29 Nov 2012

We Already Went Over the Fiscal Cliff

Debt, Economics, Krugman 46 Comments

My latest article at The American Conservative. Some excerpts:

The hemming and hawing over the looming “fiscal cliff” is akin to passengers fighting over who gets to sit in the first class seats in a jumbo jet that just ran out of fuel. The U.S. government already sent the country over the cliff years ago; it’s just taken this long to (possibly) acknowledge reality. Legislators may strike a “compromise deal” that will postpone the crisis yet again, but soon enough it will return and with greater vengeance.

Another way of assessing our current, unsustainable trajectory is to look at the Congressional Budget Office (CBO) forecasts of the official Treasury debt/GDP ratio. As time passes, the unofficial indebtedness of Social Security and Medicare will show up as “official” debt when Uncle Sam has to enter the bond markets to cover the shortfall between beneficiary payments and incoming payroll taxes. When CBO plugged into its model the assumptions that the federal government would continue with its recent behavior in terms of maintaining tax rates, continually exempting large groups of Americans from the Alternative Minimum Tax, postponing reductions in reimbursement rates for doctors, and so on, then the federal debt held by the public exceeds 200% of GDP in the year 2038.

In all of this debate, there are those like Paul Krugman who claim the fears of a debt crisis are fantasies of right-wing idiots or liars….

[E]ven if Krugman were right and the falling dollar did give a boost to US exports and thus reduced unemployment, it’s not as if world investors would suddenly become bullish on dollars right when the economy recovered….

…Even if Krugman were right, and a moderate dose of (price) inflation is just what our economy needs right now to knock off two percentage points of unemployment, he still can’t control the fact that once that genie is out of the bottle, suddenly Americans will have to tolerate much higher price inflation just to avoid a new recession.

This insidious logic of how an inflationary spiral feeds on itself is what Hayek dubbed having “a tiger by the tail.” The U.S. government is insolvent—bankrupt—according to standard accounting principles. Rather than heeding the advice of Krugman and others to simply print our troubles away and/or raise taxes on “the rich,” the responsible thing to do is cut spending. This is the best solution to a government debt crisis, as the Canadian experience in the 1990s showed, and as mainstream surveys of numerous case studiesdocument.

46 Responses to “We Already Went Over the Fiscal Cliff”

  1. Ken B says:

    Serious cuts are impossible in America these days it seems. (Too bad secession isn’t possible huh?) So what’s your prediction Bob?

    I expect some inflation, and an indirect default, effected by shifting responsibility to states and cities, which subsequently default.

    • Anonymous says:

      “Too bad secession isn’t possible huh?”

      It is possible, just not from your perspective. Your methodology for secession is akin to asking a girl if you can rape her.

      With regards to your default theory, I think you’re on to something there. I would also add that if the Feds dump things on to the States then I think quite a few of them would take their finances into their own hands and straighten their fiscal situations, while others would certainly be in a pickle. A couple of States are already moving forward with repairing their fiscal malaises. I’m with you though, I don’t see Washington having the gumption to remedy their mess.

      • Ken B says:

        I’m just pulling Bob’s chain with the secession remark. But I’m serious about cost shifting.

        If something can’t go on forever it won’t. The question is, how will the “won’t” work?

        • Matt Tanous says:

          “The question is, how will the “won’t” work?”

          However it ends up, it will be the consumer and investor getting screwed. With either a default (direct or not), or inflation, or both, it makes sense to be in hard assets and precious metals, to me.

    • Tel says:

      Look at Australia in the 1970’s and 1980’s under Whitlam and Fraser with long term inflation that just wouldn’t go away, then home loan mortgage rates went up and up as well.

      Whitlam was a complete spendthrift, and Fraser just poked around doing a bit here and there with no real strategy. The government consistently ran big deficits and the economy consistently languished. They even tried a wage freeze, which enraged the unions and didn’t help.

      • Lord Keynes says:

        The 1970s were the era of supply side stagflation – you are implying that the ” long term inflation that just wouldn’t go away” problem was the Australian government’s fault – which it was not.

        • Major_Freedom says:

          There was a decline in housing production that made mortgage rates go up? I don’t think so. That’s inflation.

          It was the Australian government’s fault because they are in control of the money.

          • Tel says:

            It’s a lot more complicated than it looks.

