Can the US change its destiny?
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A June 11, 2010 opinion article in the Wall Street Journal, written by Arthur Laffer, caught my eye. In my opinion, many of his thoughts and insights are worthy of notice by US policy makers and citizens alike. His line of reasoning serves as a sobering reminder that the long-term ill-effects of the "Great Recession" are probably far from over. His closing statement leaves the reader with the unappealing message that the US government and Federal Reserve (FED) have a tough decision consisting of two bad choices and the general public must try its best to protect itself against formidable economic odds.
Laffer provides a well laid out and convincing argument for why the US should expect higher inflation, interest rates and taxes in the coming months and years. His basic argument is, that in order to manage the financial crisis of 2008-09 (bailouts for banks, AIG, auto companies, buying toxic assets, etc.), the US government increased the money supply by an unprecedented amount; ten times larger than any previous increase in the past 50 years on a percent of monetary base basis. This in turn has begun and will continue to drive up the prices of everything (accept houses and commercial real estate). Furthermore, he cites the unfunded liabilities the federal government faces such as Social Security, civil-service and military pensions, the present and future obligations of the Pension Benefit Guarantee Corporation (PBGC), Medicare and Medicaid as exacerbating the already dire mismatches between tax receipts and government spending. He points out that these unfunded liabilities total to over $100 trillion!! This amount, when contrasted with the current US GDP of $14 trillion and federal tax receipts of $2.4 trillion, provides the backdrop for high interest rates, vastly higher taxes and even the potential for defaults on many government promises. All of this will most assuredly create much higher price levels and disconcerting political consequences.
The previous two paragraphs merely summarize Laffer's logic. However, I would like to say that almost all of his unfunded liabilities revolve around the fact that that the US population is aging. Aging populations are expensive to maintain and they are not as productive as they once were. So, the problems caused by the "Great Recession" are made much worse by US demographics - a "perfect storm," if you wish.
To make matters even scarier, in 2011, without legislative intervention, almost all US tax rates are slated to increase. This is because the Bush era tax cuts had sunset clauses that expire at the end of 2010. These built-in tax increases allow politicians to avoid the direct wrath of voters. The pending 2011 tax increases have motivated many businesses and individuals to move income and profits forward in order to save taxes in 2011, whenever possible. These distortions have added some short-run lift to the US economy, but the resulting down turn in 2011, from lower reported earnings and higher taxes, will most likely shock the US economy back into significant contraction.
One of the two before mentioned bad choices facing government and the FED is to drive the economy back into severe recession by reducing the money supply, raising taxes even more and reducing government spending. These actions would lower the inflationary pressures. With lower inflation expectations, investors would accept lower than otherwise nominal return rates and this would translate into lower interest rates. However, the short-run political consequences of such actions are simply unacceptable. The other bad choice is to allow the money supply to remain extremely high, quickly enact tax lowering legislation and to continue present levels of government spending. This choice guarantees, as Laffer says, devastating double digit inflation, reminiscent of the 1970s; only much worse. Nevertheless, the real devastation from this course could possibly be ducked for several election cycles.
Due to political and market realities, my prediction is something in between the two bad choices of the previous paragraph. Therefore, I believe the US faces a protracted period of all of the undesirable attributes: higher taxes, prices, and interest rates, plus reduced social benefits and slow and perhaps even negative economic growth. So, what should the typical US citizen do to protect himself or herself from my dismal prediction? That is a very good question as it may be a case of, "You can run, but you can't hide."
Dr. Claggett is a columnist with China.org.cn. For more information please visit:http://www.china.org.cn/opinion/node_7078635.htm
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