and six-figure credit card bills we can't afford, until the credit stops?

A blog posted on the Motley Fool web site says that both are at fault. Americans borrow too much, it is made too easy for them, and the implications of their borrowing are not fully understood.

This is a broader perspective on the subprime loan crisis. The predatory subprime lenders focused on housing-secured loans. Predatory credit-card issuers make up in high fees what they may lose in credit-card debt that is not repaid.

What do you think?

U.S. DEBT | If and When It Matters

October 2, 2007–Congress has just approved raising the U.S. federal debt ceiling to a tad short of $10 trillion. What happened to the virtue of thrift and foresight exemplified by the fable about the ant and the cricket? The ant works all summer to save for the winter, while the cricket just sings his heart out. Come fall, the cricket begs in vain for food and starves to death, not having figured out the America Buys on Credit solution – buy what you want and put it on Uncle Sam's credit card until it maxes out at $10 trillion.

The debt ceiling had held at under $6 trillion from August 1997 to June 2002, when after 18 months in office President Bush asked for a higher ceiling. Three more increases took the ceiling to nearly $9 trillion, which was reached on October 2, according to the national debt clock, i.e., nearly $30,000 per U.S. citizen. The latest increase raises the ceiling more than 60 percent above what it was when the President took office in 2001.

A CIA table updated as of September 20, 2007 shows the national debt of France, Turkey and the United States clustered around 64.7 percent of GDP.

Debt, External Debt and Deficits. If Americans owe $30,000 to one another, some argue, it's just a wash. Perhaps the burden of the debt is shifted to the next generation. Perhaps the debt service encumbers future budgets. Perhaps the President is setting a bad example as Borrower in Chief. That's the way Mayor Bloomberg feels: “Too many of our conservatives in the United States want to run up enormous deficits and hope that some way, somehow, someone else will pay for it. That’s not conservatism, that’s alchemy at best, or if you like, lunacy.”

On the other hand, if the money is spent for investment, the next generation is benefiting from this investment and U.S. debt itself provides the buyers with a low-risk asset. The problem is that the money is not being spent for investment. The increases are for wars in Afghanistan and Iraq that are not going well and are dubious investments. The U.S. debt has been bought heavily by foreign central banks, allowing them to neutralize the extra dollars and keep the local currencies strong, at the expense of the dollar. A weaker dollar is not necessarily bad, because it means Americans can export more overseas. It also means that imports will cost more. This could well contribute to inflation. It also provides some hope that U.S. consumers will spend a smaller share of their income of imports and the enormous annual U.S. current account deficit will start to shrink.

U.S. external debt, i.e., public and private debts repayable in foreign currencies, shows the extent of the cumulative overhang. Debt obligations are calculated in U.S. dollars at current exchange rates. While U.S. external debt is the highest at $10 trillion, it isn’t much higher than the $8.3 trillion figure for the UK.

Top Five Cricket Nations by External Debt
1. United States $10.0 trillion
2. United Kingdom, $8.3 trillion
3. Germany, $3.9 trillion
4. France, $3.5 trillion
5. Italy, $2.0 trillion
Source: CIA, The World Factbook , updated as of 9/20/07.

To rank the cricket nations on a current basis, we can use current-account deficits, i.e., a country's net imports in goods and services, less net earnings from rents, interest, profits, and dividends, and less net transfer payments (such as pension funds and worker remittances) from the rest of the world during the year, calculated on an exchange-rate basis. The U.S. current account deficit in 2006 of $862 billion is nearly 15 times the UK's $58 billion.

Top Five Cricket Nations by Current Account Deficits, 2006
1. United States, -$862.3 billion
2. Spain, -$98.6 billion
3. United Kingdom, -$57.7 billion
4. Australia, -$41.6 billion
5. France, -$38.0 billion
Source: CIA, The World Factbook , updated as of 9/20/07. The Trade Balance is the net exports of goods and services, i.e., exports less imports. Examples of services would be legal and consulting services to overseas clients. The Current Account Balance (ranked for 163 countries) is the Trade Balance + net factor income from abroad (such as interest and dividends) + net unilateral transfers from abroad (such as foreign aid, pension payments from overseas or workers’ remittances from overseas). When the trade or current account balance is positive it is called a surplus. When the balance is negative it is called a deficit.

Why Do Debts and Deficits Matter? Americans owing money to one another is not worrisome. But Americans selling public debt to foreign countries, and adding to the debt at a rapid clip, is worrisome. Those who are holding dollar securities must be noticing that the value of these securities has declined seriously.

Meanwhile, U.S. consumers must eventually pay substantially more for imports. That must put an upward pressure on the CPI. We could be back to the 1970s problem of simultaneously rising unemployment and rising inflation, and therefore a rising Misery Index. The U.S. Misery Index hit a high of 22 percent in June 1980. Right now it is down to 5.6 percent.

Postscript - October 2008. One year later, asset values have plummeted. That should take care of the inflation pressure for a while, until balance sheets of financial institutions, businesses and individuals are back in some kind of order.