BLOG: Cliff Notes

The so-called "fiscal cliff" is in the news these days.  This "cliff" is the confluence of the budget deal recently concluded to raise the debt ceiling, and the expiration of the 12-year-old "temporary" tax changes collectively called the "Bush tax cuts".  All the rhetoric says the "cliff" is a danger to be avoided, when in fact, it is only step 1 toward avoiding a much more severe problem

I want to explain three myths about this "cliff".

First, the "cliff' will not balance the budget - not even close.  The total net fiscal effect of the "cliff" on the federal budget in 2013 is somewhere in the neighborhood of $600 Billion dollars.  This is a little over one half of the $1.1 Trilion deficit that is expected.  If we "fall off the cliff", we will still have a deficit in 2013 that is larger than the last year of George W. Bush's presidency. (see http://mendotaheights.patch.com/blog_posts/entitlements-promises-and-debt for background information.)

Second, the deficit is said to be essential because it is "stimulus".  Monetary stimulus clearly does not "fix" economies.  To quote Mike Shedlock: "If fiscal and monetary stimulus worked, Japan would not be facing its own fiscal cliff, with a debt-to-GDP ratio of 235 percent. If printing money worked, Zimbabwe would be the richest nation on earth."  Deficits are great for buying votes.  Voters get goodies, and the bills are paid "later".  Deficits are politically essential, hence politicians are desperate that they continue.  Deficits are economically dubious.

Third, the world will not end if we "fall off the cliff".  The most dire consequence claimed of the "fiscal cliff" is recession.  Recessions happen.  We will survive.

The fact is that we are already in a very, very deep debt hole - $16 Trillion.  We are currently adding another $1 trillion every year.  We don't know what will happen when this debt bubble pops.  Recessions happen when poor economic choices catch up with an economy.  Deficits and stimulus won't prevent recessions.  We are like an alcoholic on a bender, insisting on more drinks to keep the hangover away. Any sane person knows that debt cannot be racked up forever.  

When you are in a hole, the first thing to do: Stop digging. 

The question on the "cliff" is not what will happen if we "fall off".  We know that will be painful. The question is what will happen when the music stops.  What happens when the US government defaults on its debt?  I don't know what will happen when this bubble pops, but I can tell you this: the consequences will make us wish we had taken action sooner.

Our $16 Trillion federal debt, carried at historically average interest rates of about 5%, would soak up $800 billion per year in interest payments.  Our debt is growing at $1 trillion per year.  There is no question that our interest rates will return to (at least) historic levels.  The only question is when.

We know a recession will be painful, but we don't even know what will happen if we have a European-style debt crisis in the US.  That's what we are risking - a collapse of confidence in US creditworthyness.

The longer we keep the deficit game going, the more severe the consequences when the bubble pops.  Any action to correct our federal budget problems will be painful, but the longer we delay, the more painful it will be.  Let's do the right thing, take our lumps, and pay our debts, before it's too late.