How to Fix America’s Debt

Third quarter Gross Domestic Product increased at a 2 percent annual rate, reported the Commerce Department last Friday.  That’s up from the second quarter’s 1.3 percent growth rate.  But don’t get too excited…

According to Lucia Mutikani at Reuters, the economy needs to have sustained growth above 2.5 percent over several quarters to make any real progress cutting the jobless rate.  Moreover, the growth isn’t attributed to real wealth creation…like the kind that comes from savings and investment.  Rather it’s the kind of phony growth that shows up in the GDP numbers when capital is drawn down and wealth is burned up.  Here’s what we mean…

Consumer spending, which makes up about 70 percent of the U.S. economy, increased by 2 percent during the third quarter.  Yet, over this same time, incomes rose just 0.8 percent.  The 1.2 percent difference wasn’t likely made up with savings.

Remember, 40 percent of Americans have $500 or less in savings.  What’s more, 28 percent of Americans have no savings at all.  This means the difference between the 2 percent increase in consumer spending and the 0.8 percent increase in incomes was made up with new debt…it was borrowed from the future.

Government spending made up 0.7 percent of third quarter GDP growth.  But since the government ran a $1.1 trillion deficit for fiscal year 2012, the government’s contribution to GDP growth was also borrowed from the future.  Thus, third quarter GDP was more a measurement of the rate consumers and the government are going into debt…not the rate the economy is growing.

No Easy Solution

After years and years of ever increasing debt the economy’s become dependent on it.  That’s why new public and private debt’s needed to push up GDP growth.  Without it, the economy shrinks and defaults cascade down like a Rocky Mountain avalanche.

At this point, all it takes is for the rate of new debt creation to slow down a little and the whole economic shebang comes undone.  Through policies of mass debt creation the government’s painted the economy into a corner.  There’s no way to get out without making a great big mess.

Government policies that simultaneously raise taxes and cut spending are rarely ever tried.  But that doesn’t mean politicians don’t occasionally give it a shot.  Sometimes Congress is so dysfunctional that’s the only option.

Presently, all eyes are laser focused on the November 6 presidential election.  After that, and regardless of who wins, all eyes will shift to the rapidly approaching vertical edge of the fiscal cliff.  If an 11th hour deal isn’t made we could all be granted the unique opportunity to witness a gigantic crash as the government drives the whole economic shebang off the fiscal cliff.

Former Treasury Secretary Larry Summers recently said if something’s not done about the fiscal cliff, “you’re looking at an overwhelming likelihood of serious recession and you’re looking at a real threat to national security.”  But there really is no easy solution.  Obviously, raising taxes will only make things worse.  Reducing public spending, however, is needed…even if, in the short term, this slows the economy.

Last week top CEOs offered some ideas on what to do about the fiscal cliff…

How to Fix America’s Debt

In a letter to Congress, CEOs of over 80 large U.S. corporations said “it is urgent and essential that we put in place a plan to fix America’s debt.”  The plan should…

“Reform Medicare and Medicaid, improve efficiency in the overall health care system and limit future cost growth;

“Strengthen Social Security, so that it is solvent and will be there for future beneficiaries; and

“Include comprehensive and pro-growth tax reform, which broadens the base, lowers rates, raises revenues and reduces the deficit.”

It’s no surprise that entitlements, social security, and taxes are the critical items the CEOs identify in their request for a credible debt reduction plan.  Everyone’s known these programs are unsustainable and the arduous tax system has been stifling the economy for years.  Others have called on Congressional action before…with no effect.

Unfortunately, most members of Congress won’t give the CEOs letter much thought.  Moreover, hardly any members of Congress will support the real reforms the letter is calling for.  Why?

Because that would require hard work, thoughtful deliberation, and tough decisions.  These are the sorts of things that Congress has proven time and time again to be incapable of.  Plus, supporting the CEOs plan to fix America’s debt could cost them votes.  Instead they’ll do the opposite.

They’ll kick the can down the road and spend more money.  For a Congressman, it’s much more advantageous to promise abundance than to bring the government’s budget into balance with what the economy can support.  Eventually, and with much greater pain, creditors will withdraw their support and there’ll be a real crisis.  In the meantime, Congressional prevarication will only make things worse.

Sincerely,

MN Gordon
for Economic Prism

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