Budget Bugaboos

Brace yourself for the budget battle of the century.

Just a few hours ago, the White House delivered its $2.5 trillion budget to Capitol Hill. And already, it seems to be mired in intense controversy.

The president’s Republican base is rebelling.

The Democratic opposition is poised to launch a full-scale attack.

And today’s press reports are slamming the budget with arguments eclectically drawn from both Republicans and Democrats.

Here’s just a sampling of the lines of attack now in the works, all of which are validated by solid non-partisan research and data …

Attack #1. The president proposes to cut or eliminate 150 government programs. On the surface, this sounds like a refreshing new wave of fiscal prudence. But not according to analysts on the Republican side of the aisle in Congress!

They say that, even if the Democrats allow every single penny of their favorite programs to be cut precisely as the president recommends, the most that will be saved from the sum total of all 150 measures will be a meager $15 billion.

With the government spending close to $7 billion a day, that savings will be nearly all gone in just two days during fiscal 2006.

Attack #2. In last year’s proposed budget, the White House recommended cutting or eliminating 65 programs, for a total projected savings of $4.8 billion.

What actually happened? Hah! Congress wound up approving the elimination of only four of the 65 programs, while cutting spending on only 20. How much did they save? A meager $200 million, or a piddly 4 cents in actual savings for every dollar of proposed savings.

If this pattern repeats itself for the fiscal 2006 budget, the total savings from the president’s proposed cutbacks will be watered down to a meager $615 million — a savings that would be gone after just two hours of normal government operations!

Attack #3. Whether they’re for or against the wars in Iraq and Afghanistan, nearly all Democrats and Republicans agree that you’ve got to account for the $80 billion or so the administration figures the wars will cost. Yet, due to the uncertainty, the cost is not included in the official estimates of the deficit.

Where is that money going to come from? And what happens if the cost turns out to be more than $80 billion?

Attack #4. The president’s budget projects declining deficits until the end of the decade. But so did nearly all previous budgets proposals!

What’s the actual recent track record? Record-smashing red ink for the last three years in a row, culminating in $427 billion in red ink for fiscal 2005.

What sweeping fundamental changes do we see in the U.S. economy, world politics, or the budget process that truly reduce the deficits? None.

Attack #5. Despite a State of the Union address last week that was loud and clear regarding the president’s commitment to overhaul Social Security, the budget delivered today is silent on its expected costs, estimated at $1 trillion and $2 trillion over decades.

Where is all that money going to come from?

Attack #6. The budget is equally silent regarding the cost of making last term’s tax cuts permanent.

Attack #7. It’s also mute when it comes to the expected cost of fixing the alternative minimum tax (AMT). The choices:

A. If the AMT is allowed to continue on its current track, millions of middle-class tax payers will have to pay more than their fair share.

B. If the AMT is fixed, as nearly everyone in Washington agrees it ought to be, the fix is going to reduce government revenues and make the deficit even larger. By how much? Probably close to a half trillion dollars over ten years!

Attack #8. Our nation’s biggest budget busters — Medicare, Social Security and military spending — are largely immune from cuts. And they’re expected to grow for years to come.

Attack #9. The largely untouchable, non-discretionary spending — especially for Medicare — is expected to really take off like a rocket in the years for which today’s budget provides no estimates, starting around the time the next U.S. president takes office.

Wouldn’t it be more prudent to start addressing that problem now rather than wait until it’s way too late? Indeed, the only excuse I’ve heard so far for not doing so goes something like this:

“It’s already too late — so why bother?”

Attack #10. With virtually no other politically acceptable way to slash the deficit, the president is counting on solid economic growth to do the job, bringing in more government revenues and helping to reduce the government’s social costs.

This is not an irrational hope — economic growth DID make a huge difference in previous decades. But can we repeat that feat?

The answer:

Only if most baby-boomers stop getting older, never claim their Social Security benefits, and never get sick …

Only if the Fed stops raising interest rates, or its interest-rate hikes have virtually no impact on GDP, job growth, the bond market, and the stock market, and …

Only if the next 10 years bring something akin to the prosperity we experienced during the booming ’90s!

Bottom line:

You may choose to disagree with the budget’s priorities. But that can be handled through the normal political process.

Or you may disagree with the budget’s projections, issues that are also subject to normal debate.

But what do you do when the budget has major — sometimes massive — omissions? How do you deal with issues that many of the critical players refuse to quantify or even talk about?

No answers are forthcoming from Washington … and the silence is deafening.

You ask: “So what else is new? Isn’t that
how Washington has always operated?”

No.

Sure, almost every era in American history has had its share of corruption and scandal. But for the most part, when it came to the central pivot of our government — its budget — the government’s accountants were serious scorekeepers that did everything in their power to avoid hanky-panky.

The whole notion of “off-budget” accounting and major expenditures left hanging outside of the “official” budget process was both unknown and unimaginable.

Moreover, throughout American history, most budgets were balanced or at least very close to balanced. The Office of Management and Budget (OMB) puts it this way:

“… except for periods of war (when spending for defense increased sharply), depressions or other economic downturns (when receipts fell precipitously), the Federal budget was generally in surplus throughout most of the Nation’s first 200 years.”

