We have to face up to our economic reality.
If we don’t bring the budget deficit beneath the nominal growth rate of GDP (which is unlikely to go above 4% in the near future), our debt will explode during recessions; and we will ultimately face a debt crisis.
Those never end well. The choices we will have at that point will be far fewer and even more stark.
Let’s wargame our situation for a few minutes.
What if we increase taxes and cut spending?
What will happen if we increase taxes and cut spending enough to get the deficit and debt under control? Getting there will take compromises along the lines of what Clinton and Gingrich did, but I truly hope we’re capable of them. With our debt as large as it is, we are going to be in a somewhat slower-growth economy.
We need to get rid of the shackles on growth and get the incentive structure right with the proper tax mix. Then American entrepreneurs can probably get us out of the hole we’re in without it getting too much deeper.
With the amazing new technologies that are coming along, we can probably get to a point where we can in fact grow our way out of our debt problem over the next 10 to 15 years.
What happens if we don’t?
The more benign outcome is that we end up looking like Japan. We grow the debt to the point where we actually have to monetize it. Perhaps not the end of the world, but certainly not the high-growth, job-creating machine we would like our economy to be. The income and wealth divide would deepen.
And if you think there was pushback in the last election, just wait. We might see even higher taxes and a slower-growth economy. Entrepreneurs, established businesses, and investors would all just have bigger headaches.
What happens to the value of the dollar in that scenario?
Six years ago, I would have confidently told you it would go down. Now, as I observe the Japanese experience, I suspect that the dollar might rise, not fall. Or rather, it wouldn’t fall relative to the other global currencies. Nor would it fall as much as my hard-money friends seem to think. We would truly find ourselves in a world for which we have no historical analog.
We’re in a world where most major economies are also in trouble. If the country with the world’s reserve currency starts printing money merely to service its debt because people don’t buy its debt, then where are we? I’m talking about 10 years or more in the future. This would be a future in which total global debt would be in the $500 trillion range and global GDP would top $100 trillion.
Monetizing $1–$2 trillion a year might be like spitting in the ocean. Money will be far more fungible and liquid and movable in the financial-technology world that we are evolving to. It would be the height of hubris to think we can know with any degree of certainty what would happen.
Think the unthinkable
We have to think the unthinkable. Maybe the world decides it wants another reserve currency or substitutes something new. We don’t know. Lots of things are going to be possible in 10 years that we have no clue about today.
In such a scenario, the dollar could in fact lose a great deal of its purchasing power. That would create a great deal of uncertainty and volatility. And I can see a global deflationary debt scenario unfolding, followed by massive monetary creation.
I can see no scenario where we don’t deal with the deficit and the debt and enjoy a positive outcome.
So I choose to suggest what I think is the only politically possible thing to do. And that is to restructure the tax code, balance the budget with an increase in taxation, roll back as many rules and regulations as we can, hope we get the healthcare issue right—and then see what happens.