Fiscal Inferno (Part I)

Note: After working on this for a couple hours, I have come to the conclusion that this is too large of an undertaking for one discussion. Hence, I will be dividing it into 2 parts.

While I had meant to work on the aforementioned recap of The Origin of Wealth, I was unexpectedly sidetracked by Bill Clinton and the national debt. As I realize that might sound a little strange, I will explain. Over the past year, I have found myself on the opposite end of a number of discussions whereby certain individuals have made the claim that Bill Clinton was a great president and might even rank as one of the greatest presidents. Now, I should confess that through most of Clinton’s presidency I was a card-carrying member of the Young Republicans and thus never liked the guy. Actually, come to think of it they never did issue us cards, but “card-carrying member” sounds so much more official than just “member”. But I digress. Anyway, as I started to craft a counter-argument I found that all I could seemingly remember about him was the Lewinsky scandal that dominated the last 2 years of his presidency. I knew that I had legitimate reasons for not liking him at one time, so I decided I would re-apprise myself of the specifics. I did not want to read his autobiography 1) because I really didn’t care much about his life before the presidency and 2) I certainly wasn’t looking for a Clinton love fest. On the other hand, I didn’t want to pick up something written by a right wing extremist with an ax to grind who filled the pages with half-truths and unsupported accusations. I ended up settling on The Survivor because it was written by respected Washington Post journalist John F. Harris and carries an endorsement from both liberal historian Arthur Schlesinger Jr. and conservative Fox News correspondent Brit Hume. I am actually not quite finished with the book yet, and all I will say for the moment about how my prior opinions of Clinton stacked up against the realities in retrospect is that, predictably, it is a mixed bag. Some of the things I despised about him are still clearly evident, while on some other things he looks better than what I initially gave him credit for. But that is a debate for another time. I bring it up now only because as I was reading there is extensive talk on how one of the main foundations Clinton ran his 92 campaign on was that he was a “New Democrat” and strongly supported a balanced budget and a reduction to the national debt. Further along in the book, Newt Gingrich enters the picture with the famous “Contract with America” and he and the 94 Republicans also campaigned on a platform of fiscal responsibility and successfully orchestrated one of the greatest Congressional swings in history in the 94 election. Finally, I also recalled that somewhere around 96-97 we had supposedly balanced the budget. And then . . .nothing. Either we had solved the problem (unlikely), or people stopped caring (more likely), or talk of fiscal responsibility just wasn’t resonating with the voters anymore (quite probable). Sure, I have heard politicians and pundits make reference to the deficit and discuss it from time to time, but it just seems that neither party has maintained it as part of their core platform.

As a matter of practicality, I can see how this happened. Beginning around 1996, the dot com boom started to take off and it seemed like everyone couldn’t help but make money. It was pretty hard for the next 4 years for anyone to be taken seriously with a doom and gloom approach to fiscal matters when the economy was roaring and the Dow was setting records on an almost daily basis. Plus, with all the money everyone was making (including businesses as well as consumers), the government tax revenues were also higher then ever. I remember reading about how Congress had supposedly “balanced the budget” in 1996. Democrats and Republicans had been at a stand-still over the next budget. The Republicans want to keep taxes low but that would mean the Democrats having to cut some additional programs. Then a new report showed that the economy was growing faster than expected and there would be more tax revenue which would allow the taxes to remain where they were and still provide enough money for the programs the Democrats wanted. I don’t know why, but this just struck me as funny. In the end, neither side compromised; they just found more money. That let them both able to claim victory and announce that they had succeeded in balancing the budget. The old axiom of “give and take” in politics no longer seemed to apply; it had been replaced by “find and keep”.

In any case, the dot com boom busted in 2000 and I do believe we would have heard a lot more talk in the 2002 elections about a return to fiscal responsibility. But of course, before we got there 9/11 happened and suddenly fiscal matters were not at the forefront of anyone’s mind. Fast forward a couple of years and now the only time you hear about the deficit is in reference to “how much the war has cost us.” In other words, the deficit is being used to draw negative attention to the war, not the other way around. So, since not a lot of people seem to be talking about the debt as an issue unto itself, I will.

The issue of the national debt really resonates with me because it is one of the main issues that first got me involved in two of the areas I am most interested in today: politics and economics. Back in 1996, when talk of a Balanced Budget amendment to the constitution was still being bandied about, I was interning for a State Representative and had just become a Young Republican (I even read Newt Gingrich’s book To Renew America). At the same time, I was taking my first class in Economics and was finding it fascinating. The idea of a fiscally responsible small government that was for free markets, staying out of people’s lives, and generally believed that “the best government is the one who governs least” really appealed to me (as an aside; when I think back on this I find myself asking, to paraphrase Michael Moore’s paraphrasing of a great film, “Dude, Where’s My Party?”). It also seemed to me that traditional economic theory supported this line of thinking as well: the government’s place was to make sure markets worked as efficiently as possible. This meant that its prime focus should be to keep the citizens safe from enemies both foreign and domestic so that they would be free to do what they do best: be consumers.

