Belmont Club

You've Got to Change Your Evil Ways -- Baby

European officials, increasingly concerned that the Continent’s debt crisis will spread, are warning that any new rescue plans may need to cover Portugal as well as Ireland to contain the problem they tried to resolve six months ago.

And that in turn may pull down Spain, according to the New York Times. “Of paramount concern to policy makers in Europe is Spain, which is struggling to close its own deficit of 9 percent of G.D.P. at a time when unemployment is more than 20 percent and the economy is failing to grow.”

The President of Europe, Herman Van Rompuy warned that the spreading crisis has left both the Euro and the EU fighting for their “survival”, according to the Telegraph. “We all have to work together in order to survive with the euro zone because if we don’t survive with the euro zone, we will not survive with the EU.”

In each case the markets are charging sovereign countries more for their debt as doubts about their ability to pay grow. Derek Thompson in the Atlantic describes how the mistrust can come like a squall out of a summer sky. “One day, the markets trust a country like Greece to pay back its loans. The next day, the same investors look at country’s vital stats — high annual deficit; high debt load; falling exports — and start to panic. Interest rates spike. Investors both create and react to the panic by running away from any country with similar vitals. Rising fear spreads, interest spreads rise, and before you know it: contagion. … To Ireland… To Spain… To Italy…”

What about America?

US stocks have already dropped on the fears of a European debt crisis and suspicions that China’s growth is not sustainable. Tim Geithner acted to soothe frazzled nerves confidently declaring that Europe was capable of containing the threat — if it acted quickly. But any long-term solution was contingent on what he called “policy reforms”.

“You want to make sure you move very, very quickly and you have a combination of policy reforms that help resolve the underlying problem with some temporary financial support to help countries manage through them,” he told the Wall Street Journal CEO Council.

Those “policy reforms” were also needed in the United States according to Rep. Paul Ryan, who laid out what he called the four cornerstones of economic reform to Charlie Rose. Low and predictable tax rates. Sound monetary policy. Reasonable and predictable regulation. Government spending cuts.

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But the problem with Ryan’s cures is that they are essentially the cup of hemlock for liberal social policy.  They mean the death knell for Big Washington and Big Brussels.  And therefore these cures will be bitterly resisted by entrenched bureaucracies and special interests on both sides of the Atlantic. But as global stock exchanges sank for the seventh straight day, the incentives to apply the bandaids increase even as the instinct to Kick the Can Down the Road rise commensurately.

Eugene Robinson is all set to throw the “military-industrial complex” overboard to lighten ship  the better to let the really big spenders off the hook.  Thomas Sowell writes, “cutting defense spending to save money? That is one of the oldest moves in the liberal play book. Some soldiers may pay with their lives for this, but that could be years from now– and after the next election, which is as far as most politicians think.”

Incline or Decline?

Unfortunately cutting defense even to zero would not nearly be enough. Niall Ferguson estimated that interest payments on debt alone will exceed total spending on defense within the next decade. That is because the principal driver of US financial deficits is spending on entitlements.

The U.S. government is committed under current law to mandatory payments for programs such as Medicare, Medicaid and Social Security. The GAO projects that payouts for these programs will significantly exceed tax revenues over the next 75 years. The Medicare Part A (hospital insurance) payouts already exceed program tax revenues and Social Security payroll taxes fully cover payouts only until 2017. These deficits require funding from other tax sources or borrowing.

The present value of these deficits or unfunded obligations is an estimated $45.8 trillion. This is the amount that would have to be set aside during 2009 such that the principal and interest would pay for the unfunded commitments through 2084. Approximately $7.7 trillion relates to Social Security, while $38.2 trillion relates to Medicare and Medicaid. In other words, health care programs are nearly five times as serious a funding challenge as Social Security. Adding this to the national debt and other federal commitments brings the total obligations to nearly $62 trillion.

The Congressional Budget Office (CBO) has indicated that: “Future growth in spending per beneficiary for Medicare and Medicaid—the federal government’s major health care programs—will be the most important determinant of long-term trends in federal spending. Changing those programs in ways that reduce the growth of costs—which will be difficult, in part because of the complexity of health policy choices—is ultimately the nation’s central long-term challenge in setting federal fiscal policy.”

Given a choice between the abandonment of the welfare state project — and its associated bureaucracy — the odds are that the bureaucrats will keep on sailing until they go over the edge of the known financial world. But will, as the Keynesians believe, the financial world prove round and the debt harmless? Or will the world find itself in Tartarus, “as far beneath Hades as heaven is high above the earth”? Maybe the world is about to find out.


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