There’s been an appalling amount of nonsense put forth in justification of the differing points of view regarding how to solve our nation’s terrible debt crisis, and an even more appalling amount of nonsense is now being spewed out of the usual sources to try and shift the blame for our nation’s first ever credit rating downgrade onto anyone else but themselves.
So here are the simple truths that you need to understand.
Government ‘Spending Cuts’ Don’t Exist
The simplest truth of all is that the deal – the ‘compromise’ that was reached between Democrats and Republicans – contained no real cuts to anything at all. It was a political fiction which politicians from both parties eagerly supported.
The ‘$900 billion in spending cuts over ten years’ that we were triumphantly told had been reluctantly agreed to are not cuts at all. In reality, the government spending will increase by $7 trillion over these same ten years!
The ‘cuts’ are in reality reductions in spending increases. They are meaningless. Imagine a smoker proudly telling you ‘I’m cutting back on my smoking, I’m reducing the number of cigarettes I smoke by five a day’. And he tells you that he currently smokes 20 a day. So you’d expect him to drop down to 15 a day, right?
But no, he then tells you, without embarrassment, that after cutting down by smoking five fewer cigarettes a day, he will now be smoking 30! How is that possible, you ask him in amazement. He answers ‘Oh, I had been going to increase to 35 a day, so I’ve cut down by five and now will only be smoking 30.’
You end up wondering ‘How can a guy who smokes 20 cigarettes a day tell me he is cutting down by five a day and now be planning to smoke 30 a day?’.
It is the same with government ‘spending cuts’, and here’s how their game works. You take a federal program and increase its budget request massively for the next few years. You then make this new requested amount the baseline, rather than the actual amount spent in past years, and any reduction in this ridiculously inflated projection of expenditure for the future becomes a ‘budget cut’ – even though the program ends up getting a generous increase!
This is exactly what has happened. The government is not reducing its expenditure compared to what it is currently spending or what it spent last year. It has merely reduced its future fanciful increase.
If the government wanted to ‘reduce its spending’ even more, it could have projected a $10 trillion increase and then allowed it to be cut back to the same $7 trillion, and boasted/agonized over the $3 trillion in ‘cuts’.
So, do you understand, that the ‘reduction in federal spending’ claimed by so-called fiscal conservatives in government is nothing of the sort?
But who has been passing this truth back to you? Has your congressman or senator told you ‘I tried my best, but the government is still going to increase its spending by a humongous $7 trillion over the next ten years’? Or have they written impassioned letters to you about how any reduction at all will destroy the nation’s social fabric (if they are a Democrat) or about how the time for financial austerity is now and these bold cuts are necessary (if they are a Republican)? Both sets of claims are ridiculous, because the government has allowed itself to continue to increase its rate of expenditure.
And has the mainstream media had headlines ‘Government fails to cut any spending and will instead boost it by $7 trillion’? Nope.
For reasons you will have to guess at yourself, no-one wants to tell you the truth.
The Size of the Federal Budget and Deficit
In 2010, the federal budget in total was for $3.456 trillion dollars to be spent. This is twice the size of the budget only ten years before. If your income has doubled in the last ten years (not from promotion and seniority, but just ‘because’), then you’ll feel this to be fair. But if your income has not doubled in the last ten years, then you’ll wonder how it is the government can double the amount it spends while you (and just about everyone around you) has not been able to double the amount they spend, too.
For 2010 the government not only planned to spend $3.456 trillion, but it also had a projected $2.162 trillion dollars in tax receipts – in other words, in 2010 we had right around a $1.3 trillion deficit. One out of every three dollars the government spent was money it didn’t have.
In actual fact, the reality is even worse because the government engages in accounting practices that makes high profile corporate accounting fraudsters like Enron (CEO Kenneth Lay found guilty and was expected to receive 20 – 30 years in prison but died prior to sentencing) and Worldcom (CEO Bernard Ebbers received a 25 year jail term) look like saints rather than sinners. If public companies used the same accounting tricks and outright dishonesty that the federal government uses, their leaders are sent to prison. Even domestic goddess Martha Stewart found herself incarcerated for five months after a high profile show trial relating to avoiding a $46,000 loss by selling shares before they dropped in value.
But what are the chances of the government censuring itself? Oh, about as likely as them voting to turn off their gold plated pensions!
The government mixes up its various different sources of revenue so that social security payments – the money we pay into our social security accounts to be held for future payouts back to us – are used to adjust their present shortfalls. This is spending tomorrow’s money today, and is an incredibly foolish strategy that we ourselves know better than to do, but it is something the government happily does every day.
Look at this chart which shows the ‘official annual deficits’ (blue bars) after this government financial trickery and then compare them to the actual budget deficits (red bars) showing the true deficits. (This second chart shows a projection for the future, and you just know that these projections are way too positive, rather than realistic.)