            Yes there were supply side shenanigans in the Australian building industry. For example the Builders Labourers Federation (BLF); a union who were eventually outlawed for thuggery but at any rate unions pushed up the price of building. If you want a second example just look at the recent scandal with bank accounts connected to our honourable Prime Minister and her boyfriend Bruce Wilson with “health and safety” money collected from building companies (the full details of which haven’t fully come to light yet, and it seems to be a race between how fast court documents can go missing, against how fast the police can collect evidence). You think I’m joking, so look it up.

            It isn’t even as simple as just a bit of union activity because the Australian Labor Party are directly connected with the union movement, and Gough Whitlam was an ALP man, and knowledgeable in legal matters, but had no head for money. Whitlam ran through a bunch of treasurers:

            Frank Crean with background in Accounting and Commerce, brought in the 1973 budget with plenty of spending, expecting plenty of revenue, which was quickly followed by the oil shock and economic downturn (the revenue never showed up). After the oil shock, both inflation and unemployment shot up. Crean tried to turn his attention to keeping inflation down but his companions would not hear of it, and threw him out of the treasury position. The 1974 budget was influenced by Jim Cairns and increased government spending, but also increased taxation (it was very close to balanced). It did nothing to combat inflation and unemployment continued to rise as well.

            On 08 Dec 1973 they attempted a referendum allowing government to fix prices and incomes. It was rejected by the Australian people.

            Jim Cairns had studied economics, but was an overt Socialist. A fascinating man, but a crap treasurer, kicked out for rooting his secretary (personally I don’t have a problem with him rooting his secretary, I have a problem with his Socialism, but that’s politics for you).

            Bill Hayden was only treasurer for a few months, also studied economics, also Socialist, but more willing to compromise he tried to please everybody, and ended up pleasing nobody. He tinkered with deregulation, handled it badly, ended up destroying the fledgling (and protected) Australian electronics industry. Maybe they were doomed anyway but tariff dropped by 25% to nothing at all, without notice! They had no hope of adjusting.

            Fraser would probably take a much longer discussion, but he started trying out monetarism, found it too difficult, then resorted to Keynesian vote buying and spiralled into massive inflation and massive deficits.

            It is even more complicated on the banking and building front, because state governments make a lot of money out of the building industry (via taxes) so they have a strong incentive to keep land prices high. State governments control the release of land for building and they control the permits (you will note that Australia has no shortage of land). Thus land is perpetually throttled in Australia and governments use this to collect revenue from the people. Your banker is in effect also your tax collector.

  2. Major-Freedom says:

    Thanks for the “feet on the ground” article.

    David Walker, former comptroller general of the GAO, was also warning about this, back in 2007:


  3. hoosierXLC says:

    I just realized, reading this, that I must sound like Sarah Connor or Cassandra when I talk about this stuff with my friends.

  4. Matt Tanous says:

    “The so-called Phillips Curve, which charts the alleged unemployment/inflation tradeoff, can shift when people’s expectations change.”

    Well, it would, Bob, if it ever existed in the first place. Don’t you read Hazlitt? http://www.amazon.com/What-Should-Know-About-Inflation/dp/1162557435/ref=tmm_pap_title_0

    • Matt Tanous says:
    • Bob Murphy says:

      I would have thought “so-called” and “alleged” would have shielded me from a lecture, but “I guessed wrong” as Austin Powers would say.

      • Matt Tanous says:

        Ah, yes. That’s what I get for skimming. Still, one can never go wrong with recommending Hazlitt, I think.

        • Tel says:

          Irving Fisher: Employment is then stimulated—for a time at least.

          The last qualification says it all: the boost is temporary. I would argue that the critical time came and went at least a decade ago, probably several decades ago.

          Of course, all inflation has a time lag, because some numpty ends up being the last guy to raise prices, and that’s the guy who really paid for the rest of the chain.

  5. anon says:

    As time passes, the unofficial indebtedness of Social Security and Medicare will show up as “official” debt when Uncle Sam has to enter the bond markets to cover the shortfall between beneficiary payments and incoming payroll taxes.

    At least regarding Social Security I believe this runs counter to law. Social Security is legally prohibited from paying out more than it takes in. Social Security’s owns bonds because it previously took in more than it paid out. If Social Security can’t meet payments then either the law will be changed, taxes will be raised or benefits will be cut. You may believe the law will be changed, but it’s not set up that way now. (Although, the payroll tax holiday the past couple years maybe complicates this, but you didn’t talk about that in your article.)

