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Our Last Chance   January 4th, 2011
Token efforts will not be enough in 2011       

 
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With European countries falling like dominoes to sovereign debt problems, with our own deficit spending completely out of control, and with the Federal Reserve cranking out dollars like toilet paper, we must slash federal spending. Token spending cuts will not suffice.

For those willing to objectively analyze our world and national financial situation, there can be little doubt that we're on the verge of some kind of major worldwide economic event. I don't think anyone can say definitively how and when it will play out, or what exactly the outcome will be. But we're definitely quickly approaching critical mass, and business as usual is not going to cut it.

Here are some examples of business as usual:
  • 2-Year Federal Pay Freeze. The 2-year pay freeze on federal workers announced by President Obama, and which was apparently sponsored by Rep. Michele Bachmann (R-MN). If actually implemented this will reduce future increases by $6 billion a year (though it won't actually reduce spending or the deficit since this simply prevents future increases, it doesn't actually reduce spending).

  • 2-Week Unpaid Furlough. Rep. Mike Coffman (R-CO) has proposed that all civilian federal employees be furloughed for two weeks, unpaid, in 2011. This would save $5.5 billion in 2011. This is a little better than Obama's 2-year pay freeze. This would actually save $5.5 billion; however, as proposed, it would be a one-off plan for 2011. If it were implemented on an ongoing basis, it could save $5.5 billion per year.

  • 10% Federal Pay Cut. A 10% cut in federal pay has been proposed by Rep. Jason Chaffetz (R-UT). This would save $25 billion per year.

  • $100 Billion Cut. Incoming House Speaker John Boehner is saying he wants to cut $100 billion in discretionary non-security spending .

These plans range from Obama's symbolic 2-year pay freeze to a more substantial $100 billion/year savings if Boehner's cuts are actually implemented. But even though $100 billion per year would be "real" money, it's still not enough to change our fiscal course.

To put things in perspective, we could fire all civilian federal employees and save $250 billion per year--but we'd still have a deficit of over a trillion dollars. In fact, we could fire all civilian employees and eliminate all defense spending and we'd still have a deficit of over half a trillion dollars (this assumes federal wages of $250 billion/year and a Dept. of Defense budget of $548.9 billion). In other words, we could eliminate the federal government entirely--both civilian and military--and we'd still be running a budget deficit in the hundreds of billions of dollars per year.

Yes, our civilian federal government is too big and too expensive--but that's not what's causing the deficit. And our defense department is expensive--but that's not what's causing our deficit, either. And, no, neither are Iraq or Afghanistan.

The cause of our federal deficit is entitlements programs: Social Security, Medicare, Medicaid, and other types of welfare.

Democrats will argue that we need to raise taxes. But we'd need to increase personal income taxes by over 50% to erase the deficit; and not just on the wealthy--we'd need to increase personal income taxes by 50% across the board. And implementing a tax increase of that size would drag us further into recession and make us even less competitive in the world. The wealthy would have less money to spend, invest and hire which would increase unemployment; and many not-wealthy individuals would no longer be able to meet all their financial obligations as their taxes suddenly increased and consumed what remained of their income. There would be more personal bankruptcies and more foreclosures as personal income was taken by the federal government and jobs were lost.

Worse, a study indicates that every $1 of increased taxes leads to a $1.17 in new spending. That is, for every dollar the government raises in taxes, it ends up spending that dollar and another 17 cents. So by increasing taxes we'd actually move further away from reducing the deficit.

So we must cut spending, and we need to cut it significantly. While it's fine to talk about cutting federal pay, furloughs, reduction in pay of congressmen, and earmarks, none of those things will fix our current problem. We could do all of those things and we'd still be in serious economic trouble.

I'm increasingly concerned that Republicans will pass (or attempt to pass) some of the symbolic stuff mentioned above in 2011 and then spin it as being proof of their seriousness about deficit reduction--then stall, hedge, and campaign until we get a Republican president in 2012, perhaps with the promise of really getting serious about deficit reduction once we have our Republican president.

We can't afford to do that. We can't wait that long. In fact, I don't think we can wait at all.

Greece collapsed due to their excessive government spending and entitlements. Ireland's been bailed out. Portugal is probably next, possibly followed by Spain. And when it starts to happen, it can happen very quickly. Ireland went from relatively stable levels of default insurance (credit default swap) to international bailout in the space of about 4 months, and the critical final spike happened in just a month. So the situation can go from "we know there's a future problem" to "there's a problem right now" in a matter of weeks.

Once it's clear that our time has come, there will no longer be time to fix it on our terms.

The exact same thing would already be happening in the United States but we've bought time--quite literally--with the Federal Reserve monetizing the federal deficit. That means the federal government is spending more money than it has, and more money than it can borrow from China and the rest of the world. So the Federal Reserve is just printing some more out of thin air.

