Spending cuts, tax increases, or both? How's the debt ceiling debate going to work out?

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Spending cuts, tax increases, or both? How's the debt ceiling debate going to work out?

Mark Fitzpatrick
Residential Lender · Irvine, CA · Member since 2011 · 56 posts · 34 votes

With the specter of a US default growing over this debt ceiling issue, how do you think all this is going to work out? Republicans are firmly against tax increases and want steep spending cuts, but Democrats want tax increases and are resistant to steep spending cuts. Republicans also don't want to raise the debt ceiling unless it is accompanied by steep spending cuts. Democrats want to raise the debt ceiling right away.

Both Moody's and Fitch have warned of debt downgrades if Congress doesn't come to an agreement, which could have serious ramifications in the financial markets and push up interest rates. Chinese ratings agency Dagong is saying the US is "already defaulting" by printing money to inflate away our debt.

How do you think this is all going to turn out? Though Speaker Boehner has been holding a hard line on the spending cuts issue as a condition for approving a debt ceiling increase, I think he'll cave on it.

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Mitch Kronowit
SFR Investor · Orange County, CA · Member since 2009 · 1k+ posts · 1k+ votes
15y

This is like telling your credit card company that even though you've maxed out your account, they had better raise your credit limit or you'll stop making the minimum payments. That wouldn't fly with Visa or Amex, but here is the government trying to extort money once again from the American taxpayer.

And I really wish everybody would stop using the phrase "printing money". The United States is NOT post WW I Germany and we do NOT create our money in the mints, but at the Federal Reserve.

The US mints only print paper money and stamp out metal coins to meet the demand of people who need or want to hold cold hard cash, e.g., ATM visitors, video arcade patrons, drug traffickers, etc. In fact, I believe only about 25-35% of the US money supply exists in the form of paper currency and loose change. The rest of the "money" is nothing more than a bookkeeping entry at the Federal Reserve banks. THAT is where money is created (and destroyed), not the mint.

For some perspective on all this "doom and gloom" regarding our increasing money supply, look at this recent graph of the M-2 supply (used for forecasting inflation).

As you can clearly see, the M-2 supply is growing in a nice steady linear fashion (gray area), not skyrocketing off the chart. One thing that is probably keeping our money supply in check is the tight-fisted approach banks are taking towards lending. Since every dollar on deposit MAY ultimately result in an increase of $10 in the money supply, it has the potential for explosion, but not until the banks start loosening up the purse-strings and getting the money in circulation. So no need to panic... yet! :wink:

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  • Mitch Kronowit
    SFR Investor · Orange County, CA · Member since 2009 · 1k+ posts · 1k+ votes
    15y

    This is like telling your credit card company that even though you've maxed out your account, they had better raise your credit limit or you'll stop making the minimum payments. That wouldn't fly with Visa or Amex, but here is the government trying to extort money once again from the American taxpayer.

    And I really wish everybody would stop using the phrase "printing money". The United States is NOT post WW I Germany and we do NOT create our money in the mints, but at the Federal Reserve.

    The US mints only print paper money and stamp out metal coins to meet the demand of people who need or want to hold cold hard cash, e.g., ATM visitors, video arcade patrons, drug traffickers, etc. In fact, I believe only about 25-35% of the US money supply exists in the form of paper currency and loose change. The rest of the "money" is nothing more than a bookkeeping entry at the Federal Reserve banks. THAT is where money is created (and destroyed), not the mint.

    For some perspective on all this "doom and gloom" regarding our increasing money supply, look at this recent graph of the M-2 supply (used for forecasting inflation).

    As you can clearly see, the M-2 supply is growing in a nice steady linear fashion (gray area), not skyrocketing off the chart. One thing that is probably keeping our money supply in check is the tight-fisted approach banks are taking towards lending. Since every dollar on deposit MAY ultimately result in an increase of $10 in the money supply, it has the potential for explosion, but not until the banks start loosening up the purse-strings and getting the money in circulation. So no need to panic... yet! :wink:

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  • Mark Fitzpatrick
    OP
    Residential Lender · Irvine, CA · Member since 2011 · 56 posts · 34 votes
    15y
    Originally posted by Mitch Kronowit:

    And I really wish everybody would stop using the phrase "printing money". The United States is NOT post WW I Germany and we do NOT create our money in the mints, but at the Federal Reserve.

