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Simpson-Bowles: $4 Trillion of Beltway Mumbo Jumbo

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In the here and now, where it counts, the plan amounts to an earnest pinprick and little more.

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Based on the wailing in Washington DC you might think the deficit commission co-chairmen, Erskine Bowles and Alan Simpson, have gored some sacred cows. In fact, they have produced 59 pages of nearly incomprehensible beltway mumbo jumbo and gimmicks -- an alleged deficit-slashing plan that actually takes a powder on every one of the core fiscal issues.

And that starts with the gushing river of budgetary red ink itself. In order to "get real" as former Republican Senator Simpson is wont to say, you must account for incremental deficits of about $350 billion per year from the inevitable lame-duck deal to extend the Bush tax cuts, the AMT patch, the various expiring tax credits, the doc fix, the estate tax fix, extended unemployment benefits, Build America Bonds, and all the other hide-the-ball phony program expiration tricks now embedded in the budget. Then, add a couple hundred billion per year more in red ink because the commission's economic assumptions -- such as 5% unemployment and 5% per year nominal GDP growth by 2015 -- are way too optimistic. Lay all that over the so-called "current law" budget baseline and you have a minimum federal deficit of $1.2 trillion per year through 2015; that is, $6 trillion of new bonds and bills that need to find a home over the next five years.

And what does Simpson-Bowles do about this tidal wave of US Treasury paper? Well, it urges a fat zero in fiscal year 2011 and then a pinprick savings of $56 billion, or 5% of the built-in deficit, in 2012. After that, the reductions get bigger, but still total only $875 billion over the full five-year period, or less than 15% of the deficit baseline. Stated differently, after all of the alleged "tough choices" and policy heroics recommended by the co-chairmen, we would only need to finance $5 trillion of new Treasury debt, not $6 trillion, through 2015.
The surface reason for this timidity is the assumption that the US economy is too "fragile" to absorb any material tax increase (or spending cuts) over the next several years. Therefore we must borrow another $5 trillion from our children and grandchildren -- so that not a single middle- or upper-class taxpayer will be denied the spending power to buy a few more Coach (COH) bags, iPads (AAPL), barbecue grills, and Caribbean cruises.

Besides the rather ignoble intergenerational heist implied in this proposition, the main problem is that it assumes the required massive deficit financing sources -- the international monetary system and global bond markets -- are not equally as fragile as the US economy is alleged to be. And that wholly unexamined assumption is by no means obvious.

At the moment, the Fed is monetizing 100% of the deficit. This means that it's crediting the deposit accounts of government bond dealers with money made out of thin air to the tune of about $100 billion per month in exchange for existing bonds and notes. In turn, dealers and traders use these deposit account proceeds to take down an equivalent $100 billion monthly of newly issued Treasury paper, thereby keeping Uncle Sam's checks from bouncing.

But only $600 billion of QE2 monetization has been so far announced by the Fed -- meaning that at the current $100 billion monthly rate, the bucket will be drained by next spring. In theory, of course, the Fed could resort to QE3, QE4, and so forth -- printing its way through the entire $5 trillion of new federal financing that would be required after the Simpson-Bowles "savings" have been fully implemented. Yet by 2015 that means the Fed's balance sheet would reach an elephantine $7.5 trillion -- a figure nine times greater than the central bank's footings on the eve of the Lehman heart attack in September 2008.

Assuming that not even Helicopter Ben would go for a money drop that big, the true "fragility" issue then presents itself. When the Fed's big fat POMO bid disappears from the Treasury market, or the post-meeting press release merely hints that it's coming, or especially when the Fed's PR mole embedded at CNBC leaks the news, won't the smart money, the fast money, and the wise guys go sellers -- if they haven't done so already?

The fact is, the $9 trillion US Treasury market will reach $14 trillion, or 100% of current GDP -- even after all the Simpson-Bowles savings have been harvested. Yet the marginal buyers of US Treasury issuance in the recent past -- China, the other East Asian mercantilists, Brazil, and OPEC -- can no longer afford to renew a heavy bid without importing virulent inflationary pressures into their own over-heated economies (by printing even more of their own currency to buy dollars). So when the Fed's bid ends and the fast traders go sellers, the global bond market is likely to provide a thundering demonstration of what "fragility" in the economic sense really means. Needless to say, it will be a lot more unpleasant than the 10% sales drop at Target (TGT), Ford (F), Home Depot (HD), or Carnival Cruise Lines (CCL) that might result from requiring American citizens to pay at least some portion of their government's bills.

To be sure, the esteemed co-chairmen aren't known to be card-carrying Keynesians of the orthodox creed -- so they probably don't believe in the spending and tax "multipliers", and for good reason. After a 30-year borrowing and money-printing binge, the US economy is freighted down with $52 trillion in public and private debt, which represents an excess burden of $30 trillion compared to the pre-1980 leverage ratio on national income. Under these conditions, an incremental dollar of debt-financed consumer spending catalyzes nothing. Like Cash for Clunkers and credits for new homebuyers, it pulls purchases forward on a one-time basis and then disappears without a ripple.

The explanation for Simpson-Bowles' giant whiff on the one true here-and-now-deficit reducer -- letting all the Bush tax cuts including the AMT patch expire at an immediate gain of $300 billion -- is thus straight-forward: The Wall Street propaganda machine has vaccinated nearly the entire beltway population -- include its few brave denizens like the co-chairmen -- with a politically convenient strain of ersatz Keynesianism. Unlike the real thing, the latter holds that consumption spending on anything -- even by people who already have everything -- is to be embraced without question. On that meretricious point, of course, the questions should start, not end.

In fact, the question of serious revenue raising is never really addressed by the Simpson-Bowles plan -- not even in the by-and-by a decade from now when the current macro-economic "fragility" has presumably passed. Thus, compared to current policy, the co-chairman's plan would raise the grand sum of $100 billion by 2015 or just over one-half of 1% of GDP. Yet any honest plan to close the nation's massive structural deficit needs five times that much new revenue -- $500 billion per year or upwards of 3% of GDP.
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