Flip, Trip, Double-Dip
Peter Orszag fell on his sword last week. Barack Obama’s budget director left after disagreeing with Obama’s tax pledge. ‘Read my lips,’ the chief executive might have said; no new taxes for people earning less than $250,000.
Mr. Orszag hastened to distort the record:
“I want to emphasize that it would be inaccurate to say that I have told the president personally that I’m leaving because of concerns about our fiscal policies,” he said in his exit interview.
Mr. Orszag can’t seem to put a simple sentence together. But he can count. According to the last census results, there were 1.7 million households in America with incomes of $250,000 or more. Even if you took an additional $250,000 in tax from each one of them, raising the effective rate on many of them to nearly 150% of income, it you would still have a trillion-dollar deficit. There is no way the rich alone are going to be able to shoulder America’s growing debt burden.
“Peter feels strongly that this is a pledge that has to be broken…” said an administration source.
Mr. Orszag is only the latest OMB casualty of modern debt financing. The first came a quarter century ago next month. David Stockman was the “propeller head” of the early ‘80s. He could count too. When the Reagan team refused to raise taxes to close the deficit gap, Stockman moved on. He quit on August 1st, 1985 and went on to write his memoir: “The Triumph of Politics; why the Reagan Revolution failed.”
Stockman was right. Politics prevented the Reagan administration from getting control of deficits.
If the Reagan administration had been in the oil business at the time, it might have invented deep water drilling. Instead, one of the Reaganites’ signal contributions was to liberate America’s conservatives from their hatred of deficits. The Republicans didn’t know it at the time, but their innovation would later prove disastrous.
But Reagan was able to increase federal debt without causing a breakdown in federal finances. When interest rates were falling from 15% to 3% it was hard to go broke. Almost no matter how much debt you had, you could refinance at lower rates. Which gave the rest of the world the wrong idea. It seemed like you could borrow forever.
Alas, all good things…and bad things…come to an end. Borrowing in the private sector peaked out in 2007. Since then it has been downhill.
Of course, the lesson was lost on the feds. They’ve got their economists, their theories, and their elections. As you know, people come to think what they must think when they must think it.
The Europeans have their backs to the wall. In front of them is the bond market – unwilling to extend more credit. They have to believe that cost-cutting is the way forward. So far, practically every government in Europe has promised to take a sharp knife to fat public budgets. Since we’ve been back in Europe, almost every headline takes up the story.
All in the name of austerity! But what can you do when you can’t borrow any more money?
On Monday, it looked like the gods were against them too. Greece announced a new borrowing campaign and the Parthenon got struck by lightning. Zeus will only put up with so much.
Poor Ireland, too, is in bad shape. The Irish have been good sports about it. They’ve embarked on one of the most aggressive cost-cutting campaigns in the Old World. But do you think lenders are pleased? Nope. They’ve actually forced up Irish sovereign debt yields.
And now, investors are wondering: what next? How much ‘austerity’ can governments deliver? How much is enough? And what happens to stocks while the world is de-leveraging?
The Dow fell more than 240 points yesterday. If the stock market looks ahead, as the experts say, what is it looking at?
We don’t know. But if it opens its eyes at all it will see that actually the world isn’t de-leveraging. Not yet. The US is still borrowing heavily. Its borrowers show no sign of fatigue.
Meanwhile, the G-20 meeting ended with a call to trim public debt. But no one said ‘now!’ That’s what they bond market says…when it has had enough. And for the moment, governments are still adding to their debts in anticipation of lowering them when the economy picks up.
But wait…what makes them think the economy is getting better? Aren’t we headed to a ‘double-dip recession?’
And if the economy goes down again…won’t unemployment go up? Maybe to around 12% this time?
And won’t tax receipts go down?
And won’t public spending go up – with more unemployment compensation, food stamps, and counter-cyclical social spending?
And won’t deficits actually grow larger, not smaller?
Which brings us back to the aforementioned David Stockman, Ronald Reagan’s director of the Office of Management and Budget. Stockman gave a speech last October in which he predicted that the economy would not ‘recover’ as promised…and that the budget deficit, then about $1.5 trillion, would grow to as much as $2 trillion per year.
Stockman may be right again.
And more thoughts…
“Ireland is a mess,” began a colleague. “Just drive down the street. You’ll see houses for sale everywhere. And there are unfinished housing developments. And empty offices too.
“The funny thing is that prices have not fallen. That’s the government’s contribution to this problem. They’ve made it worse by taking in all the bad property debt into one very bad bank, backed by the government. This has meant that the lenders, builders and developers have not had to own up to their mistakes. There’s been no rush to sell…and few desperate sellers, because the worst of them can effectively refinance through the government’s bad bank.
“Of course, it means that the property market can’t correct itself either.
“Everybody’s happy when prices are going up. But when prices are going down they don’t seem to have the stomach for it. So, they do everything they can to stop it. Of course, it creates this zombie situation, where the market can’t correct itself. It can’t clear. Because prices aren’t allowed to fall. So people who have money don’t want to buy. And people who don’t have money can’t sell.
“And what can we do about it?
“Nothing…so let’s go down to Henry Downes and have a shot of whisky.”
We were in Ireland for a meeting of the minds of our Bonner Family Office. This is a project unlike anything else your editor has ever been involved in – very long-term investing for the benefit of future generations. Interested readers are invited to read more about it here.