Paul Volcker Explains Why The Fed Can’t Raise Rates
In an op-ed posted by Paul Volcker and Peter Peterson in the NYT, the two financial titans start off by pointing out just how “strange” the current presidential campaign is in its historical context…
Together, the two of us have 179 years of life experience and 13 grandchildren. We have served presidents of both parties. We have seen more campaign seasons than we care to count — but none as strange as this one. Insults, invective and pandering have been poor substitutes for serious debate about the direction in which this country is going — or should be going. And a sound and sustainable fiscal structure is a key ingredient of any viable economic policy.
… but the main issue that troubles the two financial titans, is the lack of any practical discussion of the soaring US debt during the entire bizarre campaign – the one issue both agree is the biggest challenge facing the US economy today:
Yes, this country can handle the nearly $600 billion federal deficit estimated for 2016. But the deficit has grown sharply this year, and will keep the national debt at about 75 percent of the gross domestic product, a ratio not seen since 1950, after the budget ballooned during World War II. Long-term, that continued growth, driven by our tax and spending policies, will create the most significant fiscal challenge facing our country. The widely respected Congressional Budget Office has estimated that by midcentury our debt will rise to 140 percent of G.D.P., far above that in any previous era, even in times of war.
That staggering number has been ignored by most, and certainly the Obama administration, which has been glad to take credit for a sputtering “recovery” while ignore what caused it.
Unfortunately for Obama, just last week it was revealed that none other than the chair of the Democratic Party, Donna Brazile, was “peddling fiction” when the head of the DNC admitted to John Podesta that the “people are more in despair about how things are – yes new jobs but they are low wage jobs… HOUSING is a huge issue. Most people pay half of what they make to rent.”
While the reality of the recovery was set to emerge sooner or later, the US debt continues to grow, and as of Friday hit an all-time high of 19,785,585,189,878.12, just $214 billion away from a nice, round $20 trillion, nearly doubling under President Obama, and worse: starting to accelerate again, despite the lack of any apparent economic crisis that demand a surge in debt issuance.
Back to the Volcker-Peterson lament, in which the two points out that “unfortunately, despite a brief discussion during the final presidential debate, neither candidate has put forward a convincing plan to restrain the growth of the national debt in the decades to come.
Throughout the campaign, Donald J. Trump has called for a combination of deep tax cuts that appear to far exceed proposed spending reductions, at the clear risk of substantially increasing the ratio of debt to G.D.P. Hillary Clinton has set out more balanced and detailed proposals, but they would still fail to stabilize and reduce our debt burden. Whoever wins, the new president will eventually face fiscal realities that force him or her to develop strategies for decreasing the national debt as a share of the economy over the long term.
Still, one can’t really blame the government for continuing its debt-funded spending spree – despite protests to the contrary – after all rates are so low, it would be irrational not to take advantage and add on more debt. However, it is here that the punchline from the Volcker op-ed kicks in, and explains why the Fed is stuck and will find it next to impossible to hike rates:
Our current debt may be manageable at a time of unprecedentedly low interest rates. But if we let our debt grow, and interest rates normalize, the interest burden alone would choke our budget and squeeze out other essential spending. There would be no room for the infrastructure programs and the defense rebuilding that today have wide support.
And there you have it: with debt continuing to soar, growing by the third-highest amount on record in fiscal 2016…
…all that would take for US interest expense to spiral out of control is a spike in debt servicing costs, i.e., interest. But that’s not all: US government debt is just a tiny fraction of total US liabilities and future obligations. How tiny? As the following chart from Bridgewater shows, it is less than 10% of the massive stack of US obligations that amount to well over 1,100% of GDP!
So, yes: a practical person may be forgiven for wondering just what will happen to the roughly $200 trillion in total US obligations as rates start creeping higher, especially since that “creep” is not due to actual economic growth (see the Brazile quote above and more or less every article we have written since 2009), but due to the Fed desire toonce again telegraph that it believes the US recovery has arrived (as it did in December 2015 only to admit it was dead wrong half a year later).
So what happens next? Well, in a world of rising rates and soaring debt… nothing good. Back to the Op-Ed:
It’s not just federal spending that would be squeezed. The projected rise in federal deficits would compete for funds in our capital markets and far outrun the private sector’s capacity to save, to finance industry and home purchases, and to invest abroad. Instead, we’d be dependent on foreign investors’ acquiring most of our debt — making the government dependent on the “kindness of strangers” who may not be so kind as the I.O.U.s mount up.
We can’t let that happen — not if we want an America that is able to provide growth and stability at home while maintaining global leadership. We would risk returning with a vengeance to stagflation — the ugly combination of inflation and economic stagnation that we tasted in the 1970s.
Are the any solutions? Well, according to the authors, “the solutions are clear enough” – they are just unpleasant.
A realistic approach toward the major entitlement programs is required, given that they are projected to account for all of the growth of future noninterest spending. We should make gradual adjustments to the Social Security system that still maintain present benefit levels for those at or near retirement, with particular attention to those most in need. Our health care systems can be made more efficient, with better approaches toward cost control. Since health care represents 70 percent of the growth of our major entitlement programs over the next 30 years, bending the cost curve is essential to the long-term well-being of our economy.
It’s no secret that our federal tax system is broken — unfair, inefficient and prone to political manipulation. It’s filled with exclusions, deductions, exemptions and preferential rates — so-called tax expenditures — that are ripe for reform. Those policies cost about $1.5 trillion each year and disproportionately benefit the well off. Tax reform could provide better incentives for economic growth, while raising more revenue, even as the code is simplified.
But we face an immutable fact. Fair and responsible reforms will take years to implement. And businesses and individuals will need time to adjust. Delaying action now will make the needed changes only more painful and difficult later on, while also increasing the risk of financial crisis before the reforms are even made. That is why the real debate should begin immediately.
Yet at the final presidential debate, both candidates missed the opportunity to clearly lay out their visions for a fiscally responsible, long-term future for our country. There’s still time to solve this problem. But our next president needs to show leadership in the first months.
Well yes, nothing serious was touched upon in the debate, but then again the American people no longer care about serious things. Instead, they are far more fascinated by whether Trump is a Putin spy, or if Hillary will revert to the TPP as soon as she becomes president and the next check from Malaysia clears.
As for Volcker and Peterson, they personally have nothing to worry about: “At our age, neither of us will personally suffer from a failure to act. It is those with long lives ahead — grandchildren and great-grandchildren — who deserve the benefit of prospering in a nation with sound finances. Take some advice from two observers who have been around for a while: The long term gets here before you know it.”
Sadly, nobody ever won a US election by focusing on what is truly important, and thus painful: case in point – Ron Paul. As for the broader American population, it is about to get the president it truly deserves, be it Trump or Hillary: those who routinely ignore the important, and focus on the trivial.