Sun Tzu, Scott Brown and the Debt Bomb

The post below is an interesting take on the Scott Brown election and the concomitant debt bomb. It was written by a virtual friend noted as “VF”. VF’s original remarks follow the dashed line, RedSt8r comments are labeled as such and any follow up comments from VF are also labeled.

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VF:         Sun Tzu, the 7th Century BC military strategist once said “When your enemy has the high ground do not attack.”  Scott Brown, the Tea Party activists and the RNC took that advice to heart. Late last year, in the dead of winter, the Brown campaign circled around the Coakley camp and made her abandon her high ground (a sense of entitlement and arrogance).  But as soon as she had pivoted, Brown moved on to skirmish elsewhere using the media to drive his message.  Coakley never regained her balance.  The Coakley team, like the army of the Chinese emperor of Chu, was defeated by a much smaller force, nimbler and smarter.  A year ago the Republicans looked much like the Confederate army after Gettysburg, defeated by losing sight of strategic goals (fiscal prudence), being distracted by tactical changes on the ground (Obama’s occupation of the center) and fighting battles that should not have been fought (defending the Bush record).  Today they look like Obama’s guerilla army of volunteers in 2008 rising up, this time, in the midst of the bluest of blue. 

RedSt8r:          The left, liberal, democrat condescension is that Coakley gave Brown a gaping opening when she left town for a vacation as opposed to Brown running a better campaign and, more importantly, having a better message. Add to those positives some RNC cash and staff and the win was a little less like a guerilla war than a Sun Tzu style defeat of a larger enemy by a smaller force.

The Republican comparison to the Confederates post Gettysburg is quite apt as is the defeat of Coakley “by a much smaller force”. I do think the Congressional Republicans had little alternative to defending Bush’s record since they were so much a part of it. Even they couldn’t pivot that far, that fast to disavow their own participation in that fiscal disaster. 

 VF:      Bush got derailed by Paulson, Geitner and Bernake.  Frankly, he blinked.  But we’ll never know for sure how the markets would have sorted it out.  I for one was terrified  that my pension would evaporate as asset values would plummet so far so fast that payments would have to be reduced or suspended to preserve capital, so I blinked, too.

 RedSt8r:          My great fear is that the independents and Tea Party activists will get swallowed by the traditional Republican morass rather than being the very much needed thorn in their side.

 VF:      The good thing is that the RNC is just providing support but where there is money there is payback, the Tea Partiers need to deliver. 

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VF:         In politics where there is victory there is always defeat.  The one politician that was defeated this past Tuesday was Obama not Coakley.  In an instant he saw his agenda collapse and what we saw on Thursday was that Obama and the Democrats will continue the “Coakley Pivot” to the populist message of ‘evil bankers’.  With the release of Glass-Steagall Lite  (T-shirts available soon) and his response to the SCOTUS decision on political speech we see him grasping at anything where he can claim victory or win populist polling points.  He is reverting to the position most recent presidents have taken, use the institutions of government to advance domestic policy and do it through regulation, the tax code and rhetoric and not much reliance on new spending programs. 

RedSt8r:          Sad to say you are spot on here. Early “leaks” (wholly intentional to test the winds I’m sure) of Obama’s State of the Union speech continue the faux populist message with budget freeze (on 17% of the budget) and “middle class” entitlement expansion. Oh joy, more rubber checks for the workers. No jobs, just rubber checks. 

VF:      That again is Obama smoke and mirrors because all that is fungible is payroll and as I said only about $100 billion is politically possible unless there is a consensus on major reform. 

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VF:         It looks like Healthcare Reform is dead and Cap and Tax Trade is on life-support (the coal states and Midwest power producing states will likely kill it) and all that is left of the Obama agenda is to put Wall Street in the stocks and supply the rotten tomatoes.  And this is a new beginning, a new era, eh?

RedSt8r:          Change and hope, hope and change, hallelujah! Dang that was short lived. The king is dead. Long live the king. But he’s got three more years to resurrect stuff or use the “regulation, the tax code and rhetoric” avenue. I don’t believe any of it is really dead unless a wooden stake is driven through the heart. We won a battle, the war rages on.

VF:      I disagree the budget realities have hit home, they have lost a strategic advantage of striking fast and hard before their enemy could awaken and counter.  Obama is trapped and permanently.  The only thing that will rescue him is economic growth.  And that is all anyone really wants.  But that is always a function, in the short run,  of a normal economic recovery. 

