Burgess Laughlin

Is the USA headed for economic disaster?

5 posts in this topic

I have not studied economics in any systematic way. I have a question that concerns me personally and every one I value.

David M. Walker, as administrator of the Government Accountability Office (GAO), is the comptroller general of the U. S. government. He predicts financial disaster for the U. S. if deficit spending continues its trend.

Problem: Is his prediction objective?

(There is another topic-thread, "Bankrupt USA" (link) that briefly takes an investment perspective, but my question is about the alleged trends and projections themselves. Are they valid?)

For the quote below, I cut out most of the article. It may be worth reading it in total, not only for the economic statements, but for its political implications, especially the 2008 presidential elections.)

http://news.yahoo.com/s/ap/20061028/ap_on_...ca_the_bankrupt

GAO chief warns economic disaster looms

By MATT CRENSON, AP National Writer

[October 28, 2006 on Yahoo News]

[...] The vast majority of economists and budget analysts agree: The ship of state is on a disastrous course, and will founder on the reefs of economic disaster if nothing is done to correct it.

[...] [Walker] has committed to touring the nation through the 2008 elections, talking to anybody who will listen about the fiscal black hole Washington has dug itself, the "demographic tsunami" that will come when the baby boom generation begins retiring and the recklessness of borrowing money from foreign lenders to pay for the operation of the U.S. government.

[...] To show that the looming fiscal crisis is not a partisan issue, he brings along economists and budget analysts from across the political spectrum. In Austin, he's accompanied by Diane Lim Rogers, a liberal economist from the Brookings Institution, and Alison Acosta Fraser, director of the Roe Institute for Economic Policy Studies at the Heritage Foundation, a conservative think tank.

"We all agree on what the choices are and what the numbers are," Fraser says.

Their basic message is this: If the United States government conducts business as usual over the next few decades, a national debt that is already $8.5 trillion could reach $46 trillion or more, adjusted for inflation. That's almost as much as the total net worth of every person in America — Bill Gates, Warren Buffett and those Google guys included.

A hole that big could paralyze the U.S. economy; according to some projections, just the interest payments on a debt that big would be as much as all the taxes the government collects today.

And every year that nothing is done about it, Walker says, the problem grows by $2 trillion to $3 trillion.

[...] The federal government actually produced a surplus for a few years during the 1990s, thanks to a booming economy and fiscal restraint imposed by laws that were passed early in the decade. And though the federal debt has grown in dollar terms since 2001, it hasn't grown dramatically relative to the size of the economy.

But that's about to change, thanks to the country's three big entitlement programs — Social Security, Medicaid and especially Medicare. [...]

And with the first baby boomers becoming eligible for Social Security in 2008 and for Medicare in 2011, the expenses of those two programs are about to increase dramatically due to demographic pressures. [...]

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This is a tough issue. Economic reality dictates there's no free lunch, that one can't spend more than one takes over the long run without consequence. The problem is: what will the consequence be, and how long will the "long run" be? And, in the face of this, what will or should be done?

There are basically two ways to fix a spending problem: reduce the spending or increase revenue. For an entitlement / welfare program, reducing spending can mean cutting benefits to recipients, reducing the number of people able to collect (e.g., pushing up age requirements for Social Security, or putting wage or wealth caps on Medicare recpients), and so on. To increase revenue, the government can increase taxes, tarriffs, and fees, borrow money, or inflate the money supply (which then allows loans to be borrowed at one value and paid back in deflated dollars).

Politically, I suspect there'll be a combination of inflation, borrowing, tax increases, and benefit reductions in order to deal with the looming Medicare and Social Security crises. (One factor that I rarely see discussed is the role of immigration in increasing the tax base. Yes, the boomer generation's retirement will be expensive for taxpayers, but the inflow of immigrants will lessen the burden somewhat.)

