James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter: @JamesGRickards.
One of the early challenges facing the Reagan administration was how to dismantle what was known as the "liberal ratchet". A ratchet is a tool designed to turn one way but never reverse. The liberal ratchet referred to the fact that in a policy debate, the liberal position might win or lose, but, if the liberal position won, they would never give back their gains. Government could become more liberal but it would never become less liberal. In the end, liberals would triumph. All they needed was patience to weather those periods when they got less than everything they wanted.
Reagan wanted to reverse the liberal tide and make some gains for conservatism. He knew this would be difficult to do by attacking programs directly. Even liberal programs could attract conservative supporters once enough jobs, expenditures, and contracts were involved. Agencies favored by liberals such as the Department of Education could be honey pots for conservative government contractors once the Republicans were in charge. This was part of Washington's "iron triangle" of agencies, congressional committees, and outside contractors that kept growing the size of government in all administrations.
Rather than fight the iron triangle, Reagan settled on a method known as "starve the beast"—the beast being government spending. The idea was to pursue spending programs that Reagan favored while at the same time cutting taxes. This would greatly increase deficits and leave little money for liberal programs. Policy debates would become moot because if there was no money available for new programs, no amount of advocacy would make them happen.
As this policy was pursued, the Republicans discovered an added benefit. Not only would deficits constrain new liberal programs during a Republican administration, they would act as handcuffs on liberal programs even when the Democrats came back into office. This is exactly what happened to President Clinton. During the 12 years of Reagan and Bush 41, annual budget deficits rose from $73 billion in 1983 to $340 billion in 1992, and the cumulative deficit was $2.55 trillion. By the time Clinton entered office his hands were already tied.
When Clinton's strategist, James Carville, suggested new spending on some liberal programs he was sternly warned by the economic team that budget deficits had to be addressed immediately. Clinton and Carville were told that bond markets would not tolerate larger deficits. Carville famously replied, "I used to think if there was reincarnation, I wanted to come back as the president… But now I want to come back as the bond market. You can intimidate everybody." To his credit, Clinton did pursue a path of fiscal restraint. Deficits fell steadily and Clinton actually produced budget surpluses in the last two years of his administration.
With the coming of the Bush 43 administration, it seemed time to revive the Reagan playbook. Bush 43 deficits started where Bush 41 deficits ended at over $300 billion. But they expanded rapidly reaching a new high of $642 billion in 2008. This was due to a combination of increased spending and new tax cuts. It was a replay of the Reagan years—spending for programs favored by Republicans and tax cuts for everyone. The combination left little for the liberal ratchet to cling to. It seemed that Bush 43 would resemble Reagan and Bush 41 in another way. The Democratic successor, this time Obama, would be left with no choice but to reduce budget deficits, so that Democrats would once again be accomplices in putting their own priorities aside in order to address the greater issue of fiscal solvency.
This time it was different. Obama did not follow the Clinton playbook in response to Republican deficits. Obama had one thing Clinton did not have—a ready made financial crisis that called out for deficit spending under the guise of "stimulus." Whether stimulus was good economic policy was beside the point. It was the perfect excuse to keep deficit spending high when normal economic times would have called for restraint. A new policy of "feed the beast" was underway.
The Obama deficits were an order of magnitude greater than anything ever attempted. The deficit numbers were staggering—$1.5 trillion in 2009, $1.37 trillion in 2010, $1.37 trillion again in 2011 and an estimated $1.4 trillion in 2012—a cumulative four-year total of over $5.6 trillion dollars. The liberal ratchet was back with a vengeance.
The Obama administration took over large parts of the auto, banking, healthcare, and other industries, and did so in ways that were not only difficult to reverse but that institutionalized the spending. Now the only choices were to ratify spending with tax increases or go broke. Obama's bet was that Congress would not let the country go broke and, in the end, both his programs and his spending would prevail. America would be transformed. The liberal ratchet would win by using the liberal's greatest strengths—patience and the passage of time.
Fiscal policy in the United States now resembles a scene in which one schoolyard bully dares another to do something reckless and the other bully accepts the dare just to show he won't be intimidated. For 30 years, Republicans have dared Democrats to keep spending in the face of uncontrolled deficits and now a Democrat has taken the dare. The result is neither starve the beast nor feed the beast. It is something closer to kill the beast, because now the United States is going broke in visible, measurable ways. With no tax increases or spending cuts in sight, only rapid inflation—another form of going broke—can save us. Get ready.