I will begin my discussion of the specifics of the debt with the basics. If you already know them, skip ahead.

So what the hell is the national debt? Obviously, it is money that the government owes. Who does it owe it to? In a word, everyone. About 40% the government owes to itself (that is, one part of the government owes it to another part). The remaining 60% is privately held. For the private portion, the government’s typical choice of debt instrument is the Treasury Bill (for short-term debt) and government bonds (for long-term debt). Each is simply a promise to pay back the face value of the bond at a specified date in the future in addition to periodic interest payments. Hence, every time the government issues a T-Bill or bond it is increasing its debt, and every time it pays one off at maturity it is reducing the debt. Bonds and T-Bills are sold to businesses, individuals, and other governments all over the world. There are also probably as many other ways the government can get itself into debt as there are days in the year, but this rudimentary understanding of it will serve for our purposes.

So why is the debt bad? Well, let’s just say that the above represents the beginnings of my education on the subject from a theoretical perspective. My real understanding of debt in practice came from my own personal experience during college. College is a wonderful place because of the freedom young adults are afforded for the first time in their lives. In addition to the freedom to drink yourself stupid and arbitrarily decide your classes have been cancelled for the rest of the week, for me this also included the freedom to rack up a sizeable amount of credit card debt. I remember one particular stroke of less-than-genius which hit me about 6 months before I was to graduate. I was about $6000 in debt but was completely flat broke. As I contemplated accepting another credit card with a $2000 limit, the little angel appeared on my shoulder and said, “John, if you get that card and max it out you’re going to be $8000 in debt. You don’t have $8000.” But then the devil appeared on my other shoulder and said, “John, you’re already $6000 in debt and you don’t have that, so what difference does it make?” I called and authorized the card the next day and had it maxed out before I graduated. Now what I want to highlight here is not my awesome irresponsibility (though I admit that is fully on display) but how easy it is to simply take on more debt once you have made the decision to become a debtor. Most people, if given the choice, would prefer not to be in debt. Further, for those not presently in debt the idea of it is as unpleasant a prospect as having a root canal. But once you are in debt and are managing it, it suddenly doesn’t seem so bad to take on more. If you have no debt and you are thinking about spending $800 on a new tv and $1200 on a weekend in Vegas but you don’t currently any disposable income, you will likely bristle at the thought of racking up $2000 in credit card debt and paying $100 per month for the next 24-30 months (depending on your APR). However, if the debt you currently have already is forcing you to make payments totaling $400 per month for the next 2-3 years, is it that much worse to be making an extra $100 in payments per month if it gets you the things you really want today? Basically, it’s all about relativity. The jump from $0-$100 a month is huge, while the jump from $400-$500 doesn’t seem as large. So I believe it goes with the government. While the debt was small, I believe we had a careful eye towards keeping it down. However, once the debt started to rise and the country didn’t collapse, it suddenly didn’t seem like such a bad idea to keep adding on to it, especially if it got us what we wanted today (in the form of tax cuts and new programs instead of tvs and vacations). So what’s the problem? Well, actually, for the individual as long as they continue to progress in their career and increase their earning power year over year, there is no problem. If you always make your monthly payments and continue to make enough money so that your debt-to-income ratio stays below certain key thresholds, banks and credit card companies will continue to offer you more and more money. Your raw debt is going up but at the same time your ability to pay the debt is going up too, so everything is all good, right? Yep; till the day comes when the economy tanks and you get laid off and only make a fraction of what you used to at your old job. Or if you decide you want to change professions but the industry you want to go into doesn’t pay as well. Or if your wife is pregnant and ends up having triplets instead of the one you were expecting and the rest of your expenses go far higher than you forecasted. You get the idea. And if suddenly you stop being able to make your minimum payments you are in for some pain. And I’m not talking mild discomfort. I’m talking prison-style abuse. If you have ever heard an investment banker or retirement specialist speak, they often talk about the “miracle of interest”. It means that as interest adds on to your principle savings, the interest rate for the next period will now apply to the new, larger amount and compound it. The result is slow growth at first and then progressively it spirals into bigger and bigger growth till you end up with over $1,000,000 in your 401(k) by age 60 (hopefully). Unfortunately, the spiral also works the other way too, and if your debt is at a sufficiently high enough amount when you start defaulting, there will be no slow growth period as with the start of a retirement account. It can get very obscene very quickly.

I am not arguing that debt is inherently bad. On the contrary, I think credit is a wonderful thing. But it’s like alcohol. When used responsibly, it can become a wonderful enabler and allow you to do things you couldn’t do otherwise (like dance on tables and throw flaming couches off balconies). However, when used irresponsibly, it can literally ruin lives.

So with all of that framework in place, in Part II I am going to go into the details of where the current debt situation in this country stands and what I think it might mean for us over the next 10 years and beyond. Has the US government been a positive financial role model and set us on a path towards fiscal stability? Here’s a hint: No.