The deficit is a real problem and Simpson Bowles is still the key to the solution

A week or so ago, I set about to write more about the fiscal cliff, the real one, not the one manufactured by Congress and I posed  questions to Ted Muftic,  financial consultant and chief investment officer  for private equity firms and our family’s resident Harvard MBA with over 15 years experience on Wall Street.  He is a contributor to the Muftic Forum Blog

MY QUESTION:

This bit of using debt ceiling and continuing resolution as a bluff or irresponsible threat to force the admin to bend to their will on the sequester is still really mostly a bluff, I think.  The results would be too horrible for the economy if the GOP carries through. What I would like to do is to talk about other Sword of Damocles ...that have more meaning to solving the  deficit problem. Down grade of credit rating, resulting  in higher interest rates suppressing economic growth?  More quantitative easement (treasury just printing more money) would result in inflation later?  Unlike Greece, we can just print more money; they couldn't.  I recall that in the 1980's, we did pay for the Viet Nam War and the Great Society, so afterwards, the interest rate soared to 15% plus, resulting in the election of Ronald Reagan.  Is my memory right?  I was head of the foreclosure process in Denver and I recall the foreclosure rate quadrupled every year in lock step with the increase of interest rates.  There are two perspectives: short and long term and are we already at the backfire of the long term?

HIS ANSWER:

The debt problem is deadly serious.  It is difficult to grow our way out of it.  We need to do more and Simpson Bowles is  the key.

The path that we are on should be enough to want to cause politicians to act on debt and deficits if they were doing their job.  However,  it is much easier for them to promise everything instead of doling out pain that would cost votes.  The analogy I like is that if we were really concerned about our health, wouldn't we rather want to have regular annoying visits to the doctor instead of  the inevitable  pain of chemo to fight a cancer that could have been diagnosed earlier? Without taking regular small steps now, we could be heading to Greece-like pain later.

The U.S has a debt problem and it is not just a federal issue. Consumer, mortgage, corporate, local and state debt combined dwarfs federal debt, and our growing medical costs are causing are federal debt to explode! Total U.S indebtedness is 3 or 4 times bigger than our annual economy.  That is like making 50k a year and having 200k of debt.  If rates are low enough, maybe you can meet monthly payments. But what if lenders got too concerned about the economy and your job stability , refused to roll over  your debt ,and the only lender said” yes I'll lend you money, but your rate is going to double or triple”? How would your lifestyle change? What would you have to sacrifice? Your house, your children, your health? What if all the lenders to the US (China, Japan, oil-rich countries, pension and saving plans) said enough is enough?)That is the danger. That would be a real fiscal cliff that would have profound impacts on the veritable peace and stability of our society. It is like the fall of the Roman Empire - and I am dead serious.

Can we grow our way out of the debt problem? Excluding growth caused by inflation.( real growth),  it is possible so long as we pay down debt and not expand our lifestyle or make other investments.

Furthermore, given the current anemic level of growth, it would take years to make any kind of dent in the debt and we would have to effectively freeze ALL government spending and curtail entitlements a lot too.

What other countries have done is to inflate their way out of a debt problem. Debasing our currency would greatly minimize the cost of our fixed-rate debt a lot. Indeed, the Fed has been trying to stimulate growth and inflation through just about every means possible, most drastically through quantitative easing. A little bit of inflation is fine. But massive inflation like we had in the late seventies would not be good. And frankly, there is only so much they can do when there is no corresponding fiscal policies to help. Yes...that means stimulus,  which is a dirty word in DC these days. Sadly there is no fiscal flexibility left, there is no political flexibility. There is very little monetary flexibility  to grow the economy and control debt and deficits at the same time. The policies of the Bush years leading up to the Great Recession and the ire of the Tea Party afterwards have severely limited political courage and policy innovation. n

Simpson Bowles would represent a sensible way to unleash the economy and reduce debt and deficits. In particular, radically altering the tax code, getting rid of loopholes and arcane tax policies in favor of lower, simpler and fairer taxes would, in my view, breathe new life into business activity, investments, and to consumer confidence. In addition, modifying or making sensible changes to entitlements such as extending the ages of eligibility and more means testing, applied to people say under 50 now, would be good ideas. Policies geared to just changing more tax rates on the rich will eventually become unpopular. The benefits are just not large enough to really make any meaningful difference.  

Without bold thinking and big ideas on both sides of the aisle, I fear that we will lurch from manufactured crisis to manufactured crisis with the predictable effects of diminished American relevance in the global economy, frustratingly slow growth, consistently high unemployment, and debt levels that at any moment could create a real crisis that is  not of our politicians' makings.