Dancing around distaster with deficit

The shadows dance around the flames. The Republicans walk out of the debt limit talks to dramatize their opposition to raising taxes. The president is dragged off the golf course and into the negotiations, whereupon he promptly makes a campaign speech promoting class warfare rather than seeking a debt crisis solution. Fed Chairman Ben Bernanke scratches his head in puzzlement as his monetarist remedies fail to offset the damage to the economy exacerbated by the socialist policies of the Obama Administration.

And all of this is theater.

It is in the nature of these political confrontations that a solution will not be reached until the last possible second. The good of the nation be damned – there are too many political careers at stake to compromise before it is absolutely unavoidable.

What we are seeing now is a political pas de deux in which the players seek desperately to position themselves so that they can avoid responsibility for anything controversial (by which I mean threatening to their own re-elections) while still taking credit for anything which proves to be popular.

The usual Washington dance would include stretching out the negotiations as long as possible and finally coming up with a “solution” in which a few simple things are done now and the harder, more costly and more politically dangerous decisions are left to future congresses, which will be likely to avoid them when the time comes.

This is the IBG-YBG (I’ll be gone – you’ll be gone) syndrome whose primary symptom is kicking the can down the road.

Sadly for our threatened country, we can no longer kick that can without consequences.

Those of you who read The Guidepost in February, March and April will know why our budget and debt issues are so critical to national survival and why real compromise, catalyzed by the Ryan budget plan, is needed now. If you read those blogs you understand the nature and magnitude of the threats we face.

I will not repeat all those arguments now. I’ll simply point out that our day of reckoning has gotten closer. Meanwhile our leaders fiddle and dance while our economy smolders and will soon begin to burn.

As I write this post, on June 30, the Fed is halting its purchase at low interest rates of American T-Bills. But we still have to sell some $58,000 per second in T-Bills to borrow enough to cover our deficit, including the interest we must pay on the national debt. The reason the Fed bought our own T-Bills was because no one else would buy them at the low rates the Fed was offering.

Buyers no longer trust the full faith and credit of the United States as a sufficient guarantee that they will be repaid. And they are right. So they demand a higher interest rate to cover their higher risk.  

You see the dilemma.

We must sell bonds to borrow the money we need to fund the deficit, which is now almost three times as large as it was just four years ago. But we cannot sell the bonds to real buyers except at a higher interest rate, which increases the interest we have to pay and thus the amount we have to borrow in the future.

This higher rate will very quickly drive up mortgage, credit cards and other interest rates in the United States. This will create stagflation by suppressing available credit while at the same time driving up prices. Our leaders will soon find this politically unsustainable and Bernanke will resume the purchase of our bonds.

This is called monetizing the debt. It is highly inflationary and it will further convince our international trading partners that we will only repay our debt in inflated money. For those countries which hold large amounts in dollar cash reserves, this could ruin their economies.

They will not put up with this and, in an interdependent world in which we import so much of what we use and in which we borrow 42% of every dollar our government spends, foreigners have leverage over us which they will one day use to force remedies upon us. Just like Greece.

There is a way out but Obama’s borrow, tax and spend policies ain’t it. The solution and the salvation of our country as we know it lie in a debt limit compromise based on the Republican position.

The truth is that the situation is much more dire than I have just described. Space will not permit me to tell you how bad it really is. We really, really REALLY need the current debt negotiations to produce a solution.

The Republican position is closer to what a workable solution must look like than that of the Dems, which is nothing more than continuing to do what they have been and hoping for the best.

Political and fiscal realities being what they are the debt limit will have to be raised somewhat, if only because no politician would survive if they cut the budget by 42% overnight. And no compromise will be possible unless there is some level of tax increase on the very rich. But the unavoidable core of any compromise must be massive cuts in spending of a size at least twice that of any debt limit increase, accompanied by tax reductions which encourage private sector growth and the creation of new wealth to enhance tax revenues.

At the very least this would have to include a halving of the corporate income tax and elimination of taxes on dividends and capital gains.

Finally, because no congress can ever be trusted to sustain politically difficult remedies, the core solution must include a constitutional amendment requiring a balanced budget.

Nothing less will buy us the decade or more that we need to restore the confidence of the international financial and trading community in our management of our economy. We need disciplined rational leadership, a coherent sustainable strategy of debt and deficit reduction coupled with real private sector growth and the forbearance of our creditors if we are to pull out of the pit our leaders have dug for us.  

Because the Democratic Party is in the hands of Marxists I believe that our salvation can only be found in the Republican Party. But the GOP, despite its recent shift toward fiscal sanity, also bears a degree of responsibility for our present mess. The truth is, this is no longer entirely a party issue. It is an issue of national salvation or national doom. If our leaders fail us now, there may be no recovery in our lifetimes.

Editor's Note: Barack Obama illustration by Petr Kratochil

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