Historically there've been different ways in which the populace pays for the folly of government economic policies. FDR's New Deal had an immediate impact in prolonging and deepening the Great Depression. Nixon's final abandonment of the gold standard led to decades of inflation, a bear market in the early 70s, and a stagnant economy and stock market through the 70s.

Is the USA headed for disaster? Yes, but it may not be an overnight, sudden, intense disaster; it could be drawn out for decades. Perhaps a bit of both.

What will happen? I don't know which ways we will pay for these massive ponzi schemes, but I don't see a way to avoid it. I think it will come down to political fighting over who pays how much and in what way.

What should be done? I don't know of a best approach to ending these programs to minimize the impact to the economy as a whole and in a way that's fair to everyone. Some people spent their whole lives paying into the system, and ought to get something back; others just starting their careers will pay under the current system but most likely won't see any benefits when they retire. I've heard proposals for phasing out the system, and that ought to be the best way, but I don't know which specific plan would be best.

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I meant to add to my prior post (#2) that another consideration is what should one do as an investor to protect one's wealth in the face of such events. I'm less clear on that, given the current state of investment vehicles: housing has fallen a bit from an all-time high, and may fall further; gold shot up in the last couple of years, but is nowdown from its high this summer; oil and commodities are up from prices of recent years; S&P 500 and DJIA are at all-time highs; CD and money market yields are up from the lows of a couple years ago, but are probably not much above inflation.

I like to buy as value investor and contrarian: when there's blood in the streets, I buy. But with all of these prices high, there aren't obvious choices to me.

Gold and real estate are the usual inflation hedges (among others) so if their prices go down some more in the near future, then it may be time to buy before getting hit with the bill for the FDR and LBJ spending spree.

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I have not studied economics in any systematic way. I have a question that concerns me personally and every one I value.

David M. Walker, as administrator of the Government Accountability Office (GAO), is the comptroller general of the U. S. government. He predicts financial disaster for the U. S. if deficit spending continues its trend.

Problem: Is his prediction objective?

(There is another topic-thread, "Bankrupt USA" (link) that briefly takes an investment perspective, but my question is about the alleged trends and projections themselves. Are they valid?)

For the quote below, I cut out most of the article. It may be worth reading it in total, not only for the economic statements, but for its political implications, especially the 2008 presidential elections.)

http://news.yahoo.com/s/ap/20061028/ap_on_...ca_the_bankrupt

This topic is a pet-peeve of my current Public Finance Economics professor, so we spent quite a bit of time studying it. The problem is not unique to the United States and is in fact, a much more acute problem in Europe and Japan, where the welfare state is funded in the same pay-as-you-go method but whose source of funding--the working population--is shrinking while their number of retirees is increasing faster than their overall population (and in the case of Japan, the population is actually shrinking).

The problem (on the face of it) stems from the unsustainable pay-as-you-go system, where current workers who pay taxes pay for the retirement and healthcare of current retirees. Of course, when the ratio of retirees to workers is small, the burden for the working population is relatively light, as it was in the post-World War II era. However, in recent decades it has so happened that while birth rates are well below replacement levels, death rates are falling and life-expectancy is increasing! This has a simple implication: the number of retirees over the next several decades will increase significantly relative to the number of working people, so that the burden on working people becomes so severe even European levels of taxation could not keep the system financially solvent. Had the current and future retirees saved for their own retirement this dramatic change in demographics (more old, retired people but less young, working people) wouldn't be a problem at all, as their own savings, not the earnings of current workers (many of whom are their own children and grandchildren), would have funded their retirement and healthcare. As it so happened, the government has instead confiscated the savings of workers and used it to finance its ruinous growth.

