Why Radical Spending Cuts Are Needed

The International Monetary Fund, a creature birthed at the Bretton Woods Conference in July 1944, turned 80 years old this week.  Its bureaucrats are worried.

The title of the IMF’s recently published World Economic Outlook is titled, The Global Economy in a Sticky Spot.  The source of the stickiness, per the WEO, is services inflation.  Namely, nominal wage growth, especially in the U.S., is increasing above goods price inflation.

Working stiffs haven’t received a real, inflation adjusted, raise in four decades.  Shouldn’t a slight increase in nominal wages above goods price inflation be a welcomed occurrence?

Not for the IMF and its banker buddies.  From their perspective, services inflation is inhibiting the ability for central banks like the Federal Reserve to cut interest rates.  They want lower interest rates to help soften the fallout of all the bad loans made during the coronavirus madness.  The Treasury also wants lower interest rates so it can finance its massive pile of government debt.

Other sources of IMF stickiness are escalating trade tensions, and something the IMF calls ‘diminished buffers.’  Diminished buffers, in IMF parlance, have to do with massive deficits.  The idea is that countries that are already running massive deficits will have less resources available to boost public spending during a recession or other unexpected shock.

The U.S. is an example of a country that has been unable to meet its fiscal recklessness head on.  Last week Pierre-Olivier Gourinchas, IMF chief economist, offered the following warning:

“It is concerning that a country like the United States, at full employment, maintains a fiscal stance that pushes its debt-to-GDP ratio steadily higher, with risks to both the domestic and global economy.”

Indeed, high debt, slow growth, and rising deficits don’t bode well for the future.

Lard

Fiscal stimulus, as proposed by John Maynard Keynes in the early 20th century, was to be countercyclical.  Deficits would be used during recessions to stimulate aggregate demand.  Then, during periods of expansion, deficits would be curtailed, and the economy would be allowed to stand on its own two feet.

The second part of Keynesianism, the part about curtailing deficits, has been largely ignored in the U.S. and throughout the world.  Good times or bad.  Feast or famine.  Deficit spending has been steady.  This is what Gourinchas finds concerning.

But why has deficit spending remained completely out of control in the U.S. during periods of full employment?  Don’t policymakers understand that, per Keynes, they’re supposed to be countercyclical?

Deficits, remember, are part of the political process.  They are not about sound economic policies.  They are about creating and funding pork programs that insiders can exploit for their own personal riches.

Over the last 50 years deficits have been compelled by the political class.  Countless opportunists have collected in the Washington DC suburbs of Arlington and Fairfax, Virginia, like bees to honey.  There they draw hefty incomes while plowing their intelligence and ingenuity into doing pretend work, at your expense.

Aside from all the grift and lard, a major problem with deficit spending is that it is artificial.  It is money that is borrowed from the future and directed to certain areas of the economy by the highly visible hands of government actors.

When something artificial becomes expected, the conditions adapt accordingly.  After 50 years of near continuous deficit spending, the economy has become entirely dependent on it.

Dependency

“If you want more of something, subsidize it,” remarked Ronald Reagan.

At this stage of America’s progression, dependency has been subsidized on a grand scale.

There are the freeloaders who rely on the charity of government for their daily bread.  They’ve oriented their lives around assistance programs.  They’d rather dwell in poverty than develop the skills they need to be self-supporting through their own contributions.

Less obvious are the countless intelligent and industrious people who go to work every day to advance businesses that wouldn’t exist but for the lard of government spending.  Many of these people work in the private sector.  But their income is derived from larded up government contracts or laws or regulations that they’ve built services around.

Defense.  Energy.  Education.  Medical.  Finance.  Technology.  Real Estate.  Agriculture.  Transportation.  Aerospace.  Insurance.  There’s hardly a sector of the economy that hasn’t been grossly distorted by deficit spending.  Take away the stimulus and they would wilt like a flower in the sun.

The rock and a hard place the U.S. is wedged between was entirely of its own making.  By allowing debts and deficits to run wild, Washington has taken its finances to the brink of disaster.

If interest rates remain high, the net interest on the debt consumes the budget.  Eventually, the Treasury would default.  Yet if interest rates are cut at a time of persistent inflation, the inflation will run higher.  Thus, eroding the value of the dollar and destroying individual savings accumulated over a lifetime of working.

For the central planners, cutting interest rates is the path of least resistance.

Why Radical Spending Cuts Are Needed

This week Bill Dudley, former New York Fed President and chair of the Bretton Woods Committee, called for the Fed to cut rates at next week’s FOMC meeting.  He says waiting until September unnecessarily increases the risk of a recession.

Recessions, as Dudley infers, are unpleasant.  They’re disruptive and destructive to families and workers.  People lose their jobs and homes.  They declare bankruptcy.  Some are forced to move to other cities or states in search of new opportunities.

We don’t like it.  Nonetheless, recessions are necessary to a healthy functioning economy.  And right now, at this very moment, a recession is exactly what is needed to bring the economy back into balance.

How else will the real estate market return to a place where the average house price can be afforded by the average income?  How else will consumer price inflation be moderated, and stock price valuations revert to their historic mean?

Cutting interest rates, as Dudley champions, won’t correct the fundamental imbalances within the economy.  Nor will it solve Washington’s debt problem.  At best, it will buy time so that more debt – currently approaching $35 trillion – can pile up at the risk of an even greater collapse down the road.  It could also reignite rampant consumer price inflation.

The real and only solution is to radically cut spending.  To eliminate the deficit.  To not just balance the budget, but to run a surplus and pay down the debt.

A deep recession is inherent to this solution.  Radical spending cuts would eliminate many people’s livelihoods.  The age of dependency would come to a quick end.

However, in the long run we’d all be the better for it.  America would adapt, and its people would achieve greater independence as they trudge the road of happy and unhappy destiny.

Alas, the political class won’t allow it.  Not in any meaningful way.  They love supping the fruits of big government too much to let anything stop it.

Consequently, debts, deficits, inflation, and chaos will reign.

[Editor’s note: It really is amazing how just a few simple contrary decisions can lead to life-changing wealth.  And right now, at this very moment, I’m preparing to make a contrary decision once again.  >> And I’d like to show you how you can too.]

Sincerely,

MN Gordon
for Economic Prism

Return from Why Radical Spending Cuts Are Needed to Economic Prism