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Damned Either Way
It’s a pretty good bet that Congress and the Administration are going to
try to come up with a solution on what to do with the expiring Bush tax
cuts and the AMT (Alternative Minimum Tax) before the Thanksgiving
holiday. Time is running out and hard choices have to be made.
If we “do nothing” and let the taxes sunset our budget deficit profile
will improve significantly. On the flip side, if we raise taxes across
the board on Jan 1 the economy will hit a wall. We are damned if we do and we are damned if we don’t.
The Administration has said it wants all tax increases to be pushed into
the future for at least two years. Congress (I thought) was of a
similar mind. There is now some doubt as to what they are collectively
thinking. I believe that in the end, our legislators will roll over and
give Obama what he wants; two more years to kick the can down the road.
The Congressional Budget Office looks at the impact of any legislation.
Doug Elmendorf, the boss at the “non-partisan” CBO gave a speech on
Friday on the topic of what to do with taxes. It’s not a pretty picture.
Consider this slide that attempts to define the consequences on
employment of a variety of actions the government could take.
Two observations:
A) Reducing taxes in 2011 has the least ‘bang for the buck’ in
terms of creating long-term full employment. Given that this is the
least effective alternative you have to wonder why it is being
considered.
B) Except for reducing taxes none of the other options are
politically feasible for the foreseeable future. We have congressional
gridlock. There will no stimulus package in 2011 from our new
legislators. So extending the Bush tax cuts is the only option. And that
is why it will become law.
Of course nothing is free. If we don’t get our house in order and
eliminate what was promised to be temporary cuts by Bush, the deficit
will go up. By how much? According to the CBO it will double:
In summary, look forward to a patch on taxes that accomplishes very
little in terms of future growth, one that has the least efficacy in
addressing the underlying unemployment problem and the one that will
insure that a fiscal explosion is not so far off in our future. I think
Elmendorf sums it up pretty well:
Just a question: When do we address the question of the “Fundamental disconnect”?
We haven't done that at anytime in the past. We aren't going to do it
in the present. We will only do it in the future if there is a crisis
that forces us. The conclusion is that another crisis is inevitable
because what we are doing is unsustainable. I wonder if our
congressional leaders read the stuff from the CBO. If they are, they are
ignoring it.
»
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love this discussion of tax policy towards the end of this article:
a Reagan guy, Cato think tank guy says more taxes result in smaller govt, data show that:
http://www.truth-out.org/roll-back-reagan-tax-cuts65332
This is just the same old game. The politicians run up a huge deficit and then cry that they need more taxes to fix the deficit. Then taxes are raised and they run up an even bigger deficit. Rinse and repeat ...
It is no coincidence that states with the highest tax rates like California and New York also have the largest deficits. Raising taxes causes larger deficits. It doesn't fix them.
What if a member of some real media outlet (if they exist) would ask politicians "how much money is enough?" "how much do you need?" They could or would never tell you, because they do not know. They don't care, they just keep spending, borrowing, and wanting to raise fees, taxes, fines etc...
Government "invests" your money for politicial return, not economic return.
Deficits and debt are just as likely to be highly correlated with the propensity of the regional populace to imbibe drink and drugs and otherwise break the law. (Think Jamaica).
Corruption wears many faces, high tax rates are a corrollary of scarce resources and high aspirations.
I have some sympathy for ideallists who try very hard to do the right thing but just can't deal with mankinds desire to eat for free wherever possible. Sympathy yes, support no.
CONgress will always talk about the revenue side. They'll never seriously talk about the expense side. How many times do you hear there is no govt program that can be cut. That is BS. Just like a shopaholic will tell you every purchase was warranted. they just apply for more credit cards to feed their habit.
Secondly, CONgress will never talk about improving EFFICIENCY of government. There is no incentive to make any department or program efficient. Why? Because if you don't use up your budget, it may get cut next time!
Remember, government(politicians) invest for POLITICAL return, not economic return. If we don't tackle that first, we'll never get anywhere and we'll allow the CONgress to always let things go to crisis mode and then take hasty action.
