David Stockman's Non-Recovery Part 5: Peak Debt And The Wages Of Keynesian Sin
In the final section of this five-part series (Part 1, Part 2, Part 3, and Part 4) on the dismal reality behind the non-recovery, David Stockman explains what lies ahead. He details in his new book 'The Great Deformation', that the mainstream notion that there is a choice between fiscal austerity and fiscal stimulus is wishful thinking. It does not recognize that owing to the triumph of crony capitalism and printing-press money America has become a failed state fiscally. What lies ahead is a continuous, mad-cap cycling back and forth - virtually on an odd-even day basis - between deficit cutting and fiscal stimulus to the GDP. As Stockman notes, the proximate cause of this recession waiting to happen is the federal government’s unfolding encounter with Peak Debt. The latter is not a magical statistical point such as a federal debt ratio of 100 percent of GDP, but a condition of permanent crisis - "no viable economy can survive on chronic fiscal deficits nor can it fail to save at a sufficient rate to fund a healthy level of investment in productive capital assets. The blithe assumption to the contrary which animates current policy rests on self-serving clichés such as “deficits don’t matter” and the Chinese savings glut." So the American economy faces a long twilight of no growth, rising taxes, and brutally intensifying fiscal conflict. These are the wages of five decades of Keynesian sin - the price of abandoning financial discipline.
The proximate cause of this recession waiting to happen is the federal government’s unfolding encounter with Peak Debt. The latter is not a magical statistical point such as a federal debt ratio of 100 percent of GDP, but a condition of permanent crisis. From the failed election of 2012 forward, every dollar of additional borrowing will induce new political and financial pressures while every dollar of spending cuts and tax increases will further impair the rate of GDP growth.
The mainstream notion that there is a choice between fiscal austerity and fiscal stimulus is wishful thinking. It does not recognize that owing to the triumph of crony capitalism and printing-press money America has become a failed state fiscally. Deficits and debt have now reached the point where they are too large and too embedded in social, economic, and political realities to be resolved. Accordingly, what passes for fiscal governance will become a political gong show that will make the New Deal contre-temps pale by comparison.
What lies ahead is a continuous, mad-cap cycling back and forth - virtually on an odd-even day basis - between deficit cutting and fiscal stimulus to the GDP. Thus, deficit cutting will be in play every twelve months or so in order to purchase enough “conservative” votes to raise the federal debt ceiling by another trillion dollars or so. Yet every upward increment will become harder to pass in the House and Senate, ever the more so as the debt ceiling soon breaks above the $20 trillion mark and begins to soar well above 100 percent of GDP.
The fact is, the great unwashed masses on Main Street know full well that Washington is trifling with national bankruptcy, so the debt ceiling votes have become the one clarifying legislative moment in which they can demand a halt to the madness. Accordingly, the template from the August 2011 debt ceiling crisis will become the recurring framework of fiscal governance: in return for more debt ceiling, the reluctant House and Senate majorities which are finally assembled will get a new package of fiscal restraint in the form of targets, promises, and processes to develop plans to implement budget savings.
Before the ink is even dry on these deficit reduction packages, however, they will become part of the permanent, rolling “fiscal cliff”; that is, a recurrent series of pending tax and spending shocks that would cause negative GDP prints and adverse job reports if implemented. In effect, the Main Street economy will appear to be continuously confronted by the prospect of a “fiscal recession” or a dip in activity because it will be viewed as too weak to absorb the tax increases and spending cuts needed to close the nation’s yawning and unshakeable budget gap.
And so short-duration fiscal support measures like the payroll tax holiday and extended unemployment benefits will be enacted on even days in order to bolster a faltering economy. These “stimulus” measures, needless to say, will only exhaust the available debt ceiling headroom and accelerate the next debt crisis.
This impending struggle with Peak Debt, in turn, will unleash a hammer blow to household consumption spending that will be orders of magnitude more severe than was the loss of MEW after 2007. This threat is owing to the fact that the fiscal gong show now unfolding will almost certainly trigger a drastic upward lurch in both the savings rate and the tax rate on household incomes.
These inexorable developments will mark the beginning of the great unwind from decades of borrow and spend. Needless to say, the Keynesian doctors and their Wall Street fellow travelers have not even begun to contemplate the repudiation this will bring to their model of printing-press prosperity.
There will now be relentless tax increases and spending cuts as far as the eye can see. This fiscal sword of Damocles will hang over the American economy on a permanent basis, cutting down to size that great artificially swollen edifice known as the American Consumer Economy once and for all.
One prong of this shift will be a drastic increase in the household savings rate because chronic threat of cutbacks in Social Security and Medicare will finally drive home the need to save for retirement. As indicated earlier, the pre-1980 household savings rate averaged 8.5 percent of disposable personal income at a time when the baby boom was only entering the labor force. Now with 4 million boomers scheduled to reach retirement age each and every year until 2030, the fiscal basis of the New Deal’s Faustian bargain on social insurance is certain to buckle.
