In the immediate aftermath of the global financial crisis even the deepest market fundamentalists embraced the core Keynesian insight that when in deep recession, monetary policy will be ineffective and fiscal stimulus is required. They have now abandoned that view as calls for fiscal austerity abound regardless of the increasingly fragile nature of the global recovery.
While economists and policy-makers debate the short and medium-term remedies to the crisis, there is an incredibly surprising and under-discussed consensus emerging for the longer run....and that's that the United States and East Asia (notably China) have to change the ‘structures’ of their economies.
2. But...How Did We Get Here in The First Place?The US has to stop over-consuming on credit and actually produce things for export again. East Asian nations have to slow down their over-reliance on exports and increase domestic consumption. Another way of putting it: the key actors in the world economy need to undergo structural change.
Between 1983-90 (the Reagan era) the TOTAL US DEBT (that means households, businesses big and small, government local/state/federal) grew from US $5 trillion to US $10 trillion. It took the US more than 200 years to get to US $5 trillion so the increase of an equal amount in 7 years it's rather significant!! More on this later...
3. Reaganomics...Enter Supply Side Economics
Reaganomics was based on supply side economics and his four pillars of economic policy were to:
1.Reduce government spending,
2.Reduce income and capital gains marginal tax rates,
3.Reduce government regulation
4.Control the money supply to reduce inflation.
Ronald Reagan's economic concept was that if you cut taxes you would increase Federal revenues since economic activity would increase. The increase in economic activity would bring with it increased Federal tax revenues. In other words the tax cut would be self liquidating and self paying since any lost revenues for the moment would almost immediately be made up by increased revenues in the future. It didn't cost anything, therefore, to lower taxes and the economy would be stimulated to new heights.
Ronald Reagan's principles were influenced by the Laffer Curve The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (Equilibrium Point) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100% (the far right of the curve), then all people would choose not to work because everything they earned would go to the government.
In 1981, Reagan significantly reduced the maximum tax rate, which affected the very wealthy, and lowered the top marginal tax rate from 70% to 50%; in 1986 he further reduced the rate to 28%!
As a result of all this, the budget deficit and federal debt increased considerably: debt grew from 33.3% of GDP in 1980 to 51.9% at the end of 1988 and the deficit increased from 2.7% in 1980 to more than double in 1983, when it reached 6%; in 1984, 1985 and 1986 it was around 5%.
In order to cover new federal budget deficits, the United States borrowed heavily both domestically and abroad, raising the national debt from $1 trillion to $3 trillion, and the United States moved from being the world's largest international creditor to the world's largest debtor nation.
The federal government debt when Ronald Reagan took office was about US $1 trillion. That included in it all the debt run up for the Revolutionary war, the Spanish-American war, the Civil war, World War I, World War II, the Korean war, the Vietnam war and all the Social wars of the 1930's and subsequent years. In other words it took the United States from 1776 until 1980 or more than 200 years to accumulate a national debt of $1 trillion...by 1988 the debt increased to US $3 trillion!
4. Starving the Beast...
If government cuts taxes, but not spending, it still gets the money from somewhere—either by borrowing or inflating. Either method robs the productive sector. Cutting taxes is easy. Cutting spending is hard.
As Professor Laffer himself explained: 'It’s hard to win on spending. People love getting government benefits and they hate paying for them.' Reagan's mantra was the need to 'starve the beast' strategy has been a key tenet of Republican philosophy since Ronald Reagan. The idea was basically that sympathetic politicians should engage in a game of bait-and-switch. Rather than proposing unpopular spending cuts, Republicans would push through popular tax cuts, with the deliberate intention of worsening the government's fiscal position. Spending cuts could then be sold as a necessity rather than a choice, the only way to eliminate an unsustainable budget deficit.
Along with the fundamental concept of allowing the American people to spend more of their hard earned dollars themselves, the goal of tax cuts and lower taxes has been a way of keeping a runaway government in check. The problem is that, in practice, the starve the beast concept has rested on a flawed assumption – namely that a reduction in tax revenue would inevitably lead Congress and the White House to cut government spending. Clearly, that hasn’t happened.
Instead we've seen continued increases in both the size of government and its spending...in mind-boggling numbers!!
5. Understanding US National Debt...BIGGER THAN YOU THINK
Public Debt represents money owed to those (people, businesses and foreign governments) holding government securities such as Treasury bills and bonds.
Total Debt includes intra-governmental debt, which includes amounts owed to the Social Security Trust Funds and Civil Service Retirement Funds.
The debt to the Penny and Who Holds It is a daily review of total amount of public debt outstanding offered by TreasuryDirect, a division of the U.S. Department of the Treasury Bureau of the Public Debt. The mission of Public Debt is to borrow the money needed to operate the federal government and to account for the resulting debt and it's done via a variety of savings and investment products.
As of 18.08.10 the Total Debt amounts to US $13.4 trillion, of which Public Debt amounts to US $8.8 trillion (65%) and Intragovernmental Debt amounts to US $4.6 trillion (35%).
The US economy size is measured by its GDP, and the 2010 forecast is around US $14.6 trillion...which means the TOTAL DEBT of US $13.4 trillion (92%) is nearly the size of the whole economy...and a recent report from IMF indicates that TOTAL DEBT will surpass GDP by 2012!!
The scary thing is though...the FEDERAL GOVERNMENT TOTAL DEBT is not the TOTAL US DEBT (meaning households, businesses big and small, government local/state/federal)...that's the one that remember grew from US $5 trillion to US $10 trillion under Reagan...that number is now...US $57 TRILLION!!..AND STILL CLIMBING
The Chinese View...Cheng Siwei, Vice-Chairman, China's Standing Committee (2009)
'The US spends tomorrow's money today.That's why we have this financial crisis. We Chinese spend today's money tomorrow.'
to be continued...It's The Economy Stupid!