This problem seems so intractable because no one even considers the case that, instead of being under-taxed we are over spending. Every time some damn fool entitlement, bailout, permanent government program or agency is created it's always raise taxes this and we have to face the music that as if whole battalions of newly minted bean counters and diversity counselors were an act of God over which we have no control.
Start shrinking the government or they will rightfully interpert the blessing of higher taxes (after the requisite amount of beard stroking of course) as positive reinforcement.
Bruce (and others). Why do you think we're screwed if the deficit rises?
The Fed is funding the deficit now which comes with the added benefit of costing the government zero interest. A rising deficit is therefore a non event.
Why are people worried about this? It's a good thing.
The right discussion to have is the latter part of this post: where the new spending goes / how we get our best bang for the buck. My answer here would be to emulate Australia and go for the helicopter drop (*not* means-tested).
I think going for one massive air raid of 4,000,000,000,000 dollar notes rather disguises the fact that the other 26 air raids of around 500,000,000,000 dollar notes didn't actually create much of a crater or put a dent in any roof tiles...it was all just paper before and it is all just paper now. That's a 13,000,000,000,000 paper drop excluding the 4,000,000,000,000 previous bank note drops we had before for Fraudie and Funny.
See my post on the Fed starting a gimonguos MacDonalds and Wal-Mart to create real wealth..NOT!!! Cash money has never and will never produce one factory or plant that could not already have been thought of by someone who actually has the relevant brains.
http://www.zerohedge.com/forum/fed-open-national-franchises-fed-mart-and-fed-mac-solve-all-problems-forever
Why are people worried about this? It's a good thing.
Hey Mediocritas, you wouldn't happen to work as an economics advisor for the Greek government would you? If not, perhaps you should consider applying.
You're comparing apples with oranges. The Greeks do not control the ECB. Deficit spending by Greece *is* a problem because it stupidly signed onto the Euro and ceded monetary policy to Germany. Meanwhile, deficit spending by countries like Japan, USA, Australia, Britain and China is *not* a problem because these countries still have a domestic currency issued by a domestic central bank.
that made me chuckle, right there! ;)
Greetings, Mediocritas. Always enjoy your posts. They are thoughtful and enlightening, as well as being thought-provoking and grating to long-held beliefs. I applaud you for that.
If I may ask a simple question (?): what is the mechanism the Fed uses to "fund the deficit," as you say?
Also, if the Fed has all of the bank's "toxic assets" on its books, then that qualifies as a debt that someone needs to pay back some time, some where. Here's my idea: most of the debt the Fed holds now as equity or reserve requirements from the major banks are written in mortgage-related issues and derivatives.
Everyone knows, especially in the United States, mortgages roll over very frequently. It seems to me that the bulk of these mortgages, and therefore the derivatives on them, will expire of their own volition within five to seven years. Do the equity holdings of the banks at the Fed therefore disappear over time, or are they still stuck with some residual paper? Does that mean that there are no more toxic assets?
Thanks again so much!
:D
Hi Orly,
The government spends itself into the red by issuing t-bonds that the Fed then buys. In the case where the Fed buys bonds indirectly (via Primary Dealers), the Fed swaps the PD's holdings of t-bonds for reserves (effectively crediting the PD's reserve account with the Fed). This does not expand the money supply because the PD had to pull money from the system to buy t-bonds in the first place, money that would normally be classed as reserves. In the second scenario, the Fed buys t-bonds directly effectively creating money out of thin air in the process but the important thing to note here is that it is done in conjunction with the Treasury and is actually driven by the Treasury with the money not seeing direct light of day within the traditional banking sector. This is referred to as "vertical money" which, unlike horizontal money, comes into being *without* creating a liability within the banking sector.