The resulting continuous debate on actual and potential benefit cutbacks will instill fear throughout the population, even if the actual social insurance cuts are modest, halting, and prospective. Consequently, the savings rate could easily return to the pre-1980 norm or even higher. Yet if the current 3.7 percent savings rate merely reverted to the 8.5 percent historical average, it would extract an incremental $600 billion from DPI.
In the same manner, the crash of bubble finance and desperate Keynesian tax cutting it elicited have resulted in a sharp but unsustainable decline in the rate of taxation on household income. Thus, in late 2007 personal income taxes and employee payroll tax contributions amounted to $2.49 trillion, or 17.5 percent of GDP. On the eve of the 2012 election, however, the direct tax take from household income had actually declined to 15.5 percent of GDP, thereby releasing $300 billion for additional consumption spending.
Needless to say, the era of fiscal reckoning ahead will result in a reversal of this free lunch tax policy at the same time that the savings rate is rebounding. In rough order of magnitude, the combination of these reversals from the current artificial régime of low taxes and low savings could take upward of $1 trillion out of the household consumption stream. And that assumes savings rates and tax rates revert only modestly to the pre-1980 norm.
Nor would this represent some kind of harsh punishment for high living or a reversion to reactionary Hooverite policy. In truth, no viable economy can survive on chronic fiscal deficits nor can it fail to save at a sufficient rate to fund a healthy level of investment in productive capital assets. The blithe assumption to the contrary which animates current policy rests on self-serving clichés such as “deficits don’t matter” and the Chinese savings glut.
THE EPIC GENERATIONAL MISTAKE
Dick Cheney’s shibboleth is now receiving a brutal comeuppance, however, as the Fed and other central banks reach the outer limits of their capacity to absorb incremental bond issuance. In this respect, it is evident that the crisis of government deficits and debt throughout the developed world—Japan, Europe, and the USA—reflects a common condition. Sovereign debt everywhere is vastly overvalued owing to monetary repression. Yet that condition is also artificial and unsustainable: the lesson of southern Europe is that sovereign debt will succumb to a violent free fall when and as central bank “price keeping” operations are withdrawn, fail, or even come into doubt.
At the same time, the hoary tale that America’s savings function had been outsourced to China and other mercantilist exporters was but a lame invention by the Fed to camouflage its destructive money printing. In truth, the pitifully low US savings rate over the past several decades reflects a colossal financial deformation; namely, a mistaken belief among US households that there was no need to save out of current income, but that they could spend all that came in and then borrow some more.
This epic generational mistake stemmed in large part, as has been seen, from the Fed’s serial asset bubbles in stocks and housing, which egregiously misled households about their true wealth; and also from the unwarranted confidence that the nation’s vast social insurance benefit distributions could be sustained indefinitely and in full. A crucial pivot point in American financial history has thus arrived because all of these foundational assumptions are about to be invalidated.
Housing asset values have already crashed by 33 percent and have mounted only a tepid recovery. But they will soon undergo another thundering setback when the baby boom retirement army is forced to liquidate millions of empty nests in order to survive financially. Needless to say, the next generation, saddled with $1 trillion of student debts and small earned incomes, will not be open to buy. Since prices inexorably fall in a bidless market there will be nothing to break the decline except an insolvent government.
The social insurance system is now entering an era of permanent funding crisis and chronic political turmoil. And, as detailed in chapter 32, the Bernanke stock market bubble is heading for a thundering meltdown which will vastly eclipse that of September 2008. So what lies ahead is endemic fiscal crisis, wrenching financial market dislocations, and relentlessly rising fear about financial security on Main Street.
All of this will cause household behavior to change fundamentally; that is, it will lay low America’s vaunted “consumption units.” Indeed, the coming sharp rise in tax rates and savings rates will cause a drastic hit to consumption spending even if these adjustments take several years to unfold. For example, if a $1 trillion increase in household savings and taxes is rolled in over five years, it would reduce the nation’s $11.1 trillion level of PCE by nearly 2.5 percent annually in nominal terms. For a half decade running, therefore, the central component of GDP could be reduced by 5 percent annually in real terms (assuming 2–3 percent inflation).
Needless to say, recidivist Keynesians and their supply-side fellow travelers will propose “economic growth” as the way out of this emerging economic box canyon of higher taxes and higher savings. But their fiscal panaceas of lower taxes or higher spending will be powerfully thwarted because these measures require extensive balance sheet runway - that is, short- and medium-term deficits - that no longer exists.
To be sure, advocates of fiscal stimulus will claim growth multipliers based on one or another set of “goal-seeked” statistical manipulations. But unless they want to sign up to Art Laffer’s magic napkin, none of the policy measures available will be close to 100 percent self-financing. Given a 20 percent marginal Federal tax take, for example, fiscal stimulus measures would need to generate a 5X GDP multiplier in order to break even. And that is the profound dilemma of peak fiscal debt: there is no remaining headroom in the national debt for policy makers to gamble with play money stolen from future taxpayers.
So the American economy faces a long twilight of no growth, rising taxes, and brutally intensifying fiscal conflict. These are the wages of five decades of Keynesian sin—the price of abandoning the financial discipline achieved by Dwight Eisenhower and William McChesney Martin during the mid-twentieth century’s golden age.