Forecasts of US Fiscal Armageddon Are Wrong

080519_USEconomy1My Comments: Over the years I’ve had people wonder why I’m an optimist. They’ve decided I’m simply blinded by whatever it is that causes me to lean to the left instead of the right. To their mind, the world, and in particular America, is going to hell in a handbasket.

I believe that for centuries, every generation, as they age, thinks the landscape of society is doomed, and that the younger generation is hopeless. But over my 70 plus years, I’ve enjoyed a very satisfying life. Yes, there  was WW2, the Vietnam War, rock and roll, every crisis de jour you can imagine. There have been bad days, but they’re far outnumbered by the good days. If I have a regret, it’s that I’ll not live to see the next 70 years.

I’m baffled by the attitude of the blathering pundits on TV, especially those on the right, who do everything possible to turn back the clock. They sound like 4th graders. And many of those who get to Congrass act like 4th graders. But nothing I say will change that since it’s been this way ever since.

I was and am hoping Jeb Bush decides to run for President in 2016. Not because I agree with what his party says, but because he is about the only leader on the right who has graduated from the 4th grade. And now has an advanced degree in life.

As an immigrant to this country, I believe one of America’s great strengths is the capacity to allow a spirited dialog that effectively moves all of us toward the future as it evolves. But I’ve yet to encounter a 4th grader with the ability to articulate what is best FOR ALL OF US.

This article suggests there is a strong positive in our future.

By Robert Barbera / April 7, 2014 / The Financial Times

Conventional wisdom has it that the American national debt is out of control, and that cutting the federal deficit is an urgent task if the US is to avoid a budgetary crisis. The logic is beguiling. But it is wrong – and the influence it exerts on policy makers may put a brake on future economic recovery.

Anxiety about US budget deficits has been a reality in the US for most of the postwar period. But today’s Cassandras argue that the aftermath of the financial crisis, superimposed on to the reality of an ageing America, has made the problem sharply worse. Eighteen months of recession, followed by decades of tentative recovery, mean that the burden of financing retiring baby boomers is set to overwhelm US finances in the years ahead.

The Congressional Budget Office believes that within 25 years the government’s accumulated debt will equal an entire year’s worth of economic output. Some analysts fret that interest payments will then be so onerous that cripplingly high taxes will be the only alternative to a ballooning debt and eventual default.

Such forecasts of a federal debt disaster depend on an assumption that is rarely mentioned: that interest rates will normalise even though economic growth will not. Combine decades of tepid expansion with traditional real interest rates, and an unsustainable debt burden quickly comes into view. But that combination would represent a dramatic break with history. It goes against everything we know about the mechanisms that determine real interest rates. It is, therefore, a slim reed on which to base a radical departure for economic policy.

In its February report the CBO serves up the consensus view in elaborate detail. Deficits swell over the decades ahead and the debt climbs to 100 per cent of gross domestic product. The subsequent discussion centres on how best to rein in these fiscal excesses.

This is strange. The fact is that federal deficits have fallen precipitously over the past few years. In 2011 the watchdog projected that government spending (excluding interest payments) would exceed receipts by 7 per cent of GDP in 2038. It now states that this “primary deficit” will instead be 1.6 per cent of GDP, hardly cause for panic.

Yet despite this relatively sanguine view of the deficit, the CBO continued to sound the alarm about an incipient US debt crisis. Why? Because it believes that rising interest rates will amplify the debt burden at the same time as a weak economy saps the country of the strength needed to service the growing debt.

According to the CBO, the American economy will on average create a meagre 164,000 jobs a month during 2014, slowing to monthly gains of only 66,000 four years later. Nonetheless, the CBO projects that by 2018 the US Federal Reserve will have tightened monetary policy, raising the funds rate to nearly 4 per cent from close to zero today. It thinks the government will be paying an interest rate of 5 per cent on 10-year borrowings.

It is easy to imagine a scenario in which interest rates rise – the CBO projections envisage real or inflation-adjusted interest rates not far from the average seen over the period from 1955 to 2005. But real growth during that period averaged 3.5 per cent; far higher than the feeble expansion the CBO expects in the coming years. Yet if the US is doomed to endure a period of tepid growth then interest rates, too, will surely be lower.

It is not only the base rate that can be expected to fall in the weak economy envisioned by the CBO. The “term premium” – that is, the extra reward that investors demand for holding long-term debt – will also decline as fears of future inflation subside. In the 1980s and 1990s, when investors worried about the possibility of sustained increases in the price level, long-term bonds were perceived as risky assets. No longer. Now, financial instability and recession are the risks that keep investors awake at night. Long-term bonds are a good hedge against these risks. In such a world the term premium should be lower. Of course, this could change: a more traditional pace for economic growth could return, together with more worries about inflation. In that case, however, tax receipts would be substantially higher and the deficit and debt outlook much improved.

What happens if we combine tepid growth with tame interest rate increases? The “crisis” all but disappears. If the government pays a real interest rate of 1.5 per cent, instead of 2.7 per cent as the CBO expects, then government debt in 2038 will amount to 78 per cent of GDP, a far cry from the CBO’s forecast of fiscal Armageddon.

Is this rosy scenario an unhistorical fantasy? Far from it. From 1955 to 2005 the government’s real borrowing cost was about 1 per cent below the economy’s real growth rate. It is the CBO forecast, with the US compelled to borrow at real rates dramatically higher than its growth rate, that breaks with US history.

The writer is director of the Johns Hopkins Center for Financial Economics

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