OBAMA SO INTENT ON SPENDING HE IGNORES TRUTH

What Obama Didn't Tell You In His Deficit Reduction Speech

By Jerome E. Hass

Published April 15, 2011 | FoxNews.com

What was good about President Obama’s deficit speech? He started with a clear statement of the overarching problem that has to be solved – the spiraling deficits.

In a nutshell, our federal government has amassed a public debt of about $14 trillion, which is roughly equal to one full year of the total production of goods and service in our country (Gross Domestic Product, GDP), and the current year’s deficit (revenues less expenditures, a negative number) is adding about $1.5 trillion to the debt balance. More importantly, unless we make some dramatic changes in revenues and expenditures, it is projected that annual deficits will continue in the range of $1-1.5 trillion and the debt balance will rise to about 120% of GDP by 2020.

Deficits are not bad in and of themselves. When an economy has idle productive resources (labor and capacity), government expenditures and tax incentives are logical means of not only stimulating the economy, but also tackling fundamental deficiencies (such as decaying infrastructure, education, health care).
What is bad about deficits is their cumulative effect. When the government needs to sell bonds to finance expenditures in excess of revenues, the purchasers of those bonds effectively agree to give up current consumption in exchange for future consumption (repayment at a later date with interest as compensation for doing so). The interest has to be at least as great as the rate of inflation to keep the purchasers whole in real terms.
So far, both domestic and international entities have been willing to purchase U.S. debt at very low interest rates. The total interest expense on the debt is about $400 billion (a composite interest rate of a little less than 3%).
The reason spiraling deficits are the overarching challenge has not been well explained. Why can’t we simply go on accumulating deficits? The answer is that, at some point, as the national debt grows relative to GDP, some potential purchasers of that debt will get nervous – not that the government will default, but that inflation will make bond investments unattractive.
The federal government will not go into bankruptcy – its debt is denominated in dollars and the Federal Reserve Bank can easily (as it has demonstrated) purchase the debt when third parties are unwilling to do so at low interest rates. But that purchase monetizes the debt, which provides the basis for inflation (too much money chasing too few goods and services). Suppose inflationary expectations were not 1-2%, but 4-5%. The increase would add another $400 billion to the annual interest payment component of “expenditures” (based on only $1.4 trillion debt).
President Obama set a goal of cutting accumulated deficits over the next 12 years by $4 trillion. If even a modest (by historic standards) inflation of 4% was to be embodied in to Treasury debt interest rates, the increase in debt interest would wipe out the $4 trillion over 12 years!
We cannot allow those who are willing to purchase U.S. debt (including foreign holders who now own about one-third of the $14 trillion) to lose confidence in their continuing investment in U.S. treasury debt, or demand much higher rates to compensate for inflationary risk. Do they have alternatives? Yes – purchase real assets, such as real estate and equity ownership of U.S. manufacturing and service-providing facilities (via direct acquisition or share purchase).

What was bad about Obama’s speech? He failed to explain to a large public audience the importance of achieving that target. Cutting future deficits so that the national debt as a percent of GDP declines (Obama’s “debt failsafe” constraint) will keep inflationary expectations in check while allowing our government to spend more than the revenues it receives from all sources (principally income and social security/Medicare taxation) to address essential needs. 

If the executive and legislative bodies fail to achieve this objective, inflation is inevitable – and those in our society who have not the means to protect their income and wealth will bear the greatest burden. I expect that those most vulnerable to the fundamentally life-changing effects of inflation are not the wealthy, but those for whom we all want to share in the American dream.
I like the idea of forming a “bipartisan, bicameral negotiation,” but I don’t just want it to be a group that comes up with a “legislative framework” (whatever that means) and then punts the ball back into the political playing field. I want accountability and explicit actions.
Finding the set of revenue generating and expense cutting actions that significantly cut future deficits will be difficult – just look at what it took (the threat of government shutdown) to get a $37 billion reduction this year (about 1% of budgeted expenditure). The negotiators will have more to work with if everything is on the table – no sacred cows (including social security, even if the short-term effects of modifications are small).
And then they should be put in a room and provided only bread and water until they find a mutually acceptable combination. They simply must have the resolve (and those whom they represent must grant them the authority) to find a solution. Because failure to do so will unleash an alternative outcome that will cause enormous pain and suffering to those whom we wish most to help.
Jerome E. Hass is the James B. Rubin Professor of Finance Emeritus at the Samuel Curtis Johnson Graduate School of Management at Cornell University.

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