    The US mints only print paper money and stamp out metal coins to meet the demand of people who need or want to hold cold hard cash, e.g., ATM visitors, video arcade patrons, drug traffickers, etc. In fact, I believe only about 25-35% of the US money supply exists in the form of paper currency and loose change. The rest of the "money" is nothing more than a bookkeeping entry at the Federal Reserve banks. THAT is where money is created (and destroyed), not the mint.

    I think most people know this. The term "printing money" is just the archaic way people still refer to it, kind of like "record store" or "tape" a TV show on your DVR.

    I'm too am not as concerned about massive inflation right now. I think we'll have deflation first, then inflation later when the economy starts to recover and all that new money starts circulating.

    However, the debt ceiling issue is still a concern. I don't know that the Republicans have the will to stand firm against a debt ceiling increase without major spending cuts because the consequences could be significant. If we do see a default - even a short term one - it will likely lead to higher interest rates, which could negatively impact the fiscal position of the government and hurt the economy. We have to get spending under control at some point, but I don't know if Congress has the will to do it yet.

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  • Mitch Kronowit
    SFR Investor · Orange County, CA · Member since 2009 · 1k+ posts · 1k+ votes
    15y
    Originally posted by Mark Fitzpatrick:
    I think most people know this. The term "printing money" is just the archaic way people still refer to it,

    I certainly hope so, at least among educated people, but I'm sure there are still plenty of folks out there that believe the government can simply print off a butt-load of $20 bills and pay their bills with them. Not a bad idea if it actually worked!

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  • Max Drizin
    Real Estate Investor · Milwaukee, WI · Member since 2011 · 103 posts · 22 votes
    15y

    Tax increases are the way to go. From a simple macroeconomic sense, there is absolutely no question about it.

    If we look at the fiscal policies available for a government, there are two ways to change the economy: spending and taxing.

    In the sense of correcting a recessionary gap (what we have right now), you are supposed to either decrease taxes or increase spending. When you increase spending, you increase the amount of money circulating, which is the multiplier effect. For instance, if the government increases spending by $100bn, it increases the GDP by some multiplier of that, because the people who get that money save some of it, spend the rest, and then those people save and spend, and so on.

    There's a number known as the marginal propensity to spend, which is basically how much you would spend if you received a $100 bill. Naturally, you spend some of it and you save the rest. If we made the blanket assumption that you would spend $75 of that $100, your propensity to spend is .75.

    The calculation for the multiplier effect is 1/(1-(marginal propensity to spend)), which is 1/(1-.75), or 1/.25, or 4. So, if the government spends $100bn, and the multiplier is 4, the GDP theoretically increases by $400bn. More on the theoretically in a bit.

    Taxes, however, in short, don't change the GDP as much. In fact, the tax multiplier is the spending multiplier minus one. So, if the spending multiplier is 4, the tax multiplier is 3. Therefore, lowering taxes by $100bn only increases the GDP by $300bn.

    However, that is for fixing a recessionary gap. We are currently in a recessionary gap, but we have to enact austerity measures (for the purpose of this discussion) in a way that least affects the current recessionary gap. The idea is that we don't want to exacerbate the current situation, since we would be doing exactly the opposite of what is macroeconomically correct in the situation.

    If we look at these multipliers in the other way, you can reason that we should raise taxes, since those would affect the GDP less than lowering spending. This is a simple concept, but we have to remember that we are thinking theoretically. The issue comes in with time and affect lags, as well as crowding out.

    One issue is that there are so many areas between the idea and the action that it reduces the effect. First, we have to know that there is a problem, which takes about six months for economists to come out and say. Then, a bill has to be drafted, votes have to happen, there's 30 to 40 revisions of it, lots of partisan politics, the talking heads on FOX and MSNBC have their take, and then the bill ends up on the President's desk. If it's taxes, those taxes don't get noticed until April. Spending changes are "immediate" but they happen over the course of the year's budget. Taxes that people pay affect their spending throughout an entire year, not just at one time. This whole process can be two years long, and that's another major issue.

    Of course, all of this completely disregards monetary policy, which is equally important, if not moreso given the power of the Fed today and the relative gridlock thanks to partisan politics and general idiocy within the legislature.

    I would say that it's just my two cents, but I wrote enough to say about $12 trillion worth.

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