November 19, 2008

Didn't Anticipate a Perfect Storm

In the quest for big government with low taxes, most of us seem to want not "either/or" but "both/and". In practice, this means tax cuts are not usually accompanied by spending cuts, nor spending increases with tax increases.

But not all government spending is the same, just as not all drugs are the same. Some are good drugs and some are harmful. Some are powerfully addictive, some are not. Military spending, for example, is not addictive. We saw a tremendous decrease after the Cold War ended, just as we saw after the First World War and after WWII. Spending for the poor is also not addictive. We saw a decrease in that too in the welfare reform.

But there is addictive, 'third rail' spending: that is entitlements. Social Security and Medicare are programs that continually expand in terms of the percentage of the federal budget simply because they are middle class programs. And the middle class is where the votes are. Meaning once you start them, you're married to them forever.

So the implicit Bush Administration strategy seemed to be to "starve the beast" by reducing tax rates (which arguably actually increased revenues) while at the same time spending more and more on non-addictive spending programs like Bridges to Nowhere, the Iraq War, earmarks and aid to Africa. The theory might be that if you spend enough money and shrink the revenues, you can starve entitlement programs. Because, in the end, it's entitlement programs that could bankrupt the government (or at least lead to rampant inflation via printing new money).

But something happened on the way to the forum. That theory completely overlooks that you could have a perfect storm. You could have a financial economy requiring a massive Dopamine injection such that the entitlement programs starts to look minor by comparison. You could kill the goose that lays the golden entitlement program eggs, that is the job market.

I think Greenspan saw that this whole house of cards was tumbling and that's why he got out of the Fed Reserve job just before the storm. The simultaneous failure of the Big Three automakers with banks and other financial institutions makes for a witch's brew of gloom and I wonder if the $25B proposed to the automakers seems to be only enough to get by for six months in the hope of the recession being over by then. If you can delay the automakers inevitable bankruptcy till a more favorable time economically, then some of the out-of-work auto workers may be able to find jobs elsewhere. The timing of this sucks, but it was bound to happen in precisely this way because the Big Three were sick even before the economy got sick, so it's no suprise at all that they're puking now.

Of course this post is likely way too pessimistic and 'chicken little'. Economists predict what is coming will be a nasty recession but not a depression and that we will get through it.

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