In Defense of Austerity

If you had a child that was addicted to heroine, what would you do?  Would you have him go through rehab, meaning going through a painful withdrawal?  Or, would you allow him to keep taking heroine in order to avoid the intense pain of withdrawal that comes with rehab?  I suspect your answer is to have your child go through rehab because the short-term pain is worth the long-term benefit of getting off the addiction to heroine.


Yet, when it comes to economic policy, the press and politicians are universally opposed to the "inhumanity" of austerity.  How can government withdraw social benefits?  How can government reduce spending when the economy is weak?  These are the arguments, but to me its just a question of whether you want to get your child off the heroine.


The US economy is supported by government and individual spending based on debt.  The federal government runs an annual deficit of about $1.3 trillion.  It takes in about $2.4 billion in revenue but wants to spend about $3.7 billion, so it has to borrow the difference.  That same concept is evident among states and local governments, as well as individuals, in America.


But here is the problem.  Unless your child has the biology of Keith Richards, most likely the heroine with eat away at his body and kill him. Likewise, there is a point where the level of debt incurred is so high that it basically becomes mathematically impossible to manage and the economy dies.


By dies I don't mean that economy ceases to exist.  But instead, the US loses its position as the most trustworthy economy in the world.  The consequence being that the US dollar is no longer treated as the worlds reserve currency, leading to much higher interest rates and thus borrowing costs, and less foreign capital investment in the US.  Given the amount of US debt, the higher interest rates will begin to seriously consume tax revenues.  Today, interest only makes up about 7% of US government spending.  At current US government spending levels, in four years interest expense on the debt could approach 40% of spending.  And, this is why I support austerity.  I would rather take the pain in the short-term than die a premature death.


It is critical to understand that there is no magic formula.  There is no hail mary.  The US has to get off the heroine of debt, and it will be a painful process.  Anyone who tells you otherwise is lying.  Unemployment will rise.  Social services will be reduced.  But there is no choice because there is not enough money available to pay for the current level of spending.  There are policies that can be implemented to lessen the pain.  The US could go all-in to exploit its vast oil and gas resources, thus eliminating dependence on foreign oil.  This would add around $250 billion to US GDP (or almost 2%) simply through trade balances, not to mention all the employment to extract, transport and process the oil and gas.  The US could also modify its tax code to encourage companies to operate in the US.  And, the US could modify regulations, principally environmental and labor-related, in order to encourage companies further to operate in the US.  All these policies would lead to economic growth, but they would still be overwhelmed by the negative impact of a balanced budget.  If the US federal, state and local governments ran balanced budgets, GDP would decline 10% or more.  Like I said, getting off the heroine is going to be painful.


Politicians, mostly democrats and some republicans, argue that now is not the time to cut spending since the economy is weak.  But, I have a simple question?  Why is the economy weak?  It has been over three years since the economy bottomed, yet growth is anemic.  Why?  I'll tell you why.  Its because of the debt!  If you know the US has about $10 trillion in debt outstanding, runs $1.3 annual deficits and has unfunded social security, medicare and medicaid obligations in excess of $50 trillion, would you want to invest for the long-term in America?  And, Europe and Japan are in the same situation as the US, meaning over 60% of the global economy is in countries with unsustainable spending levels.  What is happening in Europe is foreshadowing what will happen in the US in the near future if the US does not change its path.


So, when politicians say now is not the time to cut spending, I say, if not now, then when?  Next year the economy will be no stronger because the core problem has not been addressed, but debt will have increased by $1.3 trillion.  The US will have just kicked the can down the road for another year, but the same pain will still be waiting, just a year later.  There is never a good time to take the pain of kicking a drug addiction, but the sooner the better if we want the US to maintain its primacy as the strongest economy in the world.