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Fiscal Cliff in Perspective

by Tim Isbell, 10/16/20013 (the day the Senate & House voted for the Continuing Resolution to keep the government funded and also to increase the debt ceiling)

A friend sent me a helpful analysis that likens the U.S. financial situation to that of an American household. This reduced the numbers to something that we all can understand.

Then it went on to suggest how a household would respond to the problem, implying that the government should do something similar. My assessment is that the suggested response was poor financial advice for a household - and its parallel is poor financial advice for the U.S. government.

Here's the summary of the U.S. financial situation, scaled to the median U.S household income.

 Annual household income $50,000 akin to the U.S. Tax Revenue
 Annual household spending $88,000 akin to the Federal Budget
 New household debt incurred last year $38,000 akin to the Federal Deficit
 Outstanding household debt $328,000 akin to the Federal Debt

Assuming this is a typical year, the household has a serious spending problem that it must address quickly. But let's first look at the household's debt. 

  • If it is all on credit cards, spent on depreciating items and for which the interest rate is in the 17%/year range, that is awful! 
  • If it is the mortgage for the house they live in, which appreciates at about the rate of inflation and for which the interest rate is in the 4.5% range, that is not so bad. 
  • If some of it is for things like an educational loan, which is money spent now in order to increase income in the future and which typically carries a low interest rate, that may be good debt worth keeping.
  • If some of it is owed to immediate or extended family members and friends, which is also probably at a low interest rate, that is not too bad, either.

So I started thinking about how I would respond if the head of this household came to me for financial advice. I think I'd tell him/her:

  • Assuming that your credit is still good, borrow the money you need to honor your commitments to (especially external) lenders and to protect your credit rating.
  • Keep all of your day jobs and start looking for ways to bring more money into the household. Whatever you do, don't stop working! 
  • Immediately have a household meeting and come up with a plan to cut expenses - a lot! The goal is to have more income than expenses, turning the annual deficit into an annual surplus which you can use to reduce the overall debt. When you increase your income enough to get the debt level under control, you can consider increasing spending.

Relating this analysis to the U.S. financial situation

There are many differences between managing the country's money and managing a household's money. These are beyond the scope of this post so I'll ignore them. The U.S. government is not as likely to come to me for financial advice, but if they did here's what I'd suggest. 

(In a sense, though, our government does come to every one of us for advice. Every congress-person and even the President have websites inviting citizen input. These offer various ways to contact them, including simple email. So I occasionally take the time to offer my thinking on such matters. To find out how to get a message to your elected officials click on this Common Cause website; all you need is your zip code.)

1. Raise the debt limit and borrow what we need for the short term, contingent on nothing. 

Our country is still (barely) in the enviable position of having great credit - as evidenced by the low interest rates people charge us for our borrowing. We must protect whatever we have left of our credit rating! Like most households, the U.S. debt is a combination of depreciating and appreciating items. Some of our debt is to our citizens and and other debt is to outside lenders (such as China). In the aggregate, the U.S. pays very low interest rates for borrowing, though if we don't raise the debt limit this will change very fast. And it will wreck the economy.

Fortunately, congress voted to do this today. It was a painful process but it was the right thing to do.

2. Reopen the government immediately, contingent on nothing.

If we don't keep the country working and keep investing to improve our "human capital" we will damage our short and long-term income stream - making the problem bigger instead of smaller. 

Again, Washington voted to do this today. This, too, was a good thing.

3. As soon as 1 and 2 are done, start serious negotiations on the budget to lower the debt substantially within 5 years.

We certainly have both a spending problem, and an income problem. To lower the debt we need to make substantial progress on both. This is extremely important, but not quite as urgent as 1 & 2 above.

On the spending side: We can do some of this by reducing discretionary spending but to ever turn our annual deficits into annual surpluses we must reduce some entitlement spending. Much of the U.S. debt is to ourselves, so we may have to do what any smart head-of-household would do: tell the kids that instead of going to an Ivy League school across the country they need to attend the local community college and/or the state university. They may not like it, but it's just a fact of life. We cannot even threaten to save money by threatening to abandon our commitments to external lenders - or our credit rating will crash overnight and the economy will go into free-fall! And as much as possible, we must protect as many expenditures that are designed to catalyze future economic growth as we possibly can.

On the income side: We must raise more income - both by catalyzing economic growth and by gathering more taxes. 

We must do all these things in ways that reduce the gap between the rich and the poor, with an emphasis on strengthening the economics of the middle class. In the long-term, this will produce the strongest country.

This is Washington's Job 1 for the next several months. Let's encourage them to work together to get it done.

At least that's how I see it.

IMHO, Tim.

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