This week marked the 80th anniversary of the International Monetary Fund (IMF), an institution established during the Bretton Woods Conference in July 1944. Recently, IMF officials have expressed significant concern regarding the global economy.
The latest World Economic Outlook is aptly named The Global Economy in a Sticky Spot. According to the report, this stickiness largely stems from services inflation, particularly characterized by rising nominal wages in the U.S. outpacing goods price inflation.
For four decades, the average worker has not experienced a real wage hike adjusted for inflation. Shouldn’t a modest rise in nominal wages above goods price inflation be viewed positively?
Not in the eyes of the IMF and its financial allies. From their standpoint, rising services costs are obstructing central banks like the Federal Reserve from lowering interest rates. These financial institutions seek reductions to mitigate the fallout from poor loan decisions made during the coronavirus pandemic. The Treasury, likewise, hopes for lowered rates to manage its substantial debt burden.
Additionally, the IMF highlights growing trade tensions and a phenomenon it refers to as ‘diminished buffers.’ This term indicates that countries already grappling with large deficits will have fewer resources available to bolster public spending during downturns or other unexpected circumstances.
The U.S. exemplifies a nation struggling to confront its fiscal irresponsibility. Recently, IMF chief economist Pierre-Olivier Gourinchas delivered a concerning warning:
“It is concerning that a country like the United States, at full employment, maintains a fiscal stance that pushes its debt-to-GDP ratio steadily higher, with risks to both the domestic and global economy.”
Indeed, high debt levels, sluggish growth, and increasing deficits paint a troubling picture for the future.
Excesses
Fiscal stimulus, as introduced by John Maynard Keynes in the early 20th century, was intended to be countercyclical. Deficits should ideally be deployed during economic downturns to stimulate demand, and curtailed in prosperous times to allow the economy to thrive independently.
However, the second half of Keynesian theory—reducing deficits during economic upswings—has been largely ignored both in the U.S. and globally. Whether in times of prosperity or hardship, deficit spending has remained a constant. This oversight is a cause for concern, as noted by Gourinchas.
But what explains the continued escalation of deficit spending in the U.S. even during periods of full employment? Don’t policymakers recognize that, according to Keynes, they are meant to operate countercyclically?
Deficits are entangled in the political process. They are not solely reflections of sound economic strategy but are often employed to fund programs that benefit insiders financially.
In the past half-century, deficits have been driven by political interests, with numerous opportunists flocking to the suburbs of Washington, D.C., reaping substantial incomes while engaging in dubious work at taxpayers’ expense.
Aside from the wastefulness present, the primary issue with persistent deficit spending is its artificial nature. Funds are borrowed from the future and funneled into specific areas by government decision-makers.
As these artificial inflows become expected, the economy adapts. After half a century of nearly continuous deficit spending, complete reliance on it has emerged.
Culture of Dependence
“If you want more of something, subsidize it,” quipped Ronald Reagan.
Today, dependency has been significantly subsidized across the United States.
There are those who rely on government assistance for basic needs, structuring their lives around these support systems. Many prefer to remain in poverty rather than develop the skills necessary for self-sufficiency.
Less conspicuously, many diligent individuals engage daily in businesses that owe their existence to government funding. While these workers may be in the private sector, their earnings often stem from government contracts or regulations that they have built their services around.
From defense to education to finance, nearly every sector has been distorted by government deficit spending. Remove the stimulus, and these sectors would falter.
The impasse facing the U.S. is a creation of its own actions. By permitting deficits and debts to spiral out of control, Washington has brought its financial situation to the edge of catastrophe.
If interest rates remain elevated, the net interest on the debt could consume a significant portion of the budget, leading the Treasury toward default. Conversely, reducing rates amidst ongoing inflation could worsen inflation, diminishing the dollar’s value and undermining individual savings amassed over a lifetime of hard work.
For central planners, cutting interest rates appears to be the path of least resistance.
The Case for Radical Spending Cuts
This week, Bill Dudley, former President of the New York Fed and chair of the Bretton Woods Committee, urged the Fed to lower rates at the upcoming FOMC meeting. He argued that deferring until September increases the risk of a recession unnecessarily.
As Dudley suggests, recessions are far from pleasant. They disrupt lives, forcing losses of jobs and homes, bankruptcies, and often prompting moves in search of new opportunities.
Yet, recessions can serve a positive purpose in regulating a healthy economy. At this juncture, a contraction might be precisely what is necessary to recalibrate the economy.
How else might the real estate market adjust so average home prices align with average incomes? What other mechanisms would effectively moderate consumer price inflation and realign stock valuations with historical averages?
Merely cutting interest rates, as Dudley advocates, will not rectify the fundamental imbalances in the economy. This action will not resolve the debt crisis facing Washington either. At best, it could temporarily stave off greater issues, allowing debt—which is edging toward $35 trillion—to accumulate further, creating the risk of an even more significant collapse in the future. It could even trigger renewed inflationary pressures.
The real and essential solution involves making drastic spending cuts. This approach aims to eliminate the deficit entirely, balancing the budget not simply to break even but to achieve a surplus that can reduce the national debt.
A significant recession would likely accompany such radical cuts, resulting in the loss of numerous jobs as dependency comes to a swift end.
However, in the long term, this transition would ultimately benefit the nation. America could adapt, fostering greater independence among its citizens as they navigate the varying circumstances of life.
Regrettably, the political class seems unlikely to allow such changes to unfold in any meaningful way. Their reliance on the benefits of an extensive government disincentivizes reform.
As a result, we will likely continue to face debts, deficits, inflation, and disorder.
[Editor’s note: It’s remarkable how a few strategic decisions can lead to significant wealth changes. At this moment, I’m preparing for yet another such pivotal choice. >> I would like to guide you in making similar transformative decisions.]
Sincerely,
MN Gordon
for Economic Prism
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