Cutting The Deficit: They Won’t Because They Don’t Have To

The Supercommittee did what it was expected to do. There should have been a sense of urgency: outlays in fiscal 2011 rose by 4.2% to $3.6 trillion, of which a sickening 38% was paid for with borrowed money. Yet lawmakers dug in their heels. Why? They didn’t have to make painful choices. Unlike Greece or Italy, the US has a miraculous money machine that takes care of the deficits.

The idea was flawed from the outset: to cut the deficit by a small fraction—$1.2 trillion in reductions spread over ten years would amount to $120 billion a year, starting in 2013, while annual deficits are in the $1.3 trillion range. Practically a rounding error. Then came the next impossibilities.

Cut spending? It would scoop money out of the big trough that has been feeding just about everybody and everything in the US, and often enough overseas: retirees, Big Oil, museums, Solyndra, defense contractors, non-profits, government agencies, the rich, the poor, etc. And they all start screaming. A very painful situation for lawmakers, whose ears can only take so much, and whose jobs depend on doling out money.

Raise taxes? The cacophony becomes even more deafening.

Lawmakers have millions of reasons not to venture into that thorny thicket. Instead, they came up with the Supercommittee, where any efforts to deal with the deficit would die a natural death, followed by automatic spending cuts, to be modified away at a later date. This would allow political campaigns to go on unperturbed, while the rest of America goes back to square one: huge deficits and a gross national debt that will exceed $16 trillion next year and $17 trillion in 2013. In 2014, it will reach 120% of GDP, the level that Italy is struggling with today.

And there is no end in sight. The only power that could motivate Congress to deal with the deficit responsibly is the credit market. Market participants could demand higher yields or walk away from US treasuries altogether. Greece ran into that situation. It’s when the music stops playing. It’s when governments have to act.

But the Fed’s near-zero interest rate policy and aggressive monetization of debt have shielded congressional budgets from the discipline of the markets. To motivate Congress to cut the deficit, the Fed should pick up its megaphone and announce that it would refuse to buy bonds of whatever kind, come hell or high water, and that it would allow yields to be set by market forces. No more QEx. No more fancy programs to subsidize banks. When treasury yields start rising, and when funding the deficit and rolling over maturing debt get iffy, then Congress might finally deal with the deficit in a responsible manner.

The Fed will never do that. Its very existence depends on Congress. If it failed to support the budget deficits, lawmakers might no longer see any reason to keep it around. They might actually follow through on threats to repeal the Federal Reserve Act of 1913 and replace it with acts that could put the US economy back on track (or make it worse). The Fed’s lease on life is based on its ability to guarantee that budget deficits will be funded, regardless of what the consequences are on the rest of the economy and the future of America. Even presidential candidate Rick Perry has come to grips with that and has backed off his anti-Fed rhetoric.

Reducing government spending and raising taxes are politically the two hardest and most perilous things to do. The first tends to topple governments and send people into the streets, as we’ve seen in Europe; and the second tends to infuriate the rich. No one wants to get kicked off the gravy train. So we sneer at Italy’s insufficient and convoluted efforts to get a handle on its out-of-control budget—yet our own lawmakers aren’t even trying.

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