Editor’s Note: Now that we’re in October and past the first debate, it is time for my official recommendation for the presidential race. The article that begins below is not just the case against Obama—I’ve been presenting that for five years. This is the case for Romney and Ryan. (There’s a reason for the “and Ryan,” as you will see below.) In part 1, I present the case on economic grounds, in part 2, I will present the case in terms of the moral meaning of their agenda, and in part 3, I will look at what this choice implies about the American sense of life.—RWT
All elections are about “the economy, stupid,” as the old saying goes. This one more so than usual. We are now five years from the beginning of the recession. The economy has technically recovered, but there is some doubt about that; if official statistics are undercounting inflation, which is likely, we may still be in a recession. Certainly, this doesn’t have the usual characteristics of a recovery. There has been no surge of growth to bring us back to prosperity and no real improvement in employment. In fact, there is widespread speculation that we could be heading back down into a new recession.
It goes without saying that the trillions of dollars in stimulus, both through federal spending and through money-printing at the Federal Reserve, have depressed the economy instead of stimulating it, giving us the weakest economic recovery on record. Literally. This year may end up being the worst non-recession, non-depression year of economic growth on record. The second-worst year: 2011.
The alternative is to stop trying to stimulate the economy through artificial means, and instead to get the government out of the way, to keep taxes low and reduce regulatory barriers, so that the economy can recover naturally and sustainably on its own.
All of that is an argument against another term for Barack Obama and in favor of his opponent, because the president has learned nothing from the failure of his policies. President Obama was elected precisely because of this stubborn refusal to recognize the failure of the statist ideal. Four years ago, that gave him an aura of optimistic idealism. Four years later, it gives him an aura of arrogant, out-of-touch dogmatism. It makes him seem—as it did in last week’s debate—as if he just doesn’t care and he’s not even trying. And while I don’t trust Mitt Romney to understand exactly the right course of action to reverse our direction, he has been talking about a real reversal in direction, about avoiding tax increases and reducing regulation.
In particular, in vowing to repeal Obamacare, Romney has endorsed the first actual rollback of the welfare state that I can recall. For decades, Republicans have contented themselves with merely slowing the growth of the welfare state, adding to it at a lower rate and with some “market-oriented” window dressing. At best, they have fought a desperate rear-guard action, but they have not gone on the offensive against big government. This is the first time that they have attempted to remove a major addition to the welfare state after the law has actually been passed. If they can do it—and that depends on winning the presidency and control of the Senate in this election—then it will be an important new precedent.
But beyond all of that, there is one overwhelmingly compelling reason to support the Romney-Ryan ticket. They have taken the right stand on one issue in particular that ought to be at the center of the political debate: not just the size of the federal debt, but the basic structural problem that is driving us toward an economic “death spiral” of unsustainable borrowing.
In this fifth year of the “Great Recession,” it may not feel like things can get any worse, but they can. A lot worse.
Mitt Romney occasionally talks about how we’re headed to where Greece is right now. It’s a thoroughly valid comparison, but I suspect it doesn’t have the punch that it should because most people don’t really understand what is happening in Greece, so they don’t understand the parallels to what is happening in the United States.
We have to understand what really drives a sovereign debt crisis. Government borrowing triggers a crisis when a country piles up so much debt that it starts having difficulty making the interest payments. This is the point at which a debt becomes so big that it cannot be paid back.
The crisis in Greece was set off in 2009 when a new political party came to power and revealed that the nation’s debt was higher than previously thought. It was not a mere mistake. Previous governments had cooked the books and hidden part of the country’s debt years earlier so that Greece could appear to meet the debt targets required for adoption of the Euro. This was all done with a nudge and a wink on the part of the European Union, because the common currency was viewed as a political goal that was more important than economics.
With its debt hidden and the implicit backing of stronger economies, particularly Germany, Greece was able to borrow money at low interest rates and proceeded to do so. But then came the global recession and the revelation of the country’s hidden debt, and the country’s borrowing costs suddenly spiked.
The impact of the increased interest rates was shattering. The sudden increase in interest payments, coupled with reduced revenue due to the recession, put the country in a serious bind. To make its interest payments, the government had to raise taxes or cut spending, or both. But that depressed the economy, reducing revenues even farther. This made lenders even more nervous and caused rates to go even higher. We saw this same pattern recently in Spain, which imposed “austerity” only to have its spending cuts eaten up by higher interest rates. That gives you an idea of how hard it is for a country to get itself out of a debt crisis.
Here is the basic pattern of the interest rate “death spiral.” A country’s interest rates increase, making it harder to make the basic payments on its debt. This make lenders even more nervous, so they increase rates even more, making it even harder to service the debt, which makes lenders raise rates again, and so on. You want an idea of how bad this can get and how fast? Check out this grim little graph, which shows interest rates on Greek debt spiking from a little over 3% to 30% in about two years. That’s what a real sovereign debt crisis looks like, and you can see how Greece had no way out without intervention from a larger and wealthier country like Germany.
