Time to Face the Music
Ever worry where the next billion is coming from? Not if you're this spendthrift federal government, with a national debt of $8.7 trillion. Yes, President Bush is fond of pointing to the decline in the federal deficit over the past two years, but that's virtually irrelevant to the long term. How many of us realize, for instance, that Uncle Sam is spending almost four times as much on paying interest on borrowed money as on education, transportation, and NASA combined?
One person who knows-and it gives him plenty of sleepless nights-is Federal Reserve Chairman Ben Bernanke. He tells us we are in "the calm before the storm" because Social Security, Medicare, and Medicaid costs now amount to almost half of federal noninterest spending. President Bush has not increased taxes to pay for this expansion of Medicare; in fact, taxes have been cut-repeatedly. Hence, by 2030 the ratio of publicly held federal deficits to overall economic output is likely to triple, from roughly 37 percent today to a mind-boggling 100 percent. This will produce a terrible torque on our economy, since financing deficits means paying out still more in interest, adding still further to the deficit. Bernanke has a not-so-quaint term for this phenomenon. He calls it a "death spiral."
This looming financial crisis can be avoided if we start raising taxes, cutting spending, or both right now. But President Bush is a graduate of the have-your-cake-and-eat-it school and says the deficit can be eliminated in five years without a tax increase. He describes his tax cuts as the cause of the surging economy and the lower-than-predicted federal deficit. Is he right?
There is no doubt that the economy has been strong over the past five years. Our gross domestic product has been growing for a record 20 consecutive quarters. The blue-chip companies in the Standard & Poor's index racked up 18 straight quarters of 10 percent or greater increases in profits; consumers are spending more; unemployment is low, as is inflation; energy prices are plunging just in time to provide consumers with an additional jolt of discretionary income for a post-Christmas binge; hiring has been strong in the past few months, suggesting that wage gains will continue; and the softening of the housing market has had a surprisingly limited effect on the national economy.
Companies have responded to the boom by plowing billions of dollars into new factories, offices, equipment, and software, in an effort to expand operations and take advantage of growth opportunities at home and abroad. Given the continued strength in corporate profits and low-cost financing by the capital markets, financing for a whole range of new ventures is readily available, and companies are in an excellent position to borrow at a time when interest rates are still low and the rising trend in stock prices is a boost for equity financing. As a result, we are continuing to create jobs.
Bad math. The real concern in 2006 and maybe 2007 was whether the housing slump would drag down consumer spending and the economy. The concern was that if home prices fell, that would shrink the equity available for extraction through refinancing and put many properties into a negative equity position, forcing many households to cut spending. But the strength of the economy has greatly diminished this concern.
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