    If you want to get rid of Social Security so bad you should come right out with it and not spread misinformation.

    Also, it’s the rise in medical costs that are driving the debt, not social security. If you’re so worried about the debt then you should be open to lower cost systems like in France, Germany, Britain, Canada, Japan and Israel. (Dean Baker claims that with lower healthcare costs we’d be facing budget surpluses.)

    • Matt Tanous says:

      “If Social Security can’t meet payments then either the law will be changed, taxes will be raised or benefits will be cut.”

      First, those bonds that the SSA holds will be cashed out and bought using new bonds issued by the general Treasury. Thus, the current debt held by the SSA shifts over to the actual recorded debt levels.

      • anon says:

        Matt, from I understand the debt is already counted (when Social Security bought the bonds) so I’m not sure why shifting the money owed to Social Security to the private sector would matter. (It doesn’t increase the total debt owed.)

        Maybe I’m not seeing the big picture, though.

        • Major_Freedom says:

          SS “unfunded liabilities” are not counted in most “government debt” statistics. The “debt to GDP” ratios certainly don’t.

          If I asked you off the top of your head what the current government debt amount is, what would say? Around $15 trillion, right? That amount doesn’t include unfunded liabilities.

          • xgsmmy says:

            MF, this is “anon”, I haven’t said anything about “unfunded liabilities”.

            If you want to argue the law will be changed when Social Security and Medicare run out of money, fine, but that’s not the way it is set up now.

            And please tell me your not redefining all government debt as “unfunded liabilities” because you think “taxes or theft.”

    • Bob Murphy says:

      I love arguments like this from anon:

      Also, it’s the rise in medical costs that are driving the debt, not social security. If you’re so worried about the debt then you should be open to lower cost systems like in France, Germany, Britain, Canada, Japan and Israel.

      Or I could “be open” to mass exterminations of the elderly too. Since I’m not, I must not really care about budget deficits after all.

      • anon says:

        Or I could “be open” to mass exterminations of the elderly too. Since I’m not, I must not really care about budget deficits after all.

        Bob, so being open to Japanese or Israeli health care systems are comparable to being open to “mass exterminations of the elderly”? That’s strange since the Japanese old live longer than we do.

        The point was your using the debt “crisis” as an excuse to cut the program, when the problem is not Social Security or the Medicare program itself but rising US health care cost, including private sector costs.

        • Matt Tanous says:

          The health care costs are rising because of programs like Medicare. It’s a self-feeding cycle.

          • anon says:

            Matt, then how do those other countries have lower health care costs if Medicare is the problem?

            This doesn’t mean that all private system would not have lower costs, but that it’s possible to have lower costs without one.

            • Richard Moss says:

              If it is possible for a ‘private’ health care system to have lower costs than the one we (supposedly) have now in the US, why isn’t it also possible to have a higher cost government-managed system – like Medicare – than other countries?

              • anon says:

                Richard, we do have a higher cost system, already, so I don’t know what your point is.

                Medicare, unlike the VA system, buys its healthcare from the private sector and has higher costs.

              • Richard Moss says:

                You said that because other countries have government managed health care systems that are less expensive, a government managed system like Medicare here can’t be expensive.

                That doesn’t follow. Just like it doesn’t follow that because we have a higher cost ‘private’ system here, any private system will be ‘expensive.’

                And, just because Medicare buys from the private sector doesn’t make the private sector expensive. Medicare could be horribly inefficient in how it pays for medical care. (Based on anecdotal evidence, I think this is the case).

                Private companies lose money or go out of business all the time because they can’t turn a profit. Does that make the supplies they buy from the ‘private market’ expensive? Or, is it a reflection of how they are run?

              • xgsmmy says:

                Richard, this is “anon” from above.

                I didn’t mean to imply Medicare can’t be expensive. Obviously it is expensive. I simply meant to say that other countries have more control over their care systems and have lower costs than we do.

                I also compared Medicare costs with the VA system.

                And, just because Medicare buys from the private sector doesn’t make the private sector expensive. Medicare could be horribly inefficient in how it pays for medical care. (Based on anecdotal evidence, I think this is the case).

                Medicare is actually cheaper than private health insurance.

              • xgsmmy says:

                Richard, you can also compare Medicare and Medicare Advantage which relies on private companies and Medicare is cheaper.

                Also, I think Medicaid is even cheaper than Medicare.

        • Tel says:

          Yeah, the Japanese sure do live along time, statistically speaking that is.


