Neal Freeland

Over the holidays my mother-in-law shared a story about the “takers” who are ruining our country. She’d heard about a young Hispanic woman in her Oregon town who had just finished high school. The young woman didn’t have a job but had learned that the government supports single mothers, so she decided to have a baby and collect the free money. It’s a neat little story that confirms how many conservatives view the world, but it is mostly false. Our country is not facing ruin due to young, lightly educated, minority, poor, and single moms. The real takers who pose a threat to our nation’s finances actually belong to the most cherished group in our society: it is our grandmothers who are ruining the republic.

To start, let me dispel the taker myth, yet also describe why there’s a bit of truth in this story. We spend $466 billion a year, or 13% of the federal budget, on safety net programs like food stamps, school lunches, and child-care assistance (source). These programs support 45 million people, and keep 25 million out of poverty. Despite the assistance, this is not an easy way to live. Cory Booker, a classmate from Stanford and the mayor of Newark, NJ, recently challenged a twitter follower to spend a week living on food stamps. He said he struggled with hunger. My family spent a year in the 70s on food stamps, and even though I was very young I vividly remember the stress my parents were under. Anyone who thinks they should have a baby to get free government money is in for a very hard life living in or near poverty. That said, government assistance makes it possible to survive this way, and so therefore does encourage foolish behavior. Though the intention of safety net spending is good and noble, the law of unintended consequences fosters dependency on government hand outs. Conservatives are right to want to keep this spending at meager levels to encourage self-sufficiency and hard work.

Ok, if it isn’t safety net spending that is ruining our government finances, what is it? Let me be a little more precise about the timing of the fiscal threat we are facing.

Source: Concord Coalition, using OMB Historical Tables 2011 and GAO Analysis Fall 2011

While it is bad that today we have a nearly $1 trillion deficit, it is actually projected to fall over the next two years as the economy improves, tax revenues increase, and unemployment spending falls. The real threat, as the chart above shows, is that our deficits and debt are projected to start exploding in just a few more years from now. President Obama has called it “The most predictable financial crisis in history.”

Retirees are driving this explosion of deficit spending and debt. Today we already spend over $1 trillion or 40% of the federal budget on Medicare and Social Security (source). The retirement of baby boomers will cause the population over 65 to double from 40 million to 81 million over the next 30 years (source). Spending on the old is mandatory, meaning Congress doesn’t need to do anything for it to just automatically happen. This will cause the debt to rise to levels never before seen in our history, higher even then it was during the second world war. Back in the 40s we took on huge debt to fight evil fascists dictators who murdered millions in gas chambers. The payoff was that we created a free, mostly democratic, and prosperous world order that allowed us to pay off the majority of this debt over the following 25 years. Today, in contrast, we are borrowing huge sums of money so that the boomers can retire to golf courses and write angry letters to their congressional representatives warning them to leave spending on old people alone. When the retirees die there will be no payoff: we’ll just have all that debt.

This is the fundamental challenge behind all the financial wrangling our politicians have been struggling with over the last couple of years. There is just no way that we can fund all the promises that have been made to retirees. We can’t raise enough money through taxes, and even if we cut everything else in the federal budget it still wouldn’t be enough. We definitely need to look to those options, but we must, must, must reduce mandatory entitlement spending on people over 65.

Unfortunately, we’re not having anything close to that conversation. In the fiscal cliff negotiations last fall, President Obama wanted$1.6 trillion in tax increases over the next 10 years. During his campaign he said he’d seek $2 in entitlement cuts for every $1 in tax increases, which was also the recommendation of the bi-partisan Simpson-Bowles committee he commissioned in 2010. So he should have suggested $3.2 trillion in entitlement cuts to go with those $1.6 trillion in tax increases. Instead, he offered a mere $0.4 trillion, or just 12% of the needed number. The House Republicans understandably called this laughable, yet still offered $0.8 trillion in tax increases while demanding more entitlement cuts. At one point Obama wrote up a list of possible cuts and showed it to Senate Majority Leader Harry Reid (Democrat), who took the list and threw it into the fireplace of the White House. No cuts on his watch. The outcome of this negotiation: the President asked for $1.6 trillion in tax increases, the Republicans offered $0.8 trillion, and they settled on $0.6 trillion (with no spending cuts). Only in Washington can that be called victory.

The frustrating thing is that there are some good solutions to this challenge if we act now. For example, we should raise the retirement age from 65 to 70, and raise it gradually over the next 10-15 years. When Social Security was started life expectancy was 62: most people were dead before they collected anything. But today people are healthier and live longer. We therefore need to also work longer before we retire, which would create enormous relief to the federal budget (play with a retirement calculator to see for yourself). If we give ourselves enough time to plan we can all adjust to this kind of change, especially those of us under 50.

But this discussion isn’t happening. In his inaugural address President Obama sure sounded like he doesn’t plan to touch mandatory entitlement spending. The result is that we are starting to dig into discretionary spending, which Congress needs to decide to fund each year. Almost everything that is an actual investment (spend $1 today, get $2 back over 10 years) like education, transport infrastructure, and research is discretionary, and it is starting to be crowded out by mandatory spending on retirees (borrow $1 today, make your grandchildren pay $2 with interest over 20 years).