So our annual deficit is huge. Imagine if you spend 50% more than you earn this year – and imagine that you’ve been spending more than you’ve earned for each year in the last decade, and imagine further that you’re planning to continue spending 50% more than you earn each year for the foreseeable future, too. And also imagine that you’re not spending this money on investments like buying a house, investing in securities, or anything like that. You’re spending it on luxuries rather than essentials, and on things that you use up and consume and which are then gone, leaving only their cost as a reminder.
What would happen to you? How long could you continue living like this?
So, ask the same questions of our government. What will happen to our government, and by direct extension, ourselves. How long can our government continue spending money it doesn’t have? And (here’s the really scary question) – what will happen when the government’s lenders stop lending it money? (Almost the only remaining solutions then become for the government to either default on its debt or to just print more money to pay its debts, something that will create massive inflation and possibly even hyper-inflation).
The unstated huge tidal wave that will engulf us all is the growing interest on the growing balance of money we have borrowed. Look at this chart which shows what the future holds for us – the red bar is the interest we will increasingly have to pay each year. People like to talk a lot about the problem with the cost of Social Security (Social Security is not a cost, because it is something we have paid for ourselves) or the cost of Medicare/Medicaid, but what is the fastest growing part of this chart? Not the green (Social Security) or the blue (Medicare/Medicaid). It is the red – the interest on our growing debt mountain.
The Real and Very Simple Reason for the S&P Ratings Downgrade
So let’s now consider the historic first ever S&P ratings downgrade. Is it the ‘fault’ of the Tea Party? Did the Tea Party support a $7 trillion increase in government expenditure? No and no are the answers to both these questions.
We can understand the real reason for the S&P ratings downgrade very simply – by reading their statement and explanation of why they downgraded the US. There’s no need to invent other reasons, just look at the simple words they used to explain their action.
This is what they said :
- We have lowered our long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating.
- We have also removed both the short- and long-term ratings from CreditWatch negative.
- The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
- More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
- Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.
- The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.
Expressed really simply, while the politicians hope to fool us when they talk about ‘spending cuts’ that in reality are quite the opposite, they didn’t fool S&P at all. S&P can see that the ‘cuts’ are actually increases not decreases. Hence the downgrade. End of story.
Democrats have tried to spin this as being all the Tea Party’s fault, because S&P said they are concerned about the lack of political consensus. But when S&P say they are concerned about the political process, what they mean is the fact that politicians have not truly faced up to economic reality and cut any of the ever larger entitlement programs that are causing the deficit increases. All this arguing over the last few weeks was not about actual decreases in government spending at all, it was instead about how much government spending would continue to increase!
S&P are not complaining about the Tea Party trying to encourage a measure of financial responsibility; they are worried about the Republicans and Democrats who pretend to be financially responsible while acting completely the opposite. Even after all the fuss and theatrical nonsense about ‘the debt crisis’ (didn’t we all know, 100% for sure, that after a lot of chest-beating by both sides, the politicians would get together and work out a ‘compromise’ that in reality was not a compromise at all, shortly before the point where the government was to ‘run out of money’) the politicians have continued their same-old same-old approach to spending ever more to try and keep buying votes at the next election, no matter what the underlying longer term cost to our nation’s economy may be.
Note also that S&P are saying there is a chance they might downgrade our country’s rating still further if things don’t improve.
One last comment about the S&P rating. Unfortunately, economics is not an exact science, and jokes-a-plenty talk about how whenever you get any number of economists in the one room, you end up with more than that number of opinions (because some economists can’t even bring themselves to express a single opinion about anything).
Other rating agencies still have the US on the top rating, and so the S&P rating drop, while significant, does not conclusively mean that it is the end of the world for life as we know it. On the other hand, S&P’s decision to do something as hugely significant and symbolic (and to risk attracting the ire of the US government and people – Michael Moore suggested that they should be arrested as criminals) as to downgrade the US economy is certainly not something they’d do lightly, without a huge amount of discussion and thought.
How Did We Get to This Point
The US economy was formerly the rock on which the entire world based its financial system. Our economy was healthy and strong, and other nations were happy to invest in our economy and our currency, because it seemed the safest place in the world to place money, and even nations that weren’t investing in the US were happy to use our dollar as the basis for their international trade.
All those things are changing – or have already changed.
So what has happened to our economy? I’m not even going to talk about the ‘hollowing’ of the US economy – the loss of most manufacturing type industry to other countries, and the fact that just about anything and everything we buy these days comes from China rather than from a US factory. Yes, those issues are indeed problems, but they are not the root cause of the issues facing us at present.
The issue we’re facing at present is that we’re spending too much. That’s the simple problem. We – that is, our government – is ignoring how much money it can bring in, and is spending money without any thought to budgeting or fitting its expenditures to match its income.