The liability in this case is of the govt to the Fed but seeing as, in reality, these are the same thing (the Fedury) the liability is not actually a liability. Imagine if you borrowed $100 from yourself, are you now in debt to yourself? Nope. Not only is it not really a debt, there is no obligation to repay it. Added to this is something that almost 100% of people fail to know (even though it's right there on the Fed's annual financial report), that the Treasury pays 0% interest on debt to the Fed (itself).
For this reason, when the Fed is funding the deficit, the deficit is irrelevant. People need to understand that debt to the Fed is not the same as debt to a foreign Central Bank.
It is this expansion of the vertical money supply (which really is printing money from thin air) through government deficit spending that ZH so fears when it harps on about "hyperinflation", despite the obvious reality of Japan where hyperinflation has clearly NOT occurred as a consequence of expanding the vertical money supply. ZH also has it wrong when it blames Bernanke for this expansion, the originator is actually the Treasury more than the Fed. Because ZH fails to accurately understand the modern monetary system of the USA, ZH overestimates the threat of what the Fedury is doing here. ZH things that expansion of vertical money will translate into an uncontainable expansion of horizontal money once the banking sector returns to normal (not like that will happen any time soon). ZH fails to understand that vertical money (and all the leverage on top of it once it reaches the banking sector) can be immediately destroyed through taxation (part of austerity measures). ZH also fails to give credit to the various powers that the Fed has to contain inflation derived from horizontal money, as are being now demonstrated in China. (This is pretty pointless though given that EM inflation is more a consequence of the building USD carry trade than anything else).
Yes, the Fed massively expanded its holdings of MBS as a part of QE1 specifically to stabilize the banking sector and it succeeded. ZH loves to criticize the Fed for "printing money" (even though it didn't), but ZH should actually consider what would have happened had the Fed not done this. Now the Fed is sitting on a pile of shit that is worth much less than what it paid. This would be a problem for a normal bank because, at some point, the normal bank is going to have to mark that asset to market, take a hit to capital adequacy and fail to meet minimum requirements set out in Basel II. However, the Fed can hold these assets indefinitely and it will. The Fed will sit and sit and sit on these things until markets recover enough to break even, which might mean slowly selling off the underlying properties over decades, resulting in a highly managed and stable property market. More realistically, what I expect here is that the government announces a "cheap rent" program wherein the underlying of the Fed's MBS is rented out at discount prices to people who are doing it tough (the former mortgagee), with that income stream being slowly used to clear out the shit. That's what I would do if I were the Fedury and it comes with the added bonus of making the govt look as if it's trying to really help the little man.
The liability associated with a mortgage never disappears. It is only dispersed over time (as repayments are made). While the MBS that the Fed is sitting on may become worthless as the income stream dries up as a consequence of underlying mortgagees going into bankruptcy, the liability will then be born by the Fed itself (as, no doubt, insurers are already bankrupt or will be). But as I explained in the previous paragraph, the Fedury will deal with this. It will take decades, but the toxicity will eventually disappear. Hell, it wouldn't surprise me in the slightest if the govt started employing people to *demolish* surplus housing. That would be recorded as + for GDP in this fucked up world we live in.
IMHO the US should run a neutral budget. When the economy is stable we should have no deficit, when we have a cyclical slowdown we should increase spending and tolerate a deficit. But when the economy is performing well we should run a surplus that offsets the deficts created in lean times.
The current thinking is we should have deficits of AT LEAST 5% at all times, and it is just fine that we go to 10% in lean times. It won't work. The deficits will eat us alive if we follow that plan. There will come a time when we need deficit spending to get out of a hole. It could be another economic collapse, or even a war that forces that. But we will not be able to do so as we are already tapped out.
We have already emptied the cupboard. We need to put some "stuff" back on the shelf. If we don't we will starve the next time there is an emergency....
Hi Bruce.
I think what a lot of people don't understand is that if we don't have net government debt, then we don't have ANY money in our economy whatsoever. They also don't understand that there are two components of money generation: vertical (fedury) and horizontal (fractional reserve banking). The latter depends on the former.
