Many government programs depend on political legerdemain and budget gimmickry.  Social Security and Medicare are prominent examples.  Most Americans believe Social Security and Medicare funds are locked in a vault somewhere, ready for withdrawals when they retire.  We are disquieted to learn these “Trust Funds”, as they are called, are not funds at all, but accounting entries.  All those taxes we pay for Social Security and Medicare are borrowed from the “funds” by the government for the general budget, in exchange for IOU’s that are paid back with general revenues.  Any unfunded portion comes from future taxes.  Federal Reserve Board economist Roy Webb called these unfunded liabilities “stealth budgets”. ¹

The National Center for Policy Analysis (NCPA) observes, “The 2009 Social Security and Medicare Trustees Reports show the combined unfunded liability of these two programs has reached nearly $107 trillion in today's dollars!  That is about seven times the size of the U.S. economy and 10 times the size of the outstanding national debt.” ²  It is also twice the aggregate wealth of all American households. 

Economist Bruce Bartlett analyzed both the Social Security and Medicare reports for 2010 and discovered that the unfunded liabilities would require a tax increase of 81% in perpetuity. ³  Clearly, something must change structurally in the way we finance the safety net on which so many rely.   This system was workable when the public debt was 30% of GDP only 20 years ago, but is perilous when the debt is nearing 100% of GDP today.

Wishful thinking and illusion are not limited to stealth and complex government programs.   While Treasury Secretary Geithner was in Tokyo last week he affirmed the importance of a strong dollar. ⁴   A free floating currency exchange reflects the relative economic policies of the host countries and the relative demand for the goods they produce.   For the Treasury Secretary to "talk the dollar up" is as effective as a drug dealer proselytizing the junkie to drop his addiction.

" ‘Given the role of the dollar, frankly, there's not a tremendous amount one can do other than try to run a good, sound policy and restore the U.S. economy to growth,’ [World Bank President Robert] Zoellick told a panel discussion on the sidelines of the Asia-Pacific Economic Cooperation forum annual summit.” ⁵   And that is precisely what we have not been doing for many years.

What is worse, we have been flooding the market with cheap dollars in order to stimulate our economy, discomfiting Asian countries by a new impending bubble.   Even the communist Chinese saw fit to lecture capitalist Americans: “Liu Mingkang, chairman of the China Banking Regulatory Commission, said that a weak U.S. dollar and low U.S. interest rates had led to ‘massive speculation’ that was inflating asset bubbles around the world.”⁶   Have the Chinese become reformed monetarists?  Not quite.  They still insist on pegging the renminbi to the dollar while they complain.  This has three effects: 1) U.S. exporters cannot benefit from a lower dollar to sell more goods to China, 2) U.S. consumers push more dollars to China in return for artificially low prices on imported goods, and 3) other countries, particularly those in Southeast Asia, are similarly hurt by the artificial exchange rate because their currencies look high in relation to the yuan.   By any definition, this is not  free trade. 

Thus, our trade deficit actually grew in September with the lower dollar ⁷—just the opposite effect one would expect—because our appetite for foreign cars and foreign oil cannot be sated, and government won’t allow an otherwise normal exchange rate to attenuate it.   The administration’s response is to favor protectionist measures rather than to address the underlying economic conditions, potentially resulting in double trouble.

Another bit of hocus-pocus last week was the Obama administration’s plan to use TARP money to reduce the deficit:  “The administration wants to keep some of the unspent funds available for emergencies, but is considering setting aside a chunk for debt reduction.” ⁸  TARP—troubled asset relief program—was supposed to have relieved banks from the synthetic securities they designed that ultimately had no market.  Bailing these banks out was a questionable government activity to begin with, but Congress and two administrations have treated TARP like a floating fund, using it for anything but troubled assets, and arguably violating TARP’s foundational authorization that was passed over the will of the people.   Inasmuch as TARP originally added to the Federal deficit, not spending a portion would not reduce the deficit, but would merely not increase it.  There is no “setting aside” because TARP is one of those stealth programs—just an accounting entry.  This inconvenient truth does not dissuade the administration from creating the illusion that it is doing us a favor.

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[1] Webb, Roy H. “Economic Review: The Stealth Budget: Unfunded Liabilities of the Federal Government.” Federal Reserve Bank of Richmond,May/Jun1991 http://www.richmondfed.org/publications/research/economic_review/1991/pdf/er770303.pdf

[2] “Social Security and Medicare Projections: 2009”.  National Center for Policy Analysis, 11 June 2009, http://www.ncpa.org/pub/ba662

[3] Bartlett, Bruce. “The 81% Tax Increase.”  Forbes, 15 May 2009 http://www.forbes.com/2009/05/14/taxes-social-security-opinions-columnists-medicare.html

[4] “Geithner Affirms Strong Dollar Policy.” The Wall Street Journal, 11 Nov. 2009, http://online.wsj.com/article/SB125792362908743307.html?mod=WSJ_hpp_LEFTTopStories

[5] “Bubble Fears Surface at APEC Gathering.” ibid., 14 Nov. 2009 http://online.wsj.com/article/SB125812846361947215.html

