18 Jul 2008

Richard Fisher's Speech on Fiscal Policy

Although I suspect that I’m probably among the last to read it, I ran across Richard W. Fisher’s excellent speech to the Commonwealth Club of California, earlier today. Called “Storms on the Horizon”, it was delivered May 28 in San Francisco.

I think it’s worth a read by anyone; despite being a few months old at this point, it’s still quite topical. His main focus is on fiscal (as opposed to monetary) policy, which hasn’t been getting very much attention lately. In particular, he concentrates on the issue of unfunded Social Security and Medicare liabilities, and the effect they will have on the overall government budget deficit.

His general premise – that both Social Security and Medicare, but especially the latter, cost tremendous amounts of money – is not very controversial. Where he splits from the current administration’s party line is over whether we’ll have the ability to pay for them in the not-too-distant future without going into the red.

In keeping with the tradition of rosy scenarios, official budget projections suggest [the current] deficit will be relatively short-lived. They almost always do. […] If you do the math, however, you might be forgiven for sensing that these felicitous projections look a tad dodgy. To reach the projected 2012 surplus, outlays are assumed to rise at a 2.4 percent nominal annual rate over the next four years – almost double the rate of the past seven years. Using spending and revenue growth rates that have actually prevailed in recent years, the 2012 surplus quickly evaporates and becomes a deficit, potentially of several hundred billion dollars.

That deficit is driven in large part by the costs of Social Security and Medicare, which – especially when viewed long-term – are staggering to behold. Fisher gives the net present value of only the unfunded portion of both programs as $99.2 trillion USD; if paid yearly (‘pay-as-you-go’) instead of up front, as they would in a balanced budget, they represent 68% of current income tax revenue.

If that doesn’t give you immediate pause, it should. Particularly as we seem to be headed for an economic downturn, that 68% will only increase if income tax receipts decline. The bottom line is brutal:

No combination of tax hikes and spending cuts, though, will change the total burden borne by current and future generations. For the existing unfunded liabilities to be covered in the end, someone must pay $99.2 trillion more or receive $99.2 trillion less than they have been currently promised. This is a cold, hard fact. The decision we must make is whether to shoulder a substantial portion of that burden today or compel future generations to bear its full weight.

Or, of course, the third path, the one no politician wants to mention: cut back drastically on benefits. In reality I think it’s inevitable that this will be a major part of any solution. Nothing else will work, particularly if there’s a serious recession or depression. Fat chance selling the American public on that, though, especially those who have spent decades paying into a system that was supposedly for their retirement, but was actually being looted by Congress for other purposes.

Fisher warns against the temptation presented by the Mint:

We know from centuries of evidence in countless economies, from ancient Rome to today’s Zimbabwe, that running the printing press to pay off today’s bills leads to much worse problems later on. The inflation that results from the flood of money into the economy turns out to be far worse than the fiscal pain those countries hoped to avoid. […] Even the perception that the Fed is pursuing a cheap-money strategy to accommodate fiscal burdens, should it take root, is a paramount risk to the long-term welfare of the U.S. economy. The Federal Reserve will never let this happen. It is not an option. Ever. Period.

This at least is reassuring – or, rather, it should be. But as many have noted, the Fed has essentially been playing the cheap-money game for a while, and continues to play it today, by stoking the bubble economy with bargain-basement interest rates. While this admittedly isn’t Zimbabwe or Weimar Republic-style money printing, it certainly undermines the Fed’s credibility when it claims to have long-term health rather than short-term painlessness in mind.

Towards the end of the speech, Fisher points the finger at the place where the buck really stops: voters.

When you berate your representatives or senators or presidents for the mess we are in, you are really berating yourself. You elect them. You are the ones who let them get away with burdening your children and grandchildren rather than yourselves with the bill for your entitlement programs.

However, I take a little issue with his conclusion:

Yet no one, Democrat or Republican, enjoys placing our children and grandchildren and their children and grandchildren in harm’s way. […] You have it in your power as the electors of our fiscal authorities to prevent this destruction.

While I appreciate the sentiment (and his need to end on something other than a doom-and-gloom note), I see no evidence to support his assertion that either Democrats, Republicans, or the American public at large have any problem burdening their children and grandchildren in order to get a check cut today. Over and over again, we have seen just that happen. Voters are only too happy to pay Tuesday for their hamburgers today.

The voters have it in their power to prevent a disastrous fiscal policy crisis from taking shape, but they haven’t done so thus far, and I see little reason why that will change at the 11th hour.

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