The problem now is that productivity is soaring and is a permanent feature of the world economy.  Where output per remaining worker continues to grow, constraining hiring in those industries where output grows but headcount falls.  Returns to labor ala a production function are increasing but money wages are constrained by unemployment. This is structural unemployment and the only way that it has changed in the past is when new industries emerge or population growth is so rapid that the economy bumps up against a capacity constraint and has to expand.  We saw it in the 1920s and we saw it again in the 1990s but in all prior periods the rebound was buoyed by demographics. 

The next wave of creative destruction will be when a new domain of technology sweeps through the economy reaching into every part of life from the household to the factory.  But it has to be doubly strong as its effects will no longer be buoyed by demographics and will actually be constrained by negative demographic trends.  New jobs that require new skills will have to multiply by the millions to absorb the unemployed as well as new entrants. 

As Ray Kurzweil has opined, “GNR” (Genetics Nanotechnology Robotics).  Genetics is about ready to begin paying dividends in the area of curing disease and increasing healthy lifespan.  Because genetics is an information technology a Moore’s Law of genetics should begin to apply as these mappings and codings escape the cost increasing nature of current healthcare.  Nanotechnology is probably about 10 years out and Robotics is about 5 years out with “just good enough” AI.  As these three technologies sweep through the economy and combine with each other and existing technologies a radical new domain will be created. 

The automobile did not truly change life until highways were built out.  Computer tech did not truly change life until the internet was built out.  The automobile had reached its end of radical influence when the last stretch of interstate highway was built and is now constrained by capacity, expensive to add.  The internet can increase capacity by simply changing optical switches, cheap to add.  In 1999 we measured speed at the gigabit level now it is terabit and we’re headed to petabit and higher.   The interconnectedness of the world will only enable these new technologies to spread faster and deeper.

In technological evolution a new technology usually leverages and is built from existing technologies. AI and Robotics is probably where we’ll see the deepest personal effects as they will augment our abilities and move education as an expensive investment over many years to an inexpensive continuous process.  But the true unfolding of the other technologies of genetics and nanotechnology will leverage these innovations and expand them further.  Nanotech and Genetics will penetrate the economy at every level as we will manipulate nature from energy harvesting to materials science. 

The physical world will be built up by the virtual world in design and simulation and direction of building and in some cases the two will be indistinguishable. But our understanding of it will only be enabled by the prior AI and robotics revolutions.  We only grasped the meaning of the automobile because we had the analog of the railroad and horse driven coach.  Early references to automobiles were to horseless carriages and Fisher body works had its roots in making horse carriages. In fact its symbol was an early carriage largely indistinguishable from a horse driven carriage. We only understood the internet because we accessed it through a familiar technology, the computer.  We will only understand these new technologies because we are familiar with their building blocks or conceptual foundations.

But what does this have to do with Obama and the Democrats and Scott Brown’s victory?  It is interesting to note that Obama’s attention has been in preserving failing or mature industries with large union representation and in expanding entitlements that belong to a world dominated by a labor force with little or no bargaining power.  This is a static vision of the world where domestic industries have to be defended and the government has to intervene to extract a living wage and other benefits for a labor force pressured by a reserve army of the unemployed.  Though some elements of this vision appear to rest on solid ground today that ground shifts with every innovation, every change in technology. 

The base of support of the Democrats has ironically fallen to the educated class of college graduates away from the traditional rank and file working stiff.  It is fitting because it is that class that has the most to lose when the ground shifts.  As advanced skills and deep knowledge are easier to acquire and certify and vet the advantages of money and position will diminish.  Those who already have skills will be under pressure as competition increases.  With barriers to entry falling the professional class will no longer have that exclusive position.  Their alignment with Obama with his policies of preserving the status quo and increasing the distribution of a fixed pie to constituencies that seem to be moving away from him is a curious on the ground development.  It is as if those who have the most to gain from technological innovation are moving away from Obama and those who have the most to lose are supporting him.  If this is indeed the case then the Republicans have a chance to seize the future and be the party of innovation and change. 