    • Bob Murphy says:

      RPM wrote: “As time passes, the unofficial indebtedness of Social Security and Medicare will show up as “official” debt when Uncle Sam has to enter the bond markets to cover the shortfall between beneficiary payments and incoming payroll taxes.”

      anon responded: “At least regarding Social Security I believe this runs counter to law. Social Security is legally prohibited from paying out more than it takes in. Social Security’s owns bonds because it previously took in more than it paid out.”

      Anon it’s true that I didn’t worry about that complication (I’m not sure what the CBO assumes in that regard). But, at the very least, you are overlooking the fact that the “trust fund” would get converted into Treasuries held by the public, not by the SSA. So that’s $2.7 trillion as of a year ago, which some would consider real money.

      • anon says:

        You’re saying the trust fund already cashed in $2.7 trillion? (Is this because of Medicare or Social Security? Part of the problem is your using the two interchangeably when Social Security is relatively healthy.)

        Putting aside whether this is because of the tax holiday or not (at the time I worried the tax holiday would be used as an excuse to cut the program), this really didn’t add to the total debt level, it kept it the same. When Social Security bought the bonds, from what I understand, the debt increased at that time. So Social Security selling its bonds doesn’t increase the debt, but keeps it the same.

        Perhaps, I’m misunderstanding. Feel free to mock me if I am.

        • Bob Murphy says:

          Anon, no, I’m saying as of December 2011 the SS Trust Fund was $2.7 trillion. So going forward, as Social Security (not Medicare) payments exceed incoming SS payroll tax receipts, current law surely allows the SSA to draw down the Trust Fund, right? I.e. the complication you were mentioning surely doesn’t prohibit the SS trustees from selling off their Treasuries in order to cover operating deficits, right?

          In that case, my statement about “unofficial” debt turning into “official” debt would work for $2.7 trillion, at which point the Trust Fund would be dry and then your point would kick in.

          • anon says:

            Bob, I still think you’re double counting. Social Security’s bonds increased the debt at the time of their purchase. How does it increase the debt again when they’re sold or paid back. (If they’re sold to the private sector it doesn’t seem to matter at all, but if they mature, they were always going to mature. I don’t know what the problem is.)

            (You and Nick still have a point that social securities bonds may be transferring money if the people who are taxed to pay for them are different than the people who benefited from any spending from the trust fund surplus. And this could be net transfer for the older generation if the older generation consume at the expense of the young and then die.)

            If Social Security is a transfer payment and not a trust fund, though, then the wealthy are benefiting (I’m sure some of you guys will object that they really are, but whatever) by having lower marginal rates because of the cap.

            • Bob Murphy says:

              anon (xgsmmy), the debt/GDP ratio quoted by the CBO and in the popular press is “debt held by the public.” So the SS trust fund isn’t in that number. If you included it, then the federal debt/GDP ratio would already be the full debt (like they use for debt ceiling debates) divided by GDP, which is over 100% right now (I think).

              • xgsmmy says:

                Okay, but then we’re back to the same old debt debate.
                100% debt to GDP is just a number unless you subscribe to the Reinhart/Rogoff 90% red line thesis, which doesn’t seem to fit the evidence.

                It’s not like “debt held by the public” is really held by everyone equally either. Why wouldn’t it exclude foreign debt as well?

                Nonetheless, I’m going to go look this up as it’s strange.

                (You could have a problem if the government spent more in the past than it would have otherwise because it wasn’t counting Social Security trust fund as a liability. However you could still have a MMT conception of government finance where inflation is the relevant measure of solvency, keeping in mind your and Nick’s qualification.)

  6. anon says:

    Yet the actual data show a different story. It’s true, U.K. unemployment fell steadily (and slightly) from January 1972 through January 1974. But then it steadily rose, and in 1975 it accelerated upward—precisely when inflation was at its highest.

    Although, I’m uncertain about how this affects the story, and too lazy to try to look it up right now. I just want to point out this ignores both the oil shock that I think began in late 1973 and the exchange rate which was supposedly a big part o the story.

  7. Lord Keynes says:

    “The U.S. government is insolvent—bankrupt—according to standard accounting principles.

    And the principles of standard accounting do not apply to an entity that has a central bank and is legally empowered to redeem its own debt by open market operations.

    • Major_Freedom says:

      Tell that to Russia circa 1998.

