Economic advice

Fix the budget problems.

There are two schools of thought on the sustainability of growth in the U.S. No one doubts that the U.S is growing at 5% with about 250-300 thousand jobs added a month for now. Tax cuts, low interest rates, and budget deficits have all stimulated the economy. The question is whether or not this growth is sustainable.

Critics point to the fact that tax rebates are coming to an end, oil prices are on the rise, the trade deficit is unsustainable, and the budget deficit is going to be out of control once the baby boomers start collecting on pensions and benefits we never bothered to pay for. Ill grant them the last one, but I am not too much worried about the rest.

With regards to the tax cuts, they may be coming to an end, but corporate profits are at very high levels that they should remain even when the tax rebates end. Critics point out that consumers now have mortages and are in debt. Granted, but most were renting apartments before investing a new home. Now that they are homeowners, their bills are going to pay an assett and not just a temporary living facility.

As Greenspan said, history tells us that the trade deficit will correct itself (probably with a depreciation of the dollar) without much movement in the economy. (A depreciation of the dollar makes our exports cheaper, which will close the trade deficit). The problem most people worry about is that a depreciation of the dollar also puts inflationary pressure on the economy (through intermediate inputs, etc.). I'm with Greenspan, a combination of high productivity and upcoming but moderate contractionary monetary policy will keep inflation relatively stable.

What worries me is this budget deficit. No politicians, republican or democrat, are interested in closing this budget deficit. Now that the economy is close to or back at full employment, a budget deficit that is getting close to 5% of GDP is a hinderance to the economy. Consider the following equation for investment

I = S + (T-G) - (NX)

In english, this means that investment is equal to savings plus government savings - net exports. Currently, the hit investment is taking from the budget deficit is being offset by the trade deficit (NX = net exports). Since we are currently running a trade deficit, the double negative cancels out.

Yet the trade deficit will (OR SHOULD) close based on economic theory. As of now, foreign investors are invested heavily in the U.S economy. Eventually, as Greenspan notes, these investors are going to want to diversify their portfolios, which means they will leave depreciating the dollar. This depreciation will close the trade deficit.

All this means that the budget deficit is going to soon becoming a hinderance on investment, and hence long term growth. Our budget deficit is not cyclical, it is structural. Therefore, in order to close it the government is going to have to get down and dirty and start making some decisions.

My recommendations are
1) Forget anymore tax cuts. There is no need for them at the moment
2) Start getting tight with the fiscal purse. Discretionary spending must come under control. Our military needs come first which means that this is going to be tough

but the biggest one is
3) STOP PROMISING PENSIONS AND GOODIES TO SENIORS WHEN YOU CAN'T AFFORD THEM! There is absolutely no way we can pay for this prescription drug benefit. Medicare already has 37 trillion dollars in unfunded mandates (which means we promised goodies without earmarking money for it). Social security has another 7 trillion in unfunded liabilities. This two federal pension plans must be brought under control.

If this happens, the U.S. will be in good shape for sustainable long term growth. Lets see if the politicians have the guts to make it happen.