The U.S. Economy's Elephant In The Room

The Trump administration is floating a budget that will be released in full later today and, while it conforms to the modern reality, it looks like it will be more bad news for fiscal traditionalists. I count myself a member of that now rare group, being old enough to remember the days before Dick Cheney informed us that “deficits don’t matter” and non-partisan enough to regard ever-increasing debt as an issue, regardless of which party is in power.

On the surface, this budget appears to be the opposite of fiscal irresponsibility, with a proposal for over $4 trillion, including spending cuts, but the rationale behind those cuts and the politics and power dynamic of the rest of D.C. makes this yet another year when we can expect a massive deficit.

It should be pointed out that Presidential budgets are not really anything more than wish lists. According to the U.S. Constitution, fiscal power rests with Congress, and more specifically with the House of Representatives, so when, as is now the case, the White House and that body are controlled by different parties, the chances of the President’s budget being adopted are virtually zero.

What they often do, though, is set the tone.

This one is designed to be an accompaniment to yet another round of big tax cuts. The President has already voiced a desire to cut personal income taxes this year, which given that it is an election year should come as no surprise to anyone. That fact will also make it difficult for Democrats to completely nix any tax relief for the middle class, but then nor are they likely to approve a spending plan that increases defense spending but cuts domestic safety net and foreign aid programs dramatically.

What you think politically is not the point here. Whether you view those priorities as fully justified or inherently evil, the fact is that we are headed for another year when spending will be cut minimally, if at all, but revenue will shrink once again. Add that to deficit spending for the current fiscal year of $1.1 trillion and a national debt of over $23 trillion and it starts to look like a problem.

There are those that maintain that it isn’t. The theory is that as the U.S. government has the power to tax such a massive economy and the dollar is the international reserve currency, America can operate with any level of debt they might choose. That is right in a way, but it assumes that nothing will change. That is an assumption that history reveals as not just overly optimistic but quite frankly ridiculous. At some point, the economic cycle or some unforeseen catastrophe will cause a downturn, and when it does, deficits will matter very much.

There is nothing wrong with governments running deficits. They are a useful tool to smooth out economic cycles. The problem is running them during times of economic strength and expansion.

When the inevitable downturn comes, attitudes will shift. The government will still have the ability to tax a large economy, but that economy will shrink an unspecified amount. Then the assumption that nothing will change will kick into reverse. Just as now no end is seen to the good times, so then no end will be seen to the bad. That will sap confidence, starting a vicious cycle of investors demanding higher returns from Treasuries to offset risk, which increases risk, leading to higher rates etc. etc. until interest payments suck everything from the economy.

The reckoning will only come when times are bad already, which severely limits the options for dealing with the situation. You can print money to pay the interest and principle when due, but that will devalue the currency and make future inflation a danger. Or, you can increase taxes and/or cut spending, neither of which are a good idea in a shrinking economy.

There simply is no good option.

Politicians, of course, don’t care. They make the perfectly reasonable assumption that by the time that particular chicken comes home to roost they will be either dead or out of power, in which case it will be someone else’s problem. More worrying to me is that a lot of economists are giving them that justification, saying that the last thirty years or so prove that Cheney was right: deficits really don’t matter.

What they seem to forget is that that has followed a period in the 80s when the debt was ultra-low, and during which the government ran at a surplus. We are far from that now.

Proponents of deficit spending will frequently tell you that government finance is not akin to household budgeting, and that applying your common sense to the issue somehow makes you naïve. There is an element of truth to that. We, as householders, cannot tax others to bring in guaranteed income and for us, printing money, while technically possible, tends to have some bad consequences and is generally discouraged by various members of law enforcement.

However, the basic principles of fiscal responsibility and debt management still apply. Increasing debt during good times is simply not a good idea, and we should all do our best to make sure that the politicians of both parties are aware that we know that.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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