      • Lord Keynes says:

        The Russian case proves the point exactly:

        “I took some notes at the time the Russian government defaulted which go like this. After the breakdown of the Soviet Union they made their first major mistake – conveniently not mentioned by Rogoff – they pegged the ruble within tight range to US dollar – and thereby surrendered their currency sovereignty.

        Their second mistake was to allow heavy borrowing in foreign currencies.” … etc.


        Good of you to bring it up.

        • Tel says:


          They had already tried it Bilbo’s way, and they found the 1000% inflation rate difficult to work with. They also tried selling debt denominated in Roubles just like the MMTers suggest, and those were called GKO but the whole scheme fell in a heap.

          Of course, mentioning the background material would probably make the whole MMT thesis sound stupid (which it is) and I guess that’s why Bill Mitchell just forgets to talk about any of that stuff… but the point is that borrowing in foreign currency is what they tried AFTER the tried all the MMT suggestions and got nowhere.

          Mind you, corruption was high, Yeltsin was hopeless, the government ran big deficits, and everything hinged on the price of oil and gas, plus they had a lot of rebuilding to do after Communism, so disruption was inevitable.

          • xgsmmy says:

            The break up of the Soviet Union may have had something to do with the hyperinflation.

            But if you have a link on the GKO and what was going on there.

            • Tel says:

              Yes of course Russia had plenty of political problems during those years, and structural problems — probably it still does but not as badly. You can just as easily blame the default on those political problems if you like.

              Point is that they tried the MMT money-printing recipe at an early stage and rapidly it blew to pieces, so they tried pegging their currency as a last minute measure to bring inflation under control. Fundamental problems remain fundamental problems regardless of economic hand waving. Regardless of how many times the MMTers want to say it, creating something out of nothing can’t be done with a wave of the printing press.

              But now they tried a new trick–they created a cash channel. They would sell short-term, ruble-denominated treasury bills, known as GKOs (not pronounced GECKOS, as some would have you believe, but GAYKAYOOS). At first, the idea, blessed by the US advisors, seemed swell. Western and Asian investors had liquidity. Emerging markets were hot. And Russia needed cash. Moreover, Russia had 30,000 nukes and some 147 million consumers. “It can’t crash” was the refrain. The GKOs, moreover, as anyone who went big in them will now tell you, were to be guaranteed by the Central Bank.

              Was it a pyramid scheme, an international ponzi scam? To a good degree, yes. But at first, the bonds made great sense. And they worked–they delivered billions to the Central Bank. Did that money go to the budget? To pay pensions, the army, social services etc? Some of it did–the finance minister Mikhail Zadornov and others insist. But most of it went right back out–to pay off the debt that they couldn’t roll over. Obviously, the process had momentum–the higher the yields soared, the more people bought the GKOs. Up to a point. At triple-digits returns, even the deep-deep-pockets started to worry about the state’s ability to pay off the bonds.

              The state started to have a new trouble: moving the paper at its weekly auctions. Then during the spring and summer, it started canceling the auctions altogether. This was not, to put it mildly, a good sign. The debt, all the while, compounded.

              Sirens should have sounded. It was not just the bond market. (We can’t forget MinFins, Eurobonds too.) It was also the stock market, an experiment that soon grew into a cash cow for Russian and foreigner high-risk investors alike. The stock market looked like good value, even with its high risk. (Hedge funds–the monsters that helped eat up the promise of globalization—mushroomed in the Russian market). But market cap was never high. Even at its peak, the stock market never held more than $127 billion–about four times Amazon.com.’s stock value (as of this writing).


              • xgsmmy says:

                Tel, I’d just point out that the MMT people claim inflation is the one check on a sovereign government’s solvency. (Assuming it can collect taxes.)

                I’ve also read that Russia assumed the entire Soviet debt, but also that many of the other newly formed post communist countries, like Poland, either had very high inflation or hyperinflation around the same time.

          • Lord Keynes says:

            You’re conflating Russia’s post communism problems (c. 1992-1993) with the default 1998.

            And borrowing in foreign currency was a major part of the 1998 crisis, despite what you say.

            • Tel says:

              In what way are they unrelated?

              You think one year just happens in isolation to every other year?

              It is ridiculous to think that Russia restructured from Communism in that little space 1992 and 1993, anyhow the GKOs started in 1994 and continued all through that period to the default — that was MMT in action right there. It was the GKO that dragged the rest of everything down on top of it.

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