This Week's Herbert Hoover Award

There comes a time when leaders promising great change are elected, with the unspoken understanding that said leaders will make things stay the same. President Herbert Hoover was an excellent example of such a leader: as the U.S. economy crashed like a lead balloon during the 1929 Depression, he held innumerable (and pointless) meetings to help out the economy, and made vague promises for the return of "permanent prosperity."

In that particular spirit of President Hoover, we present this week's Herbert Hoover Award for wind-baggery and empty posturing. The prestigious award goes to (drumroll):

The President of the United States, Barack Obama

"Paying for what you spend is basic common sense," said the President on Tuesday, as he proposed the so-called "pay-as-you-go" spending policy on Federal outlays. "While short-term spending was necessary to get the economy moving again, our long-term fiscal problems became that much more urgent," commented Rep. Jim Cooper of Tennessee, a Blue Dog Democrat, in favour of this "PAYGO."

According to the CNN article, PAYGO would require that, if spending is to be increased in one part of the Budget, another part must be reduced that same amount. Additionally, if a tax is to be cut, tax revenue must be concurrently increased to offset the cut. The end result, as it seems to us, is intended to achieve a sort of steady-state of the Budget, as well as tax revenues. Some things, however, would be exempt under President Obama's plan, such as: estate and gift taxes, Medicare payments to doctors, and 2001/2002 tax cuts. For an overview of PAYGO, we recommend the Wikipedia article.

Upon pondering the part in the CNN article about taxes, we got a little confused. If tax revenue must be raised in correlation to a tax cut, does that not mean taxes would need to be increased to offset tax cuts? And isn't raising taxes during a Depression a really bad idea?

But leaving that all aside, let's take a hard look at what PAYGO would actually do for paying down the U.S. Government's deficit: absolutely nothing. PAYGO does not seem to have any mechanism that we can discover which would force the U.S. Congress to cease-and-desist on massive deficit spending. The Government simply couldn't increase the deficit beyond what it already is.

Problems arise even there, as it is difficult to discern exactly how big the Federal deficit really is. Is it around $11.3 trillion, as the Treasury Department suggests... or is it the vastly more monstrous $52.7 trillion that former Comptroller of the Currency David Walker revealed (see slide #17) in early 2008?

Even the exact figure is beyond the point, as we cannot seriously entertain the notion that the U.S. Congress would give itself iron-clad spending limits. If PAYGO is made the law of the land, it will do nothing to impede Congress' mad dash towards a quadrillion in debt, and probably beyond. So, we can only conclude that the PAYGO proposal from President Obama is yet another puff of hot air, floating up into the atmosphere and increasing global warming.

Congratulations, Mr. President. We guarantee your trophy will look great on your desk.

The Problem of Financing the US Federal Debt

There are countless misconceptions about where the money comes from to finance the US Federal Debt. One reads constantly in the financial press something like "the U.S. must have a sound fiscal policy, or the Chinese [or Japanese, or Arabs, etc.] will not fund the deficit." This is actually just silly.

Foreign trade partners have money to invest in US Government debt because they run trade surpluses with the USA. Debt is bought with funds left over after they have bought whatever they might want (if anything) that the USA has to sell them. The amount of debt they buy is incidental to their trading activities. Internal US policy (interest rates, inflation rates) has little impact on the process.

For a while it was a great deal for citizens of the USA. They got to buy stuff from abroad, and when the money was recycled back to the Federal Government, they got to spend it again! Things are changing, though. Foreign trade surpluses with the US are crashing. This is because foreign trade is crashing (see a previous post).

The U.S. Federal Government (and indeed any national government that has been running chronic trade deficits) will be losing a critical source of funding in the years ahead as international trade declines. It is highly unlikely that interest rates will be raised to attract funds as this would exacerbate the economic contraction. Instead, the loss of recycled trade deficits will be made up for by just that much more 'printing'.

As we have been hinting darkly, the USA is coming to the point where its economy simply cannot service the debt load it has placed upon itself. Given the way policy has been going lately, the outcome will be the quasi-default of runaway inflation.