Most dangerously, the military budget is also under pressure. The primary purpose of government is to protect the nation, yet we are shrinking the budget to $486 billion and more cuts loom (source). It’s easy to foolishly convince ourselves it’s ok to do this. We take an outcome of our military spending – a safe and peaceful world with a rules-based economic system – and use that to justify cutting our military spending – hey, the world is safe, we don’t need to spend that much. We’ve already cut $250 billion from defense spending over last two years, and the upcoming sequester threatens to take another $50 billion a year. If we keep going we’ll soon be spending as little on defense as Europe, which allocates a mere 2% of GDP (versus 3% the US currently spends), and gets a pitifully useless force as a result. They can’t even cross the tiny Mediterranean Sea to hit a brutal dictator in Libya without having their hand held by intelligence and logistical support from the US. In other words, without continued US investment in the military there will be no one to defend the global world order, even against an incompetent and inconsequential adversary like Libya. Every democratic military will soon be paper tigers, our forces stuck in barracks and in port, unable to actually do anything useful.

Ironically, this reduction in defense spending is happening exactly at the time when a new actor is emerging on the world stage. China is investing heavily in its military and working hard to develop the capabilities to challenge the US. It is also a communist nation whose leaders lack legitimacy from elections. They therefore stoke nationalism to focus attention towards external “enemies.” Citing an an invented maritime history, they claim sovereignty over five tiny uninhabited rocks off Japan. Just last week a Chinese frigate locked its fire control radar on a Japanese destroyer, which is like pointing a gun at someone’s head and cocking the trigger. It’s a very aggressive move, and any real conflict would definitely pull the US in to aid its ally Japan. Sound crazy? The first world war started when a minor regional dispute in Serbia spun rapidly out of control, eventually consuming the lives of millions across the world. Don’t get me wrong, this is a worst case scenario and I don’t expect it to happen. But it could.

I’m not worried so much about today as I am about 15 years from now. I have this image in my head of a possible future for my son, who just turned nine and has been learning Japanese at our local public school. I see him as a 24 year old Ensign assigned to USS McCampbell (DDG-85), a destroyer based in Yokosuka, Japan. The crew has been starved of fuel and rounds for training, and a lack of spare parts has reduced the readiness of several engineering systems. He is standing watch as the ship steams towards the South China Sea, an area rife with unresolved territorial claims and a well-equipped rival navy. The text he sends me is haunting: Dad, how did it get this bad? I want to tell him the truth: Sorry son, grandma ruined the republic. But I can’t do that. He, like all of us, loves his grandma.

USS McCampbell (DDG-85), home port Yokosuka, Japan

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Last week at my monthly poker game some of my friends who have read my posts teased me in a friendly way that I sound like an angry old man, yelling at kids to “get off my lawn.” I actually fear I may be like Cassandra, who warned against bringing the Trojan Horse through the gates. She could clearly see the coming doom, but her warnings went unheeded and the Greek warriors sacked her beloved city. Greece still exists today, but Troy is merely a myth, standing as a warning against accepting gifts (like retiree benefits) that seem too good to be true.

In my last post I called the US military a paper tiger, noting that our military forces cannot respond to a rising China to secure a rules-based economic system when those forces are financed by loans from China. It made a nice post, but it’s not really true. Though China is the largest foreign holder of US debt, it is actually selling off its holdings, not buying more. China is led by aggressive and savvy capitalists and I believe they have taken a look at our long term fiscal challenges, our inability to address these challenges politically, and decided: the US is a lousy investment.

So if we’re not getting cash from the Chinese, how exactly are we financing our $1 trillion in annual deficit spending? Where is this money coming from?

From thin air.

No, really, our government is just inventing the cash using a policy called Quantitative Easing. The Federal Reserve is printing about $100 billion a month to buy financial assets like mortgages from the private market. It’s a complicated process but one thing is clear: it is not sustainable. Left unchecked, this policy could lead to terrible inflation. Quantitative easing reminds me of the stories I heard during the housing boom just before the crash of 2008: borrowers could secure a loan by simply stating they had sufficient income, and no one checked. It was so ridiculous I believed it couldn’t possibly be true, but it turned out to be one of the driving forces behind the bubble and crash. I believe something similar is currently happening with quantitative easing.

Now, there are very good reasons the Fed is using this tactic: when interest rates are at 0%, the only way to prevent deflation and stimulate the economy is to print money. I believe Ben Bernake and the Fed have done the best they can to help our economy in the short term through creative monetary policy. But for this tactic to be effective over the long term it must be followed up with sound fiscal policy, ie a balanced budget. Only our politicians can make this happen, and they aren’t.

They say “the road to hell is paved with good intentions.” These fiscal challenges make me fear for our country, and for our children’s future.

The Weimar Republic (1918-1933) printed so much money to finance government spending it became worthless. Children could play with stacks of it. People’s savings were wiped out causing widespread discontent and civil unrest.

Background links

• Who holds US debt? Answer by Erik Fair
• Fed Buying 61% of US Debt
• Quantitative Easing by Wikipedia
• Weimar Republic