When the peons lose appetite for borrowing, the horizontal monetary system implodes leading to rapid deflation. In that situation, like Japan, the government has to step in to borrow on behalf of the citizens. This manifests as an expansion of the vertical monetary system seen as rapidly rising levels of government debt and a rising deficit.
However, when one understands the nature of the Fedury, it becomes clear that this expansion of government debt comes at almost zero risk because, firstly, it never has to be repaid and secondly, if the horizontal monetary system recovers and inflation appears, the vertical money supply can be shrunk via taxation.
Running eternal deficits is fine for a growing economy if the banking sector isn't functioning at full steam and it's definitely fine when the banking sector goes into collapse mode. People are unnecessarily afraid of government deficits because they think this deficit operates the same way as, say, a household spending deficit.
Not the same. Because the Fedury is a single unit, there is never any risk of default, only of inflation, but as I said earlier, inflation is addressable through austerity measures when the source of that inflation is vertical money supply.
All this said, not all deficits are created equal. An excessive (greater than other members) deficit within the Eurozone is a very big problem. Europe is totally screwed, which is why I am long USA against short Europe and will be maintaining this position until such time as Europe's leaders show any signs of growing brains. Don't hold your breath.
Agreed Bruce, a little counter cyclical govt spending would be fine, but running deficits in decent economic times just encourages corruption and, I believe, worse yet disconnects people from their govt's management. Too easy for special interests, be they be prison guard unions or big banks, feed at public trough. Nothing like pay as you go/no budget deficits to get you honest about priorities. As long as there are big fat deficits and big fat debt, you can always say such and such spending is adding to deficit and it must stop (say Soc Security) but ignore say, Defense spending. But if you do pay-go, you have to decide, higher taxes on rich, social security or defense, truly what are your priorities...And I say this as someone who thinks we should just monetize our debt ( given we print for banks, why not do it for ourselves and at least get some benefit along with the harm of such a scheme), I just think pay-go makes you more politically honest and connected to your govt.
In think you could link permission for govt deficit spending to some smoothed average of unemployment, only allow it when it is quite high. This would allow the natural decrease in tax revenue and increase social spending happen during a recession without immediate budget crises.
In MN, we kept running surpluses for awhile, at first the surplus was sent as a tax rebate check to people, but then it was dedicated to rainy day fund...came in handy when recession started but didn't last long. Perhaps we need seven years of grain in a silos.
If I am not mistaken, your description is the very basis of Keynesianism. The method makes much sense but, unfortunately, the ideas have been slandered into having well-known economists believing that the government can spend its way out of a wet paper bag.
Keynes' idea was to save for a rainy day. That's it.
It is funny how governments and their dim subjects assume that raising taxes will increase revenue.
It is like saying that one grocery store can raise prices by 10% and their revenue will increase by the same amount.
People vote with their feet and money; and the rich are the ones who can most easily take themselves or their money elsewhere.
It's not about how you feel, it's what the consequence is.
Raise taxes and the people who will take it in the crotch will be, yet again, the quickly expiring Middle Class.
I'm sorry, the slide from the CBO analysis doesn't pass the smell test: Increasing aid to the UNemployed has the biggest impact on employment????
Who believes this drivel?
Anyone who understands that businesses hire new workers when there's work to be done (even for poor people!), not when they're stock appreciates.
an interesting set of graphs via jesse
http://4.bp.blogspot.com/_H2DePAZe2gA/TOf607WxqNI/AAAAAAAAPKE/-Pry3pDPDu...
The last thing we should do is give our gubberment MORE money....they'll just lever it into MORE DEBT!!! Starve the beast.
actually, when people pay more in taxes, the govt leverages less, and people get more frugal, make their govt more efficient...I know, counterintuitive, but a Reagan guy is the one to say that is what the data shows..
http://www.truth-out.org/roll-back-reagan-tax-cuts65332
Not a chance.
One page of crying to mommy and checks for $787 Billion went to the fags and fuck-ups of fraud and you can bet your ass the presses will get hot printing for the masses eating their youth.
How about some more failure rewarded since it's Fed tradition. Record bonuses in 2010.