And what is it spending so much money on? No – not defense (something too many people love to also cite as the runaway cost that needs to be reduced the most). And, alas, neither are we spending money on bona fide capital investments and improvements (like new highways) that will give us lasting benefits for decades to come. It can sometimes make sense to borrow money to build something that will then give you decades of lasting benefit – that way you are paying for the asset during the time period you are using it.
The government is spending money on ‘entitlements’ – welfare programs and the like. Increasingly, our politicians have been buying our votes each election cycle by giving ‘us’ more benefits and handouts. In the mid sixties and through to the beginning of the 1970s, the percentage of the federal budget spent on entitlements was less than 30%. But since that time, with the only notable exception being during the Reagan years and the first half of the Bush snr presidency, entitlement spending has been steadily growing – not just in real dollar terms, but also as a percentage of the total federal budget.
Entitlement spending is now over 65% of the total federal budget (as shown in the chart at the top of this article). Two out of every three dollars the government spends goes towards payouts (some would say ‘pay-offs’) to individuals. As for defense spending, that represents a mere 20% of the federal budget. And of that 20%, about 13% goes to actually spending money on defense, and the other 7% is interest on government debt that is so-called ‘defense related’.
No wonder that half of the US population no longer pays income taxes. And that is an unsustainable and crazy situation to be in. If the definition of ‘truly needy’ has shifted from a point where the bottom 5% or even 10% of the nation needs support to now where the greater half of the entire nation all needs support, then we need to change the definition back again.
Because there is the other part of the problem. Politicians love to talk about ‘the wealthy paying their fair share’. But what is a fair share? Is it fair that half the country pays no income taxes at all? Is it fair that someone who has been successful, who has created jobs for other people, who spends money on things that help other parts of the economy function, and who saves some money, creating funds available to then be lent to others; should this person pay hundreds of thousands of dollars a year in taxes (or even millions of dollars)? Who do we better trust to keep our economy stable and growing – successful businessmen, or politicians?
How about some hard-hitting talk about the ordinary people also paying their fair share? Don’t get me wrong – I’m an ordinary person too, and I don’t like paying taxes. But the solution to my not liking paying taxes is not to tax the wealthy guy more, it is for the government to reduce its spending.
The real problem here is the government is trying to become unaccountable for its expenditures. By focusing on a minority of the population to get their tax income from, a government no longer has to worry about any retribution at the polls, because although the heavily taxed minority might vote against them, the 50%+ of the population who are net beneficiaries of government spending will support the government, and enough of the people in the grey area between paying no tax and paying a lot of tax will support the government to ensure its survival.
Lastly, let’s just think what the $14.3 trillion federal debt ceiling (prior to it being increased) means to us. It means that each and every one of the 300 million US citizens have close on a $50,000 debt incurred by the government on our behalf. If you’re a family of four, that means your share of the nation’s debt is almost $200,000.
If you think that is a lot of money to owe, there’s more to consider. This is just the total of the federal government’s debt. How about the money your state owes? Your county? Your city? How about your school district? Fire district? Port Authority? Transit Authority? All these other organizations probably have ‘negative net worth’ as well, adding further to your overall indebtedness.
So in total, you personally probably have closer to a $100,000 share of the total government debt of all types, and your family is getting close to half a million in debt. And unlike your own personal debt – a mortgage on a house, a loan on a car, perhaps a student loan still being repaid, and hopefully not too much credit card debt – what can you show for this huge ‘investment’? A lovely house? Nope. A shiny new car? Nope. How about increased earnings capabilities as a result of a degree or trade qualification? Not that either.
Which begs one final question. If we can’t see anything as a result of the huge over-expenditures the government is making, how exactly would we be harmed if the government eased back on spending money it doesn’t have?
1. http://online.wsj.com/article/SB10001424053111903454504576493173381179508.html?mod=WSJ_Opinion_LEADTop – this shows the growth in government expenditures that are payments to individuals from 1965 to 2011, and draws its raw data from OMB. The chart at the top of this article is taken from this source.
2. http://en.wikipedia.org/wiki/File:InflationAdjustedDefenseSpending.PNG – this shows the makeup of defense spending
3. http://en.wikipedia.org/wiki/File:U.S._Federal_Spending_-_FY_2007.png – this shows total 2010 government spending
4. http://www.nationalreview.com/articles/273876/mad-debt-mark-steyn – the source of the ‘government cuts $900 billion but raises spending by $7 trillion’ statement. The article goes off on a tangent by strangely comparing our debt to Chinese military spending (and probably underestimates the Chinese military budget, too) but the first part of it is excellent.
5. http://www.cnbc.com/id/44051683 – Alan Greenspan acknowledges that the government can ‘cheat’ by simply printing meaningless money to ‘pay’ its debts, then amazingly blames the US’ problems, not on itself, but on Italy!