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VF:         Obama is now an institutionalist out of necessity not an ideologue by choice.  He is trapped (Bush was too, as was Clinton to a lesser degree) by a government budget that is on autopilot. More than 85% of the fiscal 2010 3.6 trillion dollar budget is comprised of payments to individuals including government employees and defense spending. The remainder, this year, is some remaining stimulus spending ($85 billion) and unemployment insurance payments to the states, some $135 billion is allocated to net interest payments the remaining $346 billion will be spent on the cabinet departments from Agriculture to State.   Again, this is mostly autopilot spending leaving perhaps $100 billion that could be cut without political consequences but you have to track that down in every agency, in every city and town in America to do it.  This leaves little for policymakers to do all they can really do is tinker with the tax code (Bush did it and so did Clinton) and regulate (and they did that really well).  So, what’s a politician to do or a former community organizer for that matter?  Surrender to the budget and go to Hawaii, frequently, and don’t forget to take off your shirt and walk on the beach.

RedSt8r:          Would that he were trapped by the budget. Apparently he doesn’t believe in budgets as I’ve recently seen estimates of 9-12 TRILLION in new deficits/debt in the next 10 years based on current administration plans. It remains to be seen if he’s trapped or just circling the bait. I’ll buy him a mojito if he does retire to the beach.

VF:      Remember that there is a difference between gross federal debt and the privately held public debt.  Debt service payments on the privately held public debt affect the budget and payments on the intragovernmental debt to the trust funds does not. 

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VF:         But why did Obama’s agenda unravel so quickly?  It unraveled partly because of overreach and arrogance of purpose and partly because America is a center right country whose citizens are skeptical of government.  Put these two things together with entrenched interests at the public trough, job losses and foreclosures and the apparent government spending of trillions of dollars with little observable impact you have the Tea Party movement and Scott Brown toppling a political dynasty.

 RedSt8r:          A fascinating aspect is gleaned from the center left/left wing economic blog comments that actually complain Obama is governing from the center right and that’s why Brown won and Obama is failing. Huh? The left is congenitally unable to accept the reality of a center right country. They consistently believe we’re too stupid, their message was unclear and if they just double down on the program budget it will make it right with the world.

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VF:         In just 12 months in office this administration has increased the privately held public debt by almost 3 trillion dollars.  The shortfall in tax receipts was about 14.5% of the prior year’s budget but spending increased by over 40% over the prior year and relative to receipts it increased by over 50%.  (Most of this spending can be classified as countercyclical and the deficits resulting are cyclical deficits not structural)  The spending increase was driven in part by a jump in unemployment insurance claims, the $700 billion dollar stimulus, the auto bailouts, the continuing financial sector bailouts and other spending increases in Medicaid, Food Stamps and other automatic stabilizers that kick-in in a recession. 

This fiscal year spending will decline by $500 billion from 2009 and remain stable through 2011 but by 2014 something interesting occurs, the net interest payments on the outstanding privately held public debt soars in fact it increases by 240% over fiscal 2010 by 2014.  This is partly a result of the assumptions in the budget projections about interest rates and the unwinding of the Fed’s balance sheet but it grows so much so fast that the economy cannot grow fast enough to keep up.  It will be the signature achievement of the Obama administration, a structural deficit driven by debt service obligations.  If current politicians are hamstrung by the autopilot budget just wait, we’ve got something better for the next crop, a debt bomb.  If the deficit continues to hover around $500 billion a year that debt service obligation will continue to grow at about 20 billion dollars a year.  Barring higher interest rates, this is manageable but our recent experience has been that the privately held public debt is doubling every 6 to 8 years so, by 2022 debt service obligations will be closing in on 900 billion dollars per year which would indicate perhaps a much higher structural deficit over those years than $500 billion, try $1.5 to $2 trillion, now that’s a deficit.

RedSt8r:          Few reasonable folks will complain about the extended unemployment benefits, some more will complain about the growth in Medicaid, food stamps and such. But those areas were actually quite minimal relatively speaking. It’s the humongous rest of the spending that has “us” in such an uproar. Your review is both accurate and frightening. A quick and simple calculation assumes the total public debt (that is, Federal only!) at $24 Trillion (current $14T + $10T from Obama) with 10 year Tnote rates at 6% will cost $1.44 Trillion a year just in interest payments. And for what? Banker bonuses? Goldman Sachs? Handouts to State and local governments?

