From: pjm@anegada.sps.mot.com (Patrick J. McGuinness)
Subject: Re: What happens when USA goes bust?
Organization: SSDT SPS, Motorola Inc., Austin TX
Date: Sat, 17 Oct 1992 01:09:52 GMT

(Peter Nelson) writes:
>(Patrick J. McGuinness) writes:
>>(Peter Nelson) writes:
>>>  However if you reduce government spending by 20% then you're 
>>>  looking at a $280 billion reduction during that time.  This
>>>  is about 7 million jobs (not counting multipliers).  Even if
>>>  these are distributed over 5 years, how will the economy be
>>>  able to absorb them plus normal growth in the workforce and
>>>  grow at all?   Your numbers just don't add up.
>>
>>The problem I see is that we have a different model here.
>>If Government spending is reduced, it reduces the demand for
>>new borrowing. This in turn allows for lower interest rates
>>and funds for more private sector borrowing.
>
> But you, yourself, said that data from the 1980's does not suggest
> that the deficit drove up interest rates much. 

Hmmm. Did I say that? Interest rates *were* high, in real terms
during the 80's, thanks in part to strong investment demand.
However, they were falling (nominally) throughout the 80's as
we got inflation under control.
What I think I said was that deficits didn't necessarily cause
growth or inflation.  The 80's proved false the notion that deficits
inevitably lead to inflation is false.

I will agree that with global capital markets, you are in a global market
for funds, and so a deficit can be financed world-wide. Right now,
though, both germany and Japan cannot play the traditional capital
exporters, so I think there is a crowding out right now that maybe
wasn't there a few years ago.

How do we know? There was a startling statistic that recently surfaced.
About half of bank lending today is going into *U.S. Treasury notes
and bonds*. (I'm sure Ross would love this if he heard it.) Apparently
what is happening is that the bank regulations are such that
having these on the books looks much better than "shaky" loans to
businesses and persons. So they are loading up on this stuff and
ignoring the private sector.

Now look at the latest Forbes index "Consumer Installment Credit".
It has *fallen* over the last year, and continues to fall. People
are shedding debt ... or nobody's lending to them, depending on how
you look at it.

>Moreover the total
> failure of monetary policy -- how many (13?, 15?, 15?) straight 
> Fed cuts -- to stimulate the economy has convinced most economists
> that lower interest rates are not the solution.

Not when they are *contracting* credit through tighter banking regulation.
See above, and also note that they are tightening in 90 days or so. Ouch.
If they eased on bank capital requirements, we would have a
completely different story today.
Also, you are also buying the Clinton/media story that this economy
is flat on its back. It ain't. Despite the above nastiness in banking -
and yes it is a big factor in our slow-growth - we are growing faster
than most of the other G-7 countries right now. Right?
Job growth is bad ... but productivity is doing well.
We have some growth, and we might have more if they weren't clamping
down on bank capital requirements.

> And it's true that 
> today we have the lowest interest rates in 25-30 years DESPITE a 
> massive budget deficit, so clearly this is not the issue.

But you are talking short-term interest rates.
*Long* term rates are stuck up near 8% - suggesting the
belief that we can't continue with 1-2% inflation like we have now.
There's two ways to look at it. Investors are demanding
high real interest rates (6%), or they expect inflation to average
up in coming years.  I believe the reality of the deficit is a
factor in both these calculations.

>>So even with spending reductions, we could get 3% growth.
>
> *Again*, I'd like to see the numbers.

(sigh) here are some numbers:

>year  GNP    PPI    CPI    receipts     outlays        deficit  
>====  ====   ===    ===    ===========  ============   =========

>1981  2986  1.041  1.098    599 (20.1)    678 (22.7)    79 (2.6)
>1982  3130  1.000  1.035    618 (19.7)    745 (23.8)   127 (4.1)
>1983  3325  0.984  1.003    601 (18.1)    808 (24.3)   207 (6.2)
>1984  3688  0.964  0.961    666 (18.1)    852 (23.1)   185 (5.0)
>1985  3958  0.955  0.928    734 (18.5)    946 (23.9)   212 (5.4)
>1986  4177  0.969  0.913    769 (18.4)    990 (23.7)   221 (5.3)
>1987  4442  0.949  0.880    854 (19.2)   1004 (22.6)   150 (3.4)
>1988  4771  0.935  0.869    909 (19.1)   1064 (22.3)   155 (3.2)
>1989  5121  ????   0.828    976 (19.1)   1137 (22.2)   161 (3.1)
(recent years in million $s))
	revenues  spending  deficit
1990  1,031,612  1,252,000 248.6
1991  1,094,000  1,363,000 267.7
1992  1,062,000  1,462,000 299.7

Note that in nominal terms, taxes went up by 1/3 from 1982 to 1988.
The 1987 tax receipts were $752 billion in constant 1982 dollars.
The 1988 tax receipts were $781 billion in constant 1982 dollars.
This is a 22% increase in 5 years, '82 to '87, and a 26% real increase in 6 years.
Large GNP increase, large tax revenue increase. Without a tax increase.
(But with a tax cut no less!)