[6] “China's Blunt Talk for Obama.”  ibid., 16 Nov.2009 http://online.wsj.com/article/SB125826103009548975.html?mod=article-outset-box

[7] “Sinking Dollar Aids Exports, but Trade Gap Grows.” ibid., 14 Nov. 2009 http://online.wsj.com/article/SB125811859626047087.html?mod=WSJ_hps_LEFTWhatsNews

[8] “White House Aims to Cut Deficit With TARP Cash.” ibid., 12 Nov. 2009 http://online.wsj.com/article/SB125799009185344567.html?mod=WSJ_hpp_MIDDLENexttoWhatsNewsSecond

The low dollar and high deficits are cognate for two reasons.  First, the Fed had to print money to increase liquidity in answer to credit markets drying up; a policy that has failed, incidentally, because, as any small business or home buyer will tell us, credit is still tight.  The central bank also has to print money to finance the national debt.  The resulting oversupply of dollars devalues the currency.

Second, as overseas investors weigh the risk of investing in the U.S. against other countries, they prefer to place bets in lower risk, higher return markets.  Part of that risk calculus is the cost of doing business in this country—wages, taxes, insurance, property taxes—and part comes from political and fiscal risk.  When the U.S. runs high debt, investors are leery of future taxes and fees to service the debt.  Thus money—and jobs—flow away from the US, putting downward pressure on the dollar.  The combination of a low dollar and high money supply eventually fuels inflation.  A sound fiscal policy, prudent control of debt, and a business-friendly environment will be reflected, therefore, in a stronger dollar while tempering the risk of inflation.

In an Op-Ed piece in The Wall Street Journal, economist Judy Shelton observed “the projected federal debt will continue to equal or exceed our nation's entire annual economic output through 2019 … The U.S. is thus slated to enter the ranks of those countries—Zimbabwe, Japan, Lebanon, Singapore, Jamaica, Italy—with the highest government debt-to-GDP ratio”.  Zimbabwe?  And if the US were a European country, it would be denied membership into the European Union because “countries wishing to adopt the euro must first limit government debt to 60% of GDP” ¹.

David Wessel observed in the Journal that we have overcome these problems before although, “When the economy began climbing out of the deep recession of the early 1980s, federal debt -- the sum of every annual budget deficit* -- amounted to less than 30% of the nation's GDP”².  With debt now at 90% of GDP, we in much deeper this time.

The Financial Times reported “The US budget deficit hit a record $1,400bn in the last fiscal year as the government tried to spend its way out of recession, slightly less than expected but still more than three times that of 2008.”  This one year deficit, fully 10% of GDP, is a result of “Government spending [rising] 18.2 per cent from 2008, in part because of Tarp and the $787bn fiscal stimulus package.”³

So how is that stimulus working out for us?  According to the government’s web site, Recovery.gov, we have created—get ready—a grand total of 30,383 jobs⁴.  With less than two-tenths of 1% of the 15 million unemployed in this country allegedly getting jobs through the “stimulus” the administration insists the program is a success.  "Thanks largely to the Recovery Act, alongside an aggressive financial stabilization plan and a program to keep responsible homeowners in their homes, we have walked a substantial distance back from the economic abyss and are on the path toward economic recovery," wrote Larry Summers⁵.

Substantial?  Recovery.gov, reports only $2 billion of the stimulus has been distributed in contracts. This amounts to roughly $66,000 spent for each of those jobs created.  Further, the site reports “jobs saved/created” ranges from 5.93 in Rhode Island to 4693.05 in Colorado.  It is unclear how The White House thinks it “saved” a job let alone measuring salvation with accuracy to the second decimal.

Against this backdrop of run away deficits, the Senate Finance Committe passed one of the largest tax increases in history under the guise of “health care reform” at a cost of over $829 billion.  In a canard, the Congressional Budget Office claims the bill, which no one has seen because Congress refuses to post it in this age of transparent government, will not increase the deficit; but the CBO's estimate is based on fuzzy accounting replete with unsubstantiated assumptions.  Move aside Zimbabwe and Jamaica, Congress just can't say "no".

Sen. Olympia Snowe of Maine, the sole Republican to vote for the bill, said she wanted to be part of history.  She did not elaborate whether she was thinking about the Hindenburg or the Titanic.

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*  [less payments made, plus accumulated unpaid interest – MA]

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[1] “The Message of Dollar Disdain”, 13 Oct. 2009, The Wall Street Journal, http://online.wsj.com/article/SB10001424052748704107204574470961505506386.html

[2] “Deficit Dilemma: How to Dig Out?” 15 Oct. 2009, The Wall Street Journal, http://online.wsj.com/article/SB125554787267585505.html

[3] “US budget deficit hit a record $1,400bn”, 17 Oct. 2009, Financial Times, http://www.ft.com/cms/s/0/92624ee8-baa2-11de-9dd7-00144feab49a.html

[4] Recovery.gov: Track the Money, http://www.recovery.gov/Pages/home.aspx

[5]  “Summers to GOP's Boehner: Recovery Act Is Working”, 12 Oct. 2009, The Wall Street Journal, http://online.wsj.com/article/SB125534918141780117.html