Boycott April 15th! It's tanned, it's rested, it's ready! :>D
The CBO said Obummercare would be self-financing. Nonpartisan as in left of Lenin. In the business of lies agreed upon.
If unemployment insurance is the best possible use of our money, let's all sit on our asses and get a government check for being useless.... like the CBO. You're better than this, Bruce.
dup
The US has lived on the laurels of WWII and Bretton Woods for as long as we could. After WWII we had the gold, and we were the only industrialized country that hadn't been bombed to smithereens. Our troops were all across Asia, the Pacific and Europe. Ever since our advantage has been declining, but our standard of living has been increasing. Now the situation is clear - global wage arbitrage was just an exploit of the situation.
Yes of course, I agree. I just meant this is the new normal, and it is not a 0 yielding world. These countries will have to pay very high spreads for a long time-until/if they can reduce their debt, without growth, additional taxation, how can it be with asset sales maybe?-
Bond vigilantes can't pursue US, because it can monetise its debt, and the value of USD is not US', or Bernank's but the world's problem-the chinese cant just sell their USTs because they don't like the yield. It is very difficult to short tresuries becase of that.
But they will pursue these small countries, and I cant see how they wont be successful, The Germans have to pay, or rescue, the Euro , and EU is at stake. I have been checking German press, this week, includung now, there is so little coverage of Ireland, compared to when Greece was bailed out, amounts are not much different, and its 2nd 100 bil bailout in 6 months!..
Bruce,
I would like to comment on/ask your thought on one of your previous post. You had said about Ireland-'market will do this again'-. I should say I ask this from a perpective of a Fixed Income investor, who is not getting any yield currently in real terms in any currency deposit, and to get some in bonds has to take very high term/inflation risk.
Now, as it became a popular topic again, not that I considered before to invest in, I looked at Greece bond prices, they yield about 10-11% at 10 years. This was the case just around Greece bailout in May too, I dont think they fell very much even just after the bailout.(I dont have a graph) One way to look at it is that bailout didnt do much, and Greece will restructure, and it is very logical.
But isnt there another way to look at: As investor of emerging market debt in early 2000s I remember Brazil, Turkey and Venezuella bonds at 18-20% yields, for issues with 10-12% coupons (there was some yield in those days in UStbonds, and EM was never popular after Asia/Russia problems ) so selling at 70, 80 cents to the dollar, like Greeek bonds now.
Of these countries all three serviced their bonds, but surely there were defaults Equador, and ofcourse Argentina, I remember. All these couldn't access bond markets for a few years, and I know some got IMF money (bailout) which were compared to these current figures for Ireland, Greece (per capita or as a GDP ratio) pocket change.
Now here is my thought, if u invested in greece debt in may, in this 0 yield environment, you would get 10% annualized return, not much capital loss,yet:) sure when in days like these there will be uncertainity and later bailouts of portugal, then may be Spain, mark to market you will experience volatility but if you hold on, and there is no default you get a good yield. Is this very risky: yes, but so was investing in EM in early 2000s.
Dont get me wrong I am not saying this is good investment, I wouldnt invest at 20% myself, but some huge Norwegian, or Chinese or Russian bond fund will with 0.5% of assets.
And also, what is the alternative? These contries were borrowing with basis points spreads from German bunds in 2005, 6s. This was abnormal. I think this will never come back. And 11 % was the yield Turkey or Brazil could borrow in a SUCCESSFUL eurobond offering even in those days, and the population, natural resources,budget surplus(they had in mid 200s before Interest payments) and hence taxation , growth potential of all these countries were evident in those years already. -except Greece appereantly was misrepresented-
So my point is, the market of course will do it, and should do it, this is the way out. Other way ofcourse is to like Argentina default, and mot likely leave Euro, which would also be good for the countries, but in light of existence fight of Euro elite, it seems they wont let it happen, so this is the market solution.In some old post you mentioned your Duration Problem:), I remember. This may be the solution, when the market does its work you may be able to find some Eurojunk sovereigns or solid companies in these countries with 600-800 basis points above compareble bonds from Germany, or Netherlands to put 5, 10% of your FI portfolio. So the market may solve your duration problem, despite Bernank:), actually if he manages to push $ goes down,despite all this it will be a gift from Bernank).
