By now most Americans are tiring of fiscal cliff debates even if they don’t understand their exact nature. As I listen to the wrangling between Republicans and Democrats it brings me back to the fundamental problem underpinning the struggle. Unfortunately, our elected leaders (both parties) have not been forthcoming about the true extent of our fiscal problems and thus, we the people, don’t really understand the fundamentals – debt and credit. My Christmas wish is for an elected leader or perhaps more importantly, a leadership block, to tell Americans the reasons for the problem and the path towards resolution. Ultimately, this debate will come to a very simple question:
What do you want government to be?
Voters have grown accustomed to government being all things to all people with a smaller share of the population responsible for funding its activities. Since tax revenues are inadequate to meet spending, we accumulate debt to levels previously not imagined.
Until we answer the question of what we want from government and what we are willing to pay, we face more discussions of cliffs and eventually an abyss. Remember the movie 300 when King Leonidas tossed the Persian emissary into the abyss while screaming, “This is Sparta!” ? That may well be the market tossing the U.S. Government into a similar chasm while screaming, “This is debt!”
The fundamental problem for the world’s economies and goverments is debt. Debt was accumulated in historic proportions at both the private and public level. That four-letter word has been at the center of my thesis about economic problems. Debt problems are solved only through repayment or default. The world’s central banks and governments are trying hard to prevent economic deflation though they are contributing to the expansion of the debt problem. The “industrialized” world alone borrowed $10 trillion in 2011. A big risk for many countries is the potential inability to rollover or refinance its debt. This represents new debt to satisfy old debt. The world will face increasing challenges in raising this money in the private markets without paying higher interest rates. Once those interest rates spike, the refinancing task becomes even harder. Put quite simply, the world is running out of liquidity.
In the U.S., the Federal Reserve announced that they will try to provide this liquidity through the purchase of mortgages and Treasury Bonds to the tune of $1 trillion over the next year. Their rationale for doing this is to help the unemployment problem. Understand that Fed action does not make the debt go away – it simply makes them the creditor. In Escaping Oz, I cautioned against reliance on the Wizards for economic salvation. The Fed cannot solve debt problems and the public (Toto) will ultimately pull back the curtain to understand this.
Meanwhile our friends in the executive and legislative branches of government argue about who should bear a greater tax burden. Often ignored in economic decline is what happens to the “rich”. One fiscal cliff band-aid is to avert the crisis via taxation. The market has its own mechanism for normalizing wealth. According to an article in the Wall Street Journal, the top 1% of earners in 2009 (those making more than $343,000/yr) saw their total income fall by more than 30% from the stock market high year of 2007. That drop made this group see their share of income drop from 23% of all income earned to 17%. By contrast the income of the bottom 90% fell by 3%. Another study found that only 15% of the people on the Forbes 400 stayed on the list for a 21-year period. According to the study, the reasons for the rich losing their wealth can be attributed to excessive borrowing and overspending (i.e.) debt. Those reasons fit nicely within the construct of what happens in lower economic strata, just simply at a different scale. As the stock market resumes its bear and bonds of all stripes (a large bubble in itself) fall in value, look for government revenues to take yet another hit despite the best intentions of having the rich, in the words of the President, “pay their fair share.”
The folly of the fiscal cliff and grandstanding by both parties is a battle which barely scratches the surface of the debt problem. This so called “cliff” is only here because both parties agreed to create it if there was not meaningful deficit reduction prior to the end of this year. And we knew there was going to be no attention paid to deficits particularly in an election year. The topic of deficient funding for entitlement programs is a larger cliff by orders of magnitude. That, dear readers, will be some cliff.
Here’s hoping Santa confers the leadership gift to those in Washington so they can articulate the unprecedented sacrifice and reform that awaits us.
Jim is the author of Escaping Oz: Protecting your wealth during the financial crisis.