These projections are based on a number factors, including population growth, birth rate, death rate, life expectancy, held nearly constant and/or projected to change in a way consistent with today's current conditions. In other words, it rules out any dramatic, radical changes in the future. Of course, radical changes are quite probable in the long-run. Not too long ago, intellectuals and economists in the 1960's and 1970's were alarmed about rampant population growth and the consequent worldwide famine and depression. It never materialized. Conditions changed. And now they are alarmed over the opposite problem: the developed world's population (in particular, its population of working people, i.e., its producers) is not growing fast enough to keep the welfare state viable in the future, and are now proposing such things as bigger tax credits for families with children, longer paid maternity leave and all kinds of other subsidies, to encourage more baby-making :).

Apart from reforming the system in way that makes it viable in the future, there are several factors that could either prevent the disaster or aggravate it. (The following lists are certainly not exhaustive.)

Things that could prevent it:

1. Increased economic growth through rapid labor productivity growth. This would raise workers' outputs and income very rapidly and thereby form a larger pool of resources to fund the current system. Since the same if not smaller proportion of output/income would then be necessary to fund the current system, the burden would be the same if not lighter than in the past. This is unlikely however, as the same system (the welfare state) is responsible for suffocating the economies of the developed word.

2. Long, sustained baby boom. Obviously, since it would take a generation and some years before the babies reach working age and peak productivity, this "solution" would take some time to materialize. It is also possible that the disaster occurs before the baby boom has any effect.

3. Increased death rates and falling life-expectancy among old, retired people. Nothing short of either mass suicide or mass murder could achieve this, since the progress in biomedical technology will continue to prolong people's lives while saving many others.

4. Massive immigration of young, working people into the developed countries. This would significantly reduce the ratio of retirees to workers, and thereby alleviate or lighten the burden of funding the system.

Things that could aggravate it:

1. Prolonged economic stagnation or depression: This would ruin the finances of the government faster than today. It would make the system insolvent sooner than projected.

2. Birth rates continue to fall dramatically. The burden would rise even higher than feared. Again the disaster will occur sooner.

3. A massive global war than kills many young people, especially young men, who would have constituted the core of producers that funded the system.

The items on the lists are certainly not out of the question, and may in fact be even more likely than political reform :D. So take the projections as simply that: projections. There is hope, even though our ideal solution (abolition of the system in its entirety) is highly unlikely. There is one country--Chile--which has actually implemented the forced, government-regulated privatization scheme in 1981, and it has so far been what my professor calls "a stunning success". Not only is it more than fully-funded (i.e., possessing enough funds to pay off all at once everyone that has put his savings into it), it has also helped to fuel the phenomenal economic growth of Chile since 1981, as the producers' (forced) savings are channeled into productive, private firms via the stock market rather than flowing into government coffers to pay destructive government programs. This is definitely not moral or even proper, but given the alternatives, it may be the better choice (the lesser of two evils). It's one that President Bush proposed right after the 2004 elections but failed to galvanize enough enthusiasm or support. It's a real-world example that has so far worked, and from what I've read, is something that even the Russians(!) are planning to implement. I fear, however, that politicians will only "tinker with the system" (as my professor says): that is, they would simply raise taxes, reduce benefits, and raise the retirement age to keep the system afloat.

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I'm looking forward to read more on the subject. However, I suspect that no one will want to talk about this much.

I think the most likely positive resolution is to combine a transition to self-funded accounts (e.g., some kind of forced 401(k)) with increased debt to pay for current retirees and soon to be retirees. Currently, I don't see anyone, Dep or Rep, willing to suggest anything like this. A stop-gap solution would be a later retirement age.

Things that could aggravate it:

1. Prolonged economic stagnation or depression: This would ruin the finances of the government faster than today. It would make the system insolvent sooner than projected.

2. Birth rates continue to fall dramatically. The burden would rise even higher than feared. Again the disaster will occur sooner.

3. A massive global war than kills many young people, especially young men, who would have constituted the core of producers that funded the system.

With regard to your #2, the key point is the relation between birth rates and avg lifespan. So although I don't see birth rates decreasing much, I do expect to see material advancements in lifespan, partly from a change in behavior in current adults (less smoking and drinking), and partly in medical progress for older people.

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