Default, Devaluation, or Something Else?

Good idea: appoint Erskine Bowels & Alan Simpson to address spiraling federal debt problem.

Bad idea: flip Bowles-Simpson the bird and propose a budget which completely ignores the looming crisis because actually solving it would be politically uncomfortable.

Good idea: force political leaders to recognize that we cannot eat our cake (enjoy expanding entitlement obligations) and have it, too (not be required to pay for those obligations).

Bad idea: take a pledge that you won’t raise any taxes, ever.  

Here are Paul Ryan and Tim Geithner—regardless of your political preferences, these are two pretty forthright guys—having a relatively calm discussion about financial Armageddon.

Now check out this piece from The Economist.

You read that correctly: economists debating how—not whether—the U.S. will welsh on its financial obligations.  Option 1: devalue the U.S. dollar so that our repayment of Treasury bond principal & interest is cheaper in real terms.  Option 2: wait for the markets to tell us that we shouldn’t be borrowing so much, and raise our cost of debt, thus prohibiting all future debt ceiling increases.  Option 3: Pre-arrange a default with the International Monetary Fund in order to provide Democrat & Republican politicians the requisite political cover.

Can you imagine us calling in the IMF to help us default on our obligations?  

Blech!

If you put a gun to my head and said “choose one,” I guess I’d go with Option 1.  But, the dollar’s decline as reserve currency would accelerate rapidly.  And, there’s only so much you can do there now that our own central bank (the Fed) owns such a huge piece of debt.

Maybe the Fed could start investing in Chinese Yuan denominated assets, while our Treasury issues dollar denominated debt? 

But seriously, is that it?  Are our choices limited to devaluation or default?

I don’t think so.  I think growing our way out is still an option, but it’s going to require some painful changes, and fast.  Here's what growing our way out entails:  

1.  Tax receipts have to go up.  BUT, the only way this makes sense economically is through broad, permanent tax reform, not through goofy sunsets and holidays.   Drop corporate income taxes completely, then raise taxes on dividends & capital gains to ordinary income tax rates.  Close loopholes.  Eliminate deductions for interest.  Maintain some progressivity, but flatten the curve considerably.  Turn individuals into savers / capital providers and make American business uber competitive in the global environment.  Send a message to entrepreneurs that we’re done screwing up their strategic plans with tax games.  America is open for business—we’ll help you excel here like no other place on this earth. The idea that we can just coerce the rich to pay for our fiscal indolence is a mark of extraordinary silliness.  Capital flows freely in this global economy—the more you tax it, the greater incentive it has to move to other countries.  But not even a global Marxist revolution would actually satisfy our financial obligations.  It might allow us to erase them, but it would also lower standards of living in the process.
2. The retirement age / Medicare eligibility age has to be raised.  Trying to balance budget by cutting the non-discretionary stuff and even defense, to a lesser extent, is like rearranging the deck chairs on the Titanic.  Extending the eligibility ages needn't (and shouldn’t) be done for anyone 50 and above.  But it’s absurd that we still promise our citizens a pension and a gold-plated health care plan to begin at the same age in life we did 70 years ago--when the lifespan was two decades shorter.  And, of course, we should push as many of these kinds of social issues as possible back to the 50 states.  We need 50 local laboratories, not a detached federal bureaucracy, working on these problems.   

There are other good ideas that we should consider (e.g., a national sales tax to replace the income tax; Paul Ryan’s proposal to convert Medicare into a health insurance premium subsidy, etc.), but that’s about it, really.  Stop spending as much on major entitlements and enact serious tax reform.  If we do those two things, we can turn the ship before it runs aground.  

Will we? 

Giving President Obama Credit (Really)

It’s no secret that I’m not a fan of the Obama Administration.  I do still respect the office—honestly.  Unlike so many others drawn to “public service”, Mr. Obama seems to me to be a committed husband and father and is decidedly not a philandering narcissist (ala WJC).  Integrity seems important to President Obama—I respect that, too.  And if conventional wisdom is accurate that he loathes Washington politics, I actually find that quality sort of endearing.     

BUT [“C’mon Simone, let’s talk about your big but.”], the things he desires for and from American citizens are antithetical to what I hold dear.  The times where his instincts have been exactly wrong are so numerous, and his leadership skills are so inadequate, that I’d fire Mr. Obama yesterday if I could.  Wait: Vice President Biden is next in succession—on second thought... 

       

Analysis precedes advocacy.  I try to live by that principle.  I'm often lousy at it, but I try.  Here are two recent examples of when I think the president has gotten it almost completely right.

Housing Finance Reform 

On February 2, Treasury Secretary Tim Geithner delivered his update on the state of financial reform.  About ¾ of the way through came this little gem:

“Our plan will wind down the GSEs and bring private capital back into the market, reducing the government’s direct role in the housing market and better targeting our support towards first-time homebuyers and low- and moderate-income Americans.”

Yep, you read it correctly, their plan is to “…bring private capital back into the market, reducing the government’s direct role in the housing market…”  

We got the sense that this might be happening in 2011 (read about it here), but the statement above illustrates how far we've come.  This is the first time in the last 37 months that I’ve heard anything—actual policy, that is—remotely positive about private capital from this administration.  Except for occasional, vague, pandering, positive remarks about “small business”, the president has consistently portrayed private enterprise as something one might accidentally step in while mowing the lawn.  What’s important here is Mr. Obama’s implicit recognition of private capital’s importance: it can accomplish things the government simply cannot.

And they want to "wind down the GSEs"?  Fannie Mae and Freddie Mac were the mechanisms through which Washington helped create this mess.  I'm tearing up.  

An encouraging juxtaposition: the conclusion of the government’s $25 billion foreclosure suit means banks can begin to process the huge backlog of properties needing to be repossessed and sold.  Painful for the families involved, yes, but a critical healing step for the housing market.

State Exemptions from No Child Left Behind

On February 9, the U.S. Department of Education announced that 10 states, which had proposed their own school evaluation mechanisms, had been released from the dictates of No Child Left Behind.  “The goals of No Child Left Behind were the right ones,” the president noted in a statement.  But as Education Secretary Arne Duncan recognized: 

“rather than dictating educational decisions from Washington, we want state and local educators to decide how to best meet the individual needs of students.”

Excuse me?  “rather than dictating…from Washington”?  Who are you guys?

I know, I know—Mr. Duncan’s statement indicates that he wants power to go to the educators, not to school boards.  But, gee whiz, did you see that power back to the states thing?  

I can’t completely fault President Bush for NCLB.  It was an attempt to inject some measure of accountability into an industry (yes, industry) for the benefit of our children and their educations.  But let’s be honest: in NCLB he created a massive new federal program.  Would that he just deleted the whole U.S. Department of Education…but, I digress.  

What’s so heartening about these two pieces of policy—delivered only one week apart—is that they display awareness of the federal bureaucracy’s limits.  The more local our focus, the more effective our solutions.  My hunch is that these policies are just subtle enough that they’re not simply election year stunts.

 

So, nice job, Mr. President.  I’m still going to try to get you fired, but these changes are worthy of our hope.