Here is Gary’s essay, Five Mainstream Economists Sound a Warning. For more by Gary, visit his website at http://www.garynorth.com/.
Gary reviews the situation of the US deficit:
- the on-budget deficit: a mere $1.2 trillion a year.
- the real federal deficit, which reflects the unfunded liabilities of the federal government, primarily in Social Security, Medicare, and Medicaid … has a present value of $222 trillion.
- It cannot, except by one technique, namely, default.
- The Fed now owns one in six dollars of the national debt
- The five’s conclusion: The problems are close to being unmanageable now. If we stay on the current path, they will wind up being completely unmanageable, culminating in an unwelcome explosion and crisis.
Nothing will change Congress. Nothing will change the executive. There will be no cutback in spending until the numbers force the Great Default. … Americans will not be ready. State and local governments will not be ready. … Will you be ready?
Issue 1207 September 25, 2012
FIVE MAINSTREAM ECONOMISTS SOUND A WARNING
The “Wall Street Journal” ran an article the likes of
which I have never seen. “The Magnitude of the Mess We’re
In.” It was written by five well-known economists. It warns
readers about a series of highly destructive outcomes of
the federal government’s present fiscal policies. The
article says that these problems are close to being
The first economist involved is George Schulze. He
taught at the University of Chicago and MIT. He served as
the Secretary of the Treasury under Nixon and Secretary of
State under Reagan. He served as the Head of the Office of
Management and Budget under Nixon, and also Secretary of
Labor under Nixon. I can think of no other economist with
comparable experience at the highest level. He is an
insider’s insider. He is 92 years old — a true elder
The second economist is Michael Boskin. He teaches at
the Hoover Institution. He used to teach at Stanford. He
was the head of the Council of Economic Advisers under the
first Bush. Then there was John F. Cogan of Hoover and
Stanford. Then there was Allan Meltzer, who is the most
respected historian of the Federal Reserve System. Finally,
there was Stanford’s John Taylor, of “Taylor rule” fame,
one of the most respected academic economists in the USA.
A NAIVE ARTICLE
The problem with this article is it is na‹ve. It is
Pollyanna to the core. It begins with the on-budget
deficit: a mere $1.2 trillion a year. The on-budget deficit
is peripheral to the real federal deficit, which reflects
the unfunded liabilities of the federal government,
primarily in Social Security, Medicare, and Medicaid. This
deficit dwarfs the on-budget deficit. It is rising at $11
trillion a year. (http://teapartyeconomist.com/?p=8108)
This deficit has a present value of $222 trillion.
This means that the federal government, today, must invest
$222 trillion in market investments that will return about
5% per year for the next 75 years. No such investments
exist, and the federal government does not have $222
trillion in reserve. The Federal Reserve system could print
that, of course, but then that would only lead to
In other words, by starting with the on-budget
deficit, the five economists low-balled the problem. This
makes look as though the problem can be dealt with by
Congress. It cannot, except by one technique, namely,
default. They mention unfunded liabilities only briefly,
and they offer no numbers.
Nevertheless, in a na‹ve sort of way, the five
economists do point out that present politics makes it
virtually impossible for the on-budget deficit not to
escalate, and if it does, it is going to lead to a series
of inevitable disasters. The five economists go into the
details about these disasters, and it is a good thing that
somebody bothered to do this.
The article began with a good question: “Where are we
now?” Answer: a lot worse off than the article says.
It asks this question: “Did you know that annual
spending by the federal government now exceeds the 2007
level by about $1 trillion?” I do. You do. Who doesn’t?
They list the deficits: $1.4 trillion in 2009, $1.3
trillion in 2010, $1.3 trillion in 2011, and another $1.2
in 2012. “The four-year increase in borrowing amounts to
$55,000 per U.S. household.”
Recall that the unfunded liability’s present value
grew by $11 trillion over the past 12 months. So, the
article low-balls the magnitude of the mess we are in.
The Treasury must raise $4 trillion this year to pay
the interest on the on-budget debt. They warn: “. . . the
debt burden will explode when interest rates go up.” Quite
The government cannot tax upper-income people. The top
1% pay 37% of the incomes taxes. (That is because they make
most of the income, which the authors do not mention.)
Did you know that, during the last fiscal year,
around three-quarters of the deficit was financed
by the Federal Reserve? Foreign governments
accounted for most of the rest, as American
citizens’ and institutions’ purchases and sales
netted to about zero. The Fed now owns one in six
dollars of the national debt, the largest
percentage of GDP in history, larger than even at
the end of World War II.
This is true. But this means that the Treasury will
get back most of the $4 trillion it pays as interest. The
FED repays most of this at the end of the year. This is an
Conclusion: “By replacing large decentralized markets
with centralized control by a few government officials, the
Fed is distorting incentives and interfering with price
discovery with unintended economic consequences.” This is
true. It lies at the heart of the mess we are in.
