Niall Ferguson and Laurence Kotlikoff paint a dire picture of the fiscal outlook in the U.S. Much of the material is a recital of the prospects for Social Security and Medicare, with which readers of this blog are familiar. One insight that was new to me was this:
During the Clinton Administration, the CBO routinely projected that, regardless of inflation or economic growth, the federal government would spend precisely the same number of dollars, year in and year out, on everything apart from…entitlements. At the same time, the CBO confidently assumed federal taxes would grow at roughly 6 percent each year. As a result, it was able to make dizzying forecasts of budget surpluses…These phantom surpluses were the money Al Gore promised to spend on voters and George W. Bush promised to return to them during the 2000 election.
In their view, our politicial leaders, the public, and bond market investors are all in denial about the large future liabilities that the government faces.
UPDATE: Greg Ransom links to a statement from Kotlikoff.
Greenspan’s proposed cuts in Social Security are trivial relative to what’s needed and perpetuate the myth that we can finance the baby boomers’ retirement with minor fiscal adjustments…What’s needed are real statesmen to propose and enact the radical and extremely painful reforms required to ensure our nation’s fiscal solvency.”
For Discussion. If the fiscal crisis is real, how will it first manifest itself?
READER COMMENTS
Andrew Martin
Feb 28 2004 at 6:49pm
The first changes will come in the form of taxes increases. The mildest tax increase will be to simply allow the Bush reductions to retire. If the situation becomes serious to the point that it looks like entilements may have to be cut, you can put your money on further tax increases. Any increase will have to be spun as beneficial to voters by either saving entitlements from an apparent doom, or “greater good” taxes like higher gasoline or sin taxes to ‘protect the environment and public health.’ Quite simply, I feel elected officials will be much more willing to increase taxes than to face the electoral fallout from actually reducing entitlements. Don’t forget, seniors and the baby boomer generation that will shortly become retirees are huge voting blocks. If the tax cuts needed become too substantial, I would venture guess that there will be either some sort of mild cut in entitlement benefits (maybe through increasing the age which we will receive benefits by pointing to longevity statistics) or defence spending cuts. Which comes first will depend on which party is in power and how well the “war on terror” is progressing. But this is all just a guess.
Barry Ritholtz
Feb 29 2004 at 7:24am
Last Summer, I caught an utterly fascinating Bill Moyers interview with Niall Ferguson on PBS.
Moyers interviewed Ferguson and his fellow historian Simon Schama. Both gentlemen are British, both living in the United States. Niall Ferguson teaches at New York University, and is a senior fellow at Oxford. (His most recent book is EMPIRE: THE RISE AND DEMISE OF THE BRITISH WORLD ORDER AND THE LESSONS FOR GLOBAL POWER. Simon Schama was the other guest. He teaches at Columbia University, and wrote the multi-volume A HISTORY OF BRITAIN, and is the star of the BBC television series of the same name.
I put a few exercpts up here: The Triumphant Return of the British
You can see the entire transcript at the PBS site (about halfway down the page here: PBS NOW July 18, 2003 transcript
Its a fascinating perspective, and one Americans have slowly been coming around to . . .
george gilooly
Feb 29 2004 at 11:08am
The trouble with paper money
Is the problem with the dollar only that it is falling?
http://economist.com/finance/displayStory.cfm?story_id=2459841
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Those who doubt the continued worth of paper money as a store of value point to two things. The first is that the price of gold has been rising even though official inflation is low…
the second main reason for concern—is the amount of debt that rich-country governments have been running up…the present value of the American government’s future obligations, taking into account promised pensions and health-care benefits, is a staggering $45 trillion.
In theory, such debts would not be tolerated for long by investors, since the easy way out for central banks is to “monetise” them with inflation. Bond prices would fall (and thus yields rise) as investors worried that they would be paid back in a debased currency. But capital markets currently seem oblivious to spiralling debts…
The problem may be that bond investors, far from being far-sighted, are in fact myopic, and are perhaps being fooled by the temporary disinflationary effects of excess capacity and debts built up over the bubble years in both Japan and America. Perhaps, too, investors have been lulled into a false sense of security by the performance of central banks in recent years, and the independence that has been granted to many of them by governments. But this very aura of inviolability may be storing up problems, since it means that governments can borrow still more at cheap rates. And if governments then find themselves crushed by debt, you can rest assured that this independence will be taken away.