This describes what the crisis looks like, but not what drives it. What drives the crisis is the inability to stop borrowing or to pay down the debt because massive, chronic borrowing is built into the system. It is built into the system because the country has adopted a massive welfare state and bloated government employment. Government has grown so big that the private economy can no longer realistically be taxed enough to support it. Nor can the size of government be reduced significantly, because so much of the economy has become dependent on it that any reduction in welfare payments or in the rolls of government employees causes a massive increase in unemployment and deepens the recession. So the only alternative is to keep borrowing at high levels, year after year—and when the government can no longer do that, the country faces, not a mere recession, but economic collapse. When massive spending cuts are then forced onto a country, millions of people feel as if they have been suddenly cut off for no reason, and they are driven into the streets in rage.
That is what the Eurocrisis is about, and under Obama, America is setting itself up for exactly the same kind of death spiral.
The cost of the welfare state, which has been increasing for decades, has now become so great that we are forced to run chronic massive deficits—under Obama, more than $1 trillion per year for the fourth year in a row—just to keep government functioning normally.
The size of this problem is temporarily masked by the Federal Reserve’s decision to keep interest rates low indefinitely. This keeps the interest payments on the debt low and creates a false sense that we can keep borrowing forever at affordable rates. Yet it cannot go on forever.
Currently, the average interest rate on US government debt is a little over 2%, but the historical average over previous decades is about 5%. Unless you believe that “this time is different”—the siren song that lures economies into financial crisis—then interest rates will inevitably have to revert to the norm. At current rates, interest payments on the federal debt are about $300 billion per year. When rates revert to the norm, those payments will eventually double (or more), making interest on the debt into one of the largest line-items in the budget, on a par with Social Security and probably larger than Medicare.
But it gets worse. The Treasury has not been locking in our current debt at low long-term interest rates. Instead, it has been financing much of it with short-term bonds, which allows them to borrow at even lower rates. This masks the size of the debt by keeping interest payment down, but it makes us even more vulnerable to a sudden increase in interest rates. About $5 trillion of the federal debt comes due within 36 months. Since we can’t possibly pay down those loans, we will have to roll them over into new loans. So when rates go up, they will hit us fast. Combine loans coming due with new borrowing, and in three years, we could be forced to borrow $8 to $10 trillion at new, much higher rates.
Oh, and it gets even worse. A lot of our current debt is being bought by our own Federal Reserve, which purchases the debt with newly printed money. But printing money will eventually lead to inflation, so to stop inflation, or contain it, the Fed will suddenly have to stop buying US government debt. So just as rates start going up, the Fed will have to drop out as a buyer—driving rates up even higher.
But even if we start to panic about the looming debt crisis, we can’t just suddenly stop borrowing, because of the massive commitments we have made to the entitlement state. Currently, the federal government is taking in between $2 trillion and $2.5 trillion in tax revenues—and paying about the same amount out again in Social Security, Medicare, Medicaid, and unemployment insurance. We are then forced to borrow upward of a trillion dollars to pay for everything else, including basic functions of government like national defense.
This dilemma is captured in the “fiscal gap,” a measure of the long-term mismatch between federal government revenues and commitments to entitlement spending. Bond guru Bill Gross recently graphed out the fiscal gap and showed that it puts the US in the same “ring of fire” as Greece and Spain.
Here is how the debt bomb goes off. Big entitlement spending that can’t be cut drives larger and larger borrowing. When investors finally realize this is unsustainable and rates go up, so much of our debt is short-term that we suffer a rapid increase in borrowing costs, which begin to overwhelm everything else, stretching an already overwhelmed budget even farther. We start borrowing money just to pay interest on money we borrowed earlier. As investors realize this, rates go up farther, making interest payments go up faster. One moment we’re suffering under the illusion that we can keep borrowing money for free forever, and the next moment we see interest on our debt become the largest single item in the budget. But we can’t change it because it’s all built into the system. We have to keep borrowing to sustain the entitlement state.
That is the root and driver: the entitlement state. Government spending isn’t out of control because of ordinary discretionary spending. It is not out of control because of military spending, which is still much lower as a percentage of GDP than it was during the Cold War. No, spending is out of control because of the big entitlements. They are driving us toward the debt disaster.
All of this leads to one conclusion: limiting spending on entitlements is the central issue if we want to save the country from long-term economic disaster and decline, from entering into a depression and never really getting out.
And only one side is interested in addressing it. When asked about entitlement reform, the Obama administration declares, “This is not the time.” Barack Obama, displaying the depth and perspicacity we all saw at the debate, wants to talk about Big Bird and Elmo.
Mitt Romney, by contrast, has backed entitlement reform for a while, and he re-affirmed it by selecting Paul Ryan as his running mate, thereby endorsing some version of Ryan’s long-term “Road Map” for reining in entitlement spending. This is why the “Ryan” part of “Romney-Ryan” is important. It is what gives us some confidence that a presidential candidate with a record as a pragmatic moderate will actually be serious about addressing entitlement reform.
The details of Romney’s plan are still a little vague, and as it is currently conceived, the plan probably doesn’t go far enough. But the first step is recognizing that we have a problem, and Romney and Ryan recognize it. As in last week’s debate, the main thing is just to show up and demonstrate that they are engaged with the big issues.
Over decades, both parties have helped to build this debt bomb. It is now the central economic threat to the country, and only one major party ticket is interested in defusing it. They get my vote, and they should get yours.