Friday, September 28, 2007

The American Catastrophe, part 2

Last night I had the good fortune to hear economist Walter Williams speak at Hillsdale College on "Markets, Government, and the Common Good." Williams did a nice job presenting the case that in markets, self-interest is channeled into mutually beneficial activities, while most government action is a zero sum game (most government expenditures appear to be transfers, necessarily zero sum). He also noted the connection of these ideas to American Constitutional government, which severely limits the role of the state, and stressed the crucial importance of this for America’s success. And then, at the conclusion of his talk, he observed that if any of the founding fathers were to return from the dead and run for President today, they’d be wildly unpopular, and have no chance at all of winning. Too many of his fellow Americans don’t know or care about the Constitution, about the limits of force, or the benefits of free markets. They want free health care, free reconstruction for hurricane victims, free this that and the other, and they want it now.

It was a noticeably bitter ending to what had been an upbeat lecture, and it strikes me as perfectly correct. Too many Americans appear to have accepted the idea that federal government programs will be able to solve the supposed health care crisis. Unfortunately, federal government programs are a primary cause of rising health care prices, by creating enormous moral hazard problems. I’ll address this in more detail in some later post, but suffice it to say that the federal government became the largest purchaser of health care in the United States in the late 1960s, and its share of total expenditures has grown since, as have the problems. But never mind the rising prices; the more serious problem is that the federal government Medicare and Medicaid programs are badly unbalanced over the longer term, more so than the Social Security System.

The Bush administration has greatly worsened the situation with its "prescription drug benefit," the largest single welfare program since LBJ's "Great Society." How are these growing future imbalances, plus the current federal deficits, plus the expenses of the never ending "war on terror," going to be financed? The People's Bank of China has been the largest financier of American deficits of late, purchasing enough low-return federal debt to essentially pay the ongoing expenses of the Iraq fiasco. But the new China Investment Corporation is unlikely to continue this - America is no longer the only safe haven... or maybe not even such a safe haven at all, given the likelihood of a sharp drop in the dollar. America potentially has a financial train wreck ahead. I believe this could still be averted, but no politician with any chance of winning the presidency has any interest in fiscal responsibility. The "big four" Republicans (the ones who won't to speak to blacks) are falling over themselves promising more, not less, government interference in health care; I gather the goal is to outdo the Democrats' socialist schemes. Congress has no interest in fiscal responsibility either, but does seem to have some interest in "getting tough" with the Chinese and other foreigners who have been willing to finance their profligate spending.

We’re likely to get a Democrat president, given the current Republican penchant for self destruction, but it doesn’t matter much - both parties are bent on expanding the welfare state, when cutting it off is required. I’d like very much to wrong about this, but it’s hard to see what other outcome is possible.

But what is a "financial train wreck?" "Train wreck" is perhaps misleading, as there are several likely consequences, none necessarily as abrupt as the metaphor implies, and not necessarily concurrent.

1. Reduced capital inflow for the U.S.
2. Rising interest rates in the U.S.
3. Reduced investment and increasing bankruptcies.
4. A drop in the value of the dollar, meaning lower real income for Americans.

These are likely consequences stemming from the likelihood that foreigners will decide they have better options than investing in the U.S. The increasing fiscal imbalance as entitlements grow will also necessitate, farther in the future:

5. Substantial tax increases with additional deadweight losses.
6. Cuts in programs - forced cuts that will take recipients by surprise, rather than giving them sufficient notice so as to plan accordingly.

And - should sellers of oil ever decide they want Euros, rather than Dollars:

7. Ugh.

It’s not really a train wreck, in that these are all survivable. But it is a financial debacle, that means a decline in the American economy and lower living standards. And who knows what sort of political response that will trigger. Much of this, and the foreign policy disaster discussed in my earlier post, might have been averted had the current president not been utterly irresponsible. It might yet be averted, but who will do it?

This morning I heard former Prime Minister of Estonia Mart Laar speak eloquently on how he helped guide his country to freedom and economic success. Estonia is starting to sound very attractive right now.

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