Lawrance George Lux
Feb 29 2004 at 12:46pm
Doomsday Scenario:
Inflation is already with Us, check the Resource Recovery market pricing. This will be translated to the greater economy by the third generation of Production. The immediate disaster will be the lack of subscription of US Treasuries, especially by the rest of the World. The reason for this comes with the vast draft of financial resources by the US Treasuries already, the increasing Profits and desireability of foreign investment with high American outsourcing, and the increasing independence from the United States as a Supplier of technological product. lgl
Chris
Feb 29 2004 at 3:54pm
I just read Ferguson’s article and I have to say that it has me a little worried. I don’t see any way around the problem of exploding implicit debts he describes. I think that his solution — privitiation of social security and reining-in medicare — are sane and sensible. Unfortunately it is also politically impossible. This is why John Stuart Mill wrote that no one should be able to vote themselves money out of the public purse.
As for Arnold’s hope that improvements in technology will make us so wealthy that we’ll laugh off these debts, I think he is in a bit of denial as well. Nanotechnology is a joke. Moore’s Law? How is a faster microprocessor going to get us out of this mess?
Monte
Mar 1 2004 at 12:10pm
Profligate government spending on an increasing scale, particularly at the federal level, has become endemic and all indications are this trend will continue. Even so, no obvious relationship between deficits, the direction of interest rates, or the rate of inflation has ever really been established. Deficits, in and of themselves, don’t matter so much as how the borrowed funds are spent. The fact that a growing proportion of these funds is allocated towards transfer payments, defense spending, and interest payments on the national debt is important because it leaves a smaller share available for productive social investment.
Ricardian Equivalence notwithstanding, how any real fiscal crisis would first manifest itself depends largely on how the government chooses to finance its spending. If the treasury resorts to heavy borrowing, it may increase the money supply in an effort to avoid rising interest rates, creating inflationary pressures and causing a misallocation of resources through its effect on capital markets and private incentives. If, OTOH, the government chooses to increase taxes, a decrease in GNP would accompany the impact of that increase on consumption.
“Blessed are the young, for they shall inherit the national debt.” – Herbert Hoover
Eric Krieg
Mar 1 2004 at 4:35pm
“Greenspan’s proposed cuts in Social Security are trivial relative to what’s needed…”
How so? What are the magnitude of the cuts needed?
30%?
Boonton
Mar 1 2004 at 5:15pm
The gist of the article says that Medicare is about 80% of the problem.
Robert Schwartz
Mar 2 2004 at 12:44am
The sky is falling! the sky is falling!
Social Security is Bankrupt! Social Security is Bankrupt!
Medicare will drag you under by the fancy tie round your wicked throat!
Stop. Calm down. Everybody. Breath. Thank you.
The Social Security System has been going under for most of the time that I have been paying into it (30+years). The Federal Budget has run chronic deficits during large portions of my (56 year) life (and indeed longer).
Given the sensitivity of longterm projections to assumptions about demographics, technological innovation, interest rates, inflation/deflation, productivity, and dozens of other variables; any projection that purports to put a number on a future state of the world more years out than you can count with your shoes on is inherintly suspect.
45 Trillion. No Problem I’ll buy it. the assets far exceed the liabilities.
Imperial overstretch — Paul Kennedy wrote that book 20 years ago. I’m still waiting for the sequel.
Dollar about to crash. I’m short the Euro. You want to solve problems? Pick one of these USA, Russia, China, Japan. You may not re-animate Stalin, Mao or Tokagawa.
I’m sorry. I am not more excited. But I do not see a real huge issue, that cannot be solved.
The big political problem is really all in a small knot. The Democrat party in the incarnation of the 1972 party is about to implode. As such its adherents can no longer function in any mode other than partisan showdown. (As shown by the ironic fact that the Bush Social Security Plan was drafted by the late great Sen Moynihan). I expect this logjam to break in November.
I do not expect a Republican monopoly nor do I think there is a anything other than dislike of the chattering classes that holds the Republicans together. I believe that there will be two parties in the future. I beleieve that one of them will be called republican and one democrat. and I believe that there will be substantial ideological differences between them. Among the differences I see: internationalism/isolationism; free trade/fair trade; imigratiation/nativism; communitarian/libertarian; ecology/industrialism. I have no idea which issue goes with which and which party winds up on which side of what– witness the recent brouhaha about imigration.
I see no traction for tax the rich, wealth redistribution, socialism, government owned enterpises, or other 30’s era war horses, which will be sent to the glue factory along with the myth that Social Security is the 3rd rail of American Politics. Now if we can only exorcise the ghost of Al Ulman from the Capitol.
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