The Fed’s policy of keeping interest rates so low
for so long means that the real rate (after
accounting for inflation) is negative, thereby
cutting significantly the real income of those
who have saved for retirement over their
Bernanke’s FOMC says this will continue until at least
They say that the FED is replacing the Treasury as the
source of government debt management. They are correct.
They warn of price inflation. The reserves of QE3
could do this. But if the FED unwinds too fast — sells
assets, abandoning QE — “banks may find it hard to adjust
and pull back on loans. Unwinding would be hard to manage
now, but will become ever harder the more the balance sheet
The FED tried to unwind over the last 12 months. They
do not mention this. The result: the FED’s panic return to
QE3. There will be no unwinding.
Then they summarize some highlights, though
peripheral. “Did you know that the federal government had
46 separate job-training programs? Yet a 47th for green
jobs was added, and the success rate was so poor that the
Department of Labor inspector general said it should be
shut down. We need to get much better results from current
programs, serving a more carefully targeted set of people
with more effective programs that increase their
opportunities.” In short, blah, blah, blah. If we have 46,
one more program is marginal, and there will not be the
elimination of (say) 45 of them.
They go on and on, telling us of boondoggles. This is
just noise. Nothing is going to change.
Then they get to Obama’s budget. That budget will
“raise the federal debt-to-GDP ratio to 80.4% in two years,
about double its level at the end of 2008, and a larger
percentage point increase than Greece from the end of 2008
to the beginning of this year.” Quite true. But this budget
was passed by Congress. All budgets are passed by Congress.
We are headed toward $18.8 trillion in debt. That will
take $743 billion in interest payments. But, as they fail
to mention, most of this will go to the FED, and will be
returned. The problem is this: there is no negative
feedback for Congress. Rates are close to zero.
Then they get to the really tough nut to crack: the
unfunded liabilities. But they offer no specifics.
Worse, the unfunded long-run liabilities of
Social Security, Medicare and Medicaid add tens
of trillions of dollars to the debt, mostly due
to rising real benefits per beneficiary. Before
long, all the government will be able to do is
finance the debt and pay pension and medical
benefits. This spending will crowd out all other
necessary government functions.
No, it won’t. Why not? Because there will be a default
on these programs. Younger voters will mandate this. Granny
is going to get her checks cut off. The following will not
happen: “One result will be ever-higher income and payroll
taxes on all taxpayers that will reach over 80% at the top
and 70% for many middle-income working couples.”
QE3 creates uncertainty, they say. Quite true.
“Traders speculate whether and when the Fed will intervene
next. The Fed can intervene without limit in any credit
market. . . .” Quite true.
Then they mention what was never mentioned before Ron
Paul’s run in 2007: “This raises questions about why an
independent agency of government should have this power.”
Then they ask: “What’s at stake?” It’s the right
Treasury debt is not a safe haven forever, they say.
“In short, we risk passing an economic, fiscal and
financial point of no return.” There. Someone said it. Of
course, we are far beyond the point of no return. The $222
trillion in the present value of the unfunded liabilities
The USA could lose its full faith and credit status.
They see this as a great danger. I see it as
liberation. They quote Alexander Hamilton on the benefits
of the federal debt. I much prefer Thomas Jefferson’s
assessment. The full faith and credit of the U.S.
government allowed the government to finance the Civil War
and World War II. Quite true, and that is why its loss
would be a great thing.
Then comes the bottom line.
The problems are close to being unmanageable now.
If we stay on the current path, they will wind up
being completely unmanageable, culminating in an
unwelcome explosion and crisis.
We are going to stay on the present path. The problems
will become unmanageable.
The U.S. government is going to default. The five do
not use the D-word, but what they say points to it.
Then they push to full Polyanna mode.
The fixes are blindingly obvious. Economic
theory, empirical studies and historical
experience teach that the solutions are the
lowest possible tax rates on the broadest base,
sufficient to fund the necessary functions of
government on balance over the business cycle;
sound monetary policy; trade liberalization;
spending control and entitlement reform; and
regulatory, litigation and education reform. The
need is clear. Why wait for disaster? The future
is now. (http://bit.ly/HugeMess)
They are correct. The future is now. And it is not
going to change. Politics guarantees this.
I was happy to see an article from mainstream
economists on the mess we are in. Of course, the mess is
vastly worse than they indicate. The on-budget debt of $15
trillion is peanuts compared to the $222 trillion of
present-value net unfunded liabilities. But the mess is bad
enough to warrant this article.
Nothing will change Congress. Nothing will change the
executive. There will be no cutback in spending until the
numbers force the Great Default.
Americans will not be ready. State and local
governments will not be ready.
Will you be ready?
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