The facts:

1. For our first 60 years as a Nation (through 1849), cumulative budget surpluses and deficits yielded a net surplus of $70 million …

2. Between 1901 and 1916, the budget hovered very close to balance every year.

3. The budget was also in surplus throughout the 1920s.

However, the OMB recounts that this historic pattern was broken by the Great Depression and World War II, when there occurred “a long, unbroken string of deficits that were historically unprecedented in magnitude.”

Still, those debts could be at least partially justified by the unusual circumstances.

No similar justification is possible, however, for the 1980s. That’s when the historic pattern of running large deficits only in times of war or economic downturns was broken.

According to the OMB,

“In 1982, partly in response to a recession, large tax cuts were enacted. However, these were accompanied by substantial increases in defense spending. Although reductions were made to nondefense spending, they were not sufficient to offset the impact on the deficit. As a result, deficits averaging $207 billion were incurred between 1983 and 1992.”

The main reason: Huge, structural problems emerging in the budget deficit — especially in non-discretionary spending and the rising cost of defense.

Extra revenues and reduced social costs during the booming 1990s helped cover up those problems. But it didn’t help fix them. Instead, our leaders merely perpetuated the age-old pattern of conveniently leaving the thornier issues to future generations to deal with.

Now, WE are that future generation.

The True State of the Union

Consider this speech:

“I have referred to the inescapable need for economic health and strength if we are to maintain adequate military power and exert influential leadership for peace in the world. Our immediate task is to chart a fiscal and economic policy that can:

“(1) Reduce the planned deficits and then balance the budget, which means, among other things, reducing federal expenditures to the safe minimum;

“(2) Meet the huge costs of our defense;

“(3) Properly handle the burden of our inheritance of debt and obligations;

“(4) Check the menace of inflation;

“(5) Work toward the earliest possible reduction of the tax burden;

“(6) Make constructive plans to encourage the initiative of our citizens.”

“It is important that all of us understand that this administration does not and cannot begin its task with a clean slate. Much already has been written on the record, beyond our power quickly to erase or to amend. This record includes our inherited burden of indebtedness and obligations and deficits. …

“Unless budgeted deficits are checked, the momentum of past programs will force an increase of the statutory debt limit. …

“The first order of business is the elimination of the annual deficit. This cannot be achieved merely by exhortation. It demands the concerted action of all those in responsible positions in the Government and the earnest cooperation of the Congress.

“Already, we have begun an examination of the appropriations and expenditures of all departments in an effort to find significant items that may be decreased or canceled without damage to our essential requirements.

“A balanced budget is an essential first measure in checking further depreciation in the buying power of the dollar. …

“Reduction of taxes will be justified only as we show we can succeed in bringing the budget under control. As the budget is balanced and inflation checked, the tax burden that today stifles initiative can and must be eased. Until we can determine the extent to which expenditures can be reduced, it would not be wise to reduce our revenues.

“Meanwhile, the tax structure as a whole demands review. The Secretary of the Treasury is undertaking this study immediately. We must develop a system of taxation which will impose the least possible obstacle to the dynamic growth of the country.” — Dwight D. Eisenhower, State of the Union address, February, 1953.

That was said over a half century ago.

Yet, the greatest cause for surprise is not how much time has elapsed … but how little has changed. Some important lessons:

Lesson #1. Despite the best efforts of Eisenhower — and almost every president who followed him — we are still facing most of the same dilemmas and issues today as we faced back then. How to prevent spending from running amuck, how to reform an outdated tax system, what to do about the dollar.

Lesson #2. In Eisenhower’s time, the numbers were far smaller, even in proportion to GDP.

Lesson #3. In those days, our government usually confronted those smaller numbers head on. Today, while the numbers are larger, politicians from both parties are mostly looking the other way.

Lesson #4. In his last year in office, Eisenhower finally cut the deficit by 100%, with the help of a nation-wide grassroots campaign started by my father’s Sound Dollar Committee. Now, even if you ignore the ominous omissions in the budget delivered to Capitol Hill this morning, the very best the president says we can hope for is a deficit cut by 50% by the end of his term.

My Advice:

– Prepare for a great budget battle over the coming days and months.

– Don’t be surprised if the battle turns out to be disruptive to financial markets — especially Treasury bonds, the U.S. dollar, and American stocks.

– Get ready for much higher interest rates. So far, the interest-rate rise has been limited to the short-term side of the market. Soon, it is bound to spread to the long-term side as well.

– Brace yourself for more inflation and inflation fears, especially in commodities, regardless of the final decision regarding the government’s commodity price supports.

– Don’t be fooled by sharp moves in the opposite direction from that of the major trend. For example, long-term interest rates have declined, the dollar has enjoyed a rally, and gold has suffered a setback.

Until and unless you see a fundamental improvement in the U.S. budget deficit, the U.S. trade deficit, and our government’s complacency regarding both, the big-picture trends are bound to remain firmly in place: A falling dollar, rising inflation, and rising interest rates.

Good luck and God bless!

Martin

Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com

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