But running the printing press is just kicking the can down the road. It buys us a little time, but we'll soon have an even more difficult situation to deal with--a devaluing dollar, losing the dollar's status as a reserve currency, high inflation with higher prices for things such as food and oil and everything we import, and increasing risks of loss of our sovereignty.

How much time do we have? No-one knows exactly, though China is now suggesting we might have as little as 6-12 months.

The U.S. dollar will be a safe investment for the next six to 12 months because global markets are focused on the euro zone's troubles but America's fiscal health is worse than Europe's, an adviser to the Chinese central bank said on Wednesday.

Li Daokui, an academic member of the central bank's monetary policy committee, said that U.S. bond prices and the dollar would fall when the European economic situation stabilized.


China's obviously a major investor in U.S. bonds with a big stake in the game, and I think their analysis above is probably pretty accurate. I find it interesting that their 6-12 month estimate isn't that different than the large QE3 by late 2011/early 2012 that I predicted in November. A collapsing dollar and bond prices most likely would be accompanied by QE3 in a last ditch effort to prop up a government unable to borrow money at an unaffordable rate.

It's also not impossible that a 6-12 month window is optimistic. In the less than two months since QE2 was announced, 10-year interest rates have increased from 2.62% to 3.41%--that's a 30% increase in two months. This is being spun in the media as being caused by a more optimistic appraisal of U.S. growth, but it's more likely due to the fact that our politicians have shown that they're not serious about the deficit and that the Federal Reserve is not serious about protecting the value of the dollar.

While interest rates may ease off the current spike, these are the kinds of sudden interest rate jumps that we have to watch closely. Some day soon there will be a spike like this that will keep going up and up, just like happened in Greece and Ireland. And there won't be anyone to bail us out.

Printing money isn't the solution. Raising taxes isn't the solution. A sudden strong recovery (which no-one is expecting) would only buy us a little more time. Only by reducing spending can we attack our federal deficit. And we can't sufficiently reduce spending until entitlements are part of the discussion--which is why even Rep. Boehner's $100 billion proposal comes up short since it specifically ignores the part of the budget that is primarily responsible for the deficit.

Under normal circumstances politicians could get away with symbolic measures. But that's not going to do it. And I personally think that if the hard decisions are put off until after the 2012 presidential election, it may be too late. The dominoes in Europe have already begun to fall, and I think they're going to start falling faster. Eventually the United States will be the next domino--perhaps in as little as a year. And if Congress doesn't get serious about the deficit in 2011, it's very unlikely that they'll do so in the following presidential election year. And if they start talking about deficit reduction in 2013, it means we won't actually do much until 2014 at the earliest. I don't think we can ignore such a massive deficit for 3-4 more years without serious consequences.

If we're in the mood to gamble with the future of our country and the world's economy, our politicians will focus on the small potato items mentioned above and hope that we get to 2012 before our card is up. And then we hope a Republican gets elected president. And we hope that Republican president is willing to make the tough decisions, and we hope that Congress is in the mood to do the same. That's a lot of hoping, and hope is not a strategy.

No, the Republicans we just elected have to immediately remove their "politician" hats and put on their "adult statesmen" hats. They have to take up the issue of entitlements and they have to get serious about saving our country, not their careers. The spending authorized by our own Congress is a bigger threat to America than Al Qaeda or any other foreign adversary.

I hope I'm wrong, but I think there's a good chance we'll know the fate of our country by late spring 2011. If Congress is honestly addressing the problem of spending (including entitlements) then we may have a fighting chance to turn this thing around. Even if we do, we'll still have major challenges such as tens of trillions of dollars of unfunded federal mandates and trillions in unfunded state and local pensions. But if we are at least really addressing our federal deficit, there will be reason to hope.

But if, by late spring 2011, our elected officials don't have a credible roadmap to eliminating the deficit and dealing with entitlements, I think it may be too late. That doesn't mean everything will collapse in late spring of 2011, but it seems possible that the die will have been cast.

The debate and vote on raising the debt ceiling (probably in February or March) will be very revealing. It is encouraging to hear Republicans talking about not raising the debt ceiling unless some real spending cuts are enacted. But it's the size of those cuts--and whether or not Republicans stick to their guns--that will tell us if they're serious. Refusing to increase the debt ceiling until there are meaningful spending cuts is a good strategy... as long as the cuts they fight for are truly meaningful. But a showdown over spending cuts that are too small to really change our fiscal course would be little more than political theater.

We should all be writing and calling our congressmen and senators and demanding that they meaningfully address our deficit. We need to ask them to stop pretending that our fiscal situation can be fixed without talking about entitlement programs.

And then we need to pray that they tackle the very difficult fiscal problems that their predecessors have been putting off for decades.

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