The other angle here is of course these countries are in Euroland, like Germany, how will this divergence work, Brazil, Turkey could and did devalue their currencies, and couldnt issue Euros, $s to pay foreign bonds. I cant understand how this will effect these countries, and core Euro countries. Is there a precedent? What do you think? How is it for US? Profligate and fiscally sound US states both issue debt with same currency, can it be like that in EU too maybe? Has ever been in history a time when some states in US considered leaving the $, or in another currency union. I think sterlings leaving ERM isnt comparable, it was not a paper currency union, and British never like the idea of Euro, I think Irish, greek spanish people would nt like to go to their old currencies even now..
Very big bucks will be made in the sovereign debt markets. But you are too soon in my opinion. Be patient. The bottom of this cycle is a long way off.
How does one get into the "sovereign debt market"?
To buy bonds on leverage in easy. For you Orly I think 80% leverage is about right. Plenty of price action when your equity is multiplied 5 times. When you get good at it you can go to 90% leverage. If you run a big fund getting 95% is not too hard. If you have some friends in town you can do 98%.
At that point you can make or lose 50% a day. Who says bonds are boring?
I hope the CBO reads this: If you guys put out this tripe and people actually believe it - then we deserve to be governed by the power hungry sociopaths that put you up to this kind of propaganda. Outside of that - shove it where the sun does not shine!!!
What about cutting federal government outlays!? NO? Too busy drinking at your master's trough to mention that one?
You guys would rather support our federal government's stealing from the poor to subsidize their greed. Piss off.
Bruce, if you want to see your wealth go to support the state that is busy robbing us of our remaining freedoms, then WHY THE FUCK DON'T YOU DONATE YOUR WEALTH TO THE IRS?
Some of us are smart enough to realize that these theives have no constitutional right to an income tax, a capital gains tax or a dividend tax. You are their useful idiot and all we want is for you to stop dragging us into your utopian fantasy.
http://www.thedailybell.com/1541/Oath-Keeper-Stewart-Rhodes-on-the-Rise-...Conversely, why don't you move to Monaco?
How tiresome. Look. Our Federal Government spends what, something like 3 trillion a year out of 14 or so rounding to the nearest trillion while taking about 2 trillion? I have no problem with taxes rising on a temporary basis to pay the debt if and when the spending is tackled first. Until the plan for spending comes down to something like 2.1 trillion from 3 trillion, do not even bring up the subject of taxes. Let it all fall apart first.
+1 Excellent perspective.
Zero interest rates and zero tax rates. It only fair
agreed! +1 brazillion! the Fed should have no power to redistribute wealth. that is a democratic right, not a central bankers right. if QE 1 and 2 are right, then pay no taxes! can fund everything with fed chicanery!
Lame duck Democrats are going to thumb their nose at America while they slither out of Washington. What do they care, they got their retirement and health care guaranteed. Pussies! I hope the door does hit them in the ass on the way out..........
Keep sippin' dat kool-aid... sucker.
Um hello. Spending is the problem.
No shit, when do we bring the troops home?
Because We Can.
Goddamn It!
Oh well, some day we can get around to that 30% of federal expenditures that the CBO itself says are waste and fraud and maybe maybe maybe otherwise address the spending side of the ledger.
Face it people, the only thing keeping this country solvent is accounting gimmicks and a printing press! Tax every man, woman, child, 100% of income but continue to pay social security, medicare, and medicaid...and at the end of the day the gov. will still be running a defecit.
raise taxes/lower taxes point-moot.
Save your country, kill a senior citizen!
"To save the village we had to destroy it". (Mai Lai, Vietnam 1968)
It was Ben Tre, 1968 but I get the gist.