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VF:         The only solutions to a structural deficit are budget cuts or tax hikes or some combination of both the solution is never more spending.  But the problem here is that the autopilot budget continues to grow largely driven by demographics.  Sometime around 2020 our existing entitlement system will need to be partially financed through general revenues rather than solely through payroll taxes as is currently the case.  The focus then needs to be slowing the growth rate of entitlement spending.  Obama’s healthcare reform was meant to “bend the curve” on health expenditures but what finally emerged out of the Senate was a compromise that would ironically increase costs not reduce them.  It is fortunate that this bill died in the House.

RedSt8r:          Yes, we are all fortunate that the Brown election win has – so far – stopped the healthcare reform masquerade. I don’t yet see the wooden stake but I’m hopeful. Still, there is one other solution to a structural deficit owing to debt service payments. A national debt default. Not pretty but Argentina did it twice and they can still borrow. Well, after they settle their little argument with the President of their Central Bank. Details, details.

VF:      A default would reduce our credit rating and raise the premium on future borrowing so that is unlikely. It would also spark inflation as the dollar falls and import prices soar.  A reduction in our sovereign credit rating is around the corner anyway when an increasing share of receipts will be used to pay Medicare and Social Security beneficiaries.

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VF:         The director of CBO, Doug Elmendorf said in a speech last year, “The country faces a fundamental disconnect between the services people expect the government to provide, particularly in the form of benefits for older Americans, and the tax revenues that people are willing to send to the government to finance those services. The fundamental disconnect will have to be addressed in some way if the budget is to be placed on a sustainable course.”  I think that pretty fairly sums up our situation.  There are very difficult choices ahead and we need politicians who can make those choices .

RedSt8r:        Elmendorf has earned some respect for his work although it would be a lot more if he identified the flaws of the work he was asked to do. Scoring a healthcare bill as deficit neutral (or positive) by counting 5 years of expenses and 10 years of revenue is hardly reasonable.

VF:      Elmendorf did caveat on language that could be read to say if you really believe these budget fictions. In their scoring of the senate bill on their blog they stated:

” These longer-term calculations assume that the provisions are enacted and remain unchanged throughout the next two decades, which is often not the case for major legislation. For example, the sustainable growth rate (SGR) mechanism governing Medicare’s payments to physicians has frequently been modified (either through legislation or administrative action) to avoid reductions in those payments, and legislation to do so again is currently under consideration in the Congress. The legislation would put into effect a number of procedures that might be difficult to maintain over a long period of time. Although it would increase payment rates for physicians’ services for 2010 relative to those in effect for 2009, those rates would be reduced by about 23 percent for 2011 and then remain at current-law levels (that is, as specified under the SGR) for subsequent years. At the same time, the legislation includes a number of provisions that would constrain payment rates for other providers of Medicare services. In particular, increases in payment rates for many providers would be held below the rate of inflation (in expectation of ongoing productivity improvements in the delivery of health care). The projected longer-term savings for the legislation also assume that the Independent Medicare Advisory Board that would be established by the bill is fairly effective in reducing costs—beyond the reductions that would be achieved by other aspects of the bill—to meet the targets specified in the legislation.

“Based on the extrapolation described above, CBO expects that Medicare spending under the bill would increase at an average annual rate of roughly 6 percent during the next two decades—well below the roughly 8 percent annual growth rate of the past two decades (excluding the effect of establishing the Medicare prescription drug benefit). Adjusting for inflation, Medicare spending per beneficiary under the bill would increase at an average annual rate of roughly 2 percent during the next two decades—much less than the roughly 4 percent annual growth rate of the past two decades. Whether such a reduction in the growth rate could be achieved through greater efficiencies in the delivery of health care or would reduce access to care or diminish the quality of care is unclear.”

VF:      Basically saying that the uncertainties and political realities will be cost increasing and that the bill is based on a political view where everyone can just hold hands and sing camp songs.

RedSt8r:          But I disagree with him on the “fundamental disconnect”. The fundamental disconnect is between politicians who promise expansive benefits with little cost (and usually to someone else) and a public that never gets told the true and full cost to each of them over the long term. A secondary disconnect occurs to those who become enmeshed in the “benefits for older Americans” after having paid in to a system all their working lives and who now find themselves facing restrictions and limitations. They paid what they were told and now expect to get what they were promised. There is a complete lack of understanding how SSA, Medicare, et.al. were (are) just giant Ponzi schemes that would make Bernie Madoff blush with embarrassment.

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