Now .... do the same in the 1990s as we did in the 1980s, only
don't increase Government spending, cut it each year. I am assuming
we will cut $50 billion each year in real terms (the numbers are all in
"real" dollars). This corresponds to a 3.3% decrease per year. 


	taxes     spending	deficit
1993  1,160,000  1,500,000 	340,000
1994  1,190,000  1,450,000	260,000
1995  1,230,000  1,400,000	170,000
1996  1,270,000  1,350,000	 80,000

Taxes assume 3% growth, no tax hikes.
We are left in 1996 with a very managable $80 billion dollar deficit.
We can allow 2 more years to end the deficit through revenue growth:
1997  1,308,000  1,350,000
1998  1,347,000  1,350,000

I assume a 16% revenue growth over 5 years, much less than what we achieved
in the 1982 to 1987 time frame. Considering that we are coming out of
recession/slow growth, and with low inflation, I think this is conservative.

>>Because you suggested that the *only* way to reduce the deficit was
>>via 10% unemployment. This is not true. We can do it
>>another way: Gradually grow out of the deficit by cutting
>>(or at least restraining) spending and engaging in pro-growth
>>policies to increase tax revenues (not tax increases). 
>
>  *AGAIN* let's see the numbers!

I gave you the outline before. Now (above) I gave you
the whole speil.  I'm assuming we'd have 4% growth otherwise,
but the 3% budget cut corresponds to a little under 1% of GNP,
so *even under your model*, this would knock out 1% of that gowth,
and we'd have the right growth rate - 3%.
Since the new job entrants is not going to be high for the next
few years, even moderate job growth rate will keep the
unemployment rate down, well below 10%.  It CAN be done.

>  The problem, as I mentioned,
>  with a slow approach is that the national debt continues to grow 
>  at an alarming rate which forces an ever greater portion of tax
>  money to be applied to debt financing, which further constrains
>  our ability to make cuts -- i.e., an ever smaller % of the budget
>  is available to be cut, so the cuts have to be even deeper.

>>1. Don Gibson in e-mail pointed out that a significant chunk of
>>the deficit is temporary - recession and S&L related funding.
>
>  I STRONGLY doubt that recession funding is "temporary" -- as
>  I said, I anticipate double-digit unemployment this decade.

Based on your mistaken impression of what is needed to fix the deficit.
This is degenerating to arguing in circles ....
	Growth and deficit reduction are tied in together.
You say we can't have both. I am saying, if you want one, you *need*
the other.
Now, if you are saying we are going to implement every work rule
in the AFL-CIO/Democrat wish list, then, yes, maybe unemployment
will rise.

>  Nor is it clear that the S&L bailout is -- an article earlier
>  this week in (I think) the Wall Street Journal pointed out how
>  house prices in California are plummeting along with their
>  declining economy and how this will likely trigger a new round
>  of bank failures.  It added that California's economy is so big
>  (if it were a country it would have the 13th largest economy 
>  in the world) that this will ripple through the whole economy.

>>2. If the Fed Reserve is serious about tying the dollar to a basket
>>of commodities,
>
>   This would require international cooperation -- again an optimistic
>   assumption given the recent failures of GATT and EMR.

False!!! Read Lawrence Kudlow in today's WSJ. We *already* have been
on a gold standard of sorts for about 5 years, since the 1987 crash.
Gold has stayed in the $330 -$370 /oz range. There is *no* need
for any ERM or other nonsense - just follow the commodities prices to
prevent inflation or deflation. No other country need get involved.

>> as seems to be the case, we can look into gold-backed bonds for part
>> of the Government debt. This will help lower interest rate costs.
>
>   It's not clear that it would have any effect on interest rates, 
>   but again, very few major economists any longer think that
>   interest rates are an issue.

It is an issue in lowering the cost of servicing our debt. If we
recude the cost of servicing our debt by replacing 8% interest bonds
with 4% interest bond, voila, we have saved mega-bucks.

If we are serious about keeping inflation down (and we should be),
we shouldn't be paying an inflation premium to investors.
Gold bonds are a way of avoiding paying that premium.
The danger? We can't inflate our currency or we'd be hurting ourselves.

Pat
	Bill Clinton: The Status-Quo candidate