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| The American
It’s time to set our ideological talking points aside for the moment and take an honest look at what happened in the 1980s.
It’s time to set our ideological talking points aside for the moment and take an honest look at what happened in the 1980s.
To get our ailing economy back on track, we’ve been applying the Keynesian fiscal-stimulus formula for three years now (also known as “government knows best” or “intelligent design” economics). The 2008 Bush program of rebate checks ($170 billion) was the first design for stimulating demand. The next attempt was not the $700 billion Troubled Asset Relief Program (signed by Bush in October 2008, mostly paid back by now); it was the subsequent $787 billion Recovery Act of 2009—consisting mostly of short-term, one-time stimuli, like jolts from Keynesian-brand defibrillation paddles.
How’s all that stimulus working out for us? Not too well, so far. Creationism economics—driven by government experts’ decisions as to which companies should survive or perish, which investors should be saved or go broke, and which technologies should win or lose—isn’t delivering on its promise. Should we try another jobs bill with more of the same remedies, continuing to have faith that intelligent design economics will eventually work?
It’s easy to imagine Ronald Reagan shaking his head at all of this; but it’s more difficult to know whether he would be smiling at us, or frowning.
It’s time to step back, take a deep breath, set our ideological talking points aside for the moment, and take an honest look at what happened in the 1980s. A good starting point is the following excerpt from Reagan’s farewell address to the nation, which he delivered from the Oval Office more than 20 years ago.
The way I see it, there were two great triumphs, two things that I’m proudest of. One is the economic recovery, in which the people of America created—and filled—19 million new jobs. The other is the recovery of our morale. America is respected again in the world and looked to for leadership.
It could be quite a while before another U.S. president will be able to say anything similar to that. On the other hand, it could happen sooner rather than later if we’d just think a little harder about the principles behind the policies that delivered those results. Those fundamental principles were packed efficiently inside two of his favorite aphorisms: (1) “Peace through strength”; and (2) “Trust ‘em, but cut the cards.” The policies of his administration were shaped by his view of government’s limited responsibilities: provide a secure environment for the long term, enable the free market, invest in the financial health of the private sector, then trust the people and the economy to flourish again under these new, more favorable conditions.
Fortunately for the nation, Reagan never backed away from those first principles, even when short-run fiscal conditions seemed to threaten his long-run vision. His priorities reached further into the future than the current-year budget or the next election—and that’s one of the traits of a true statesman.
The Reagan-era deficits were not ‘regrettable’
A deficit is harmless, even desirable, when it is utilized to help pay for successful investments that deliver benefits long into the future.
Reagan did mention the deficit in his farewell address: “I’ve been asked if I have any regrets. Well, I do. The deficit is one.” Even though his administration had presided over the taming of inflation, the rebuilding of the military, and the restoration of the economy to boom conditions, the deficits were—he mistakenly thought—a bothersome, regrettable thorn. Although a deficit (i.e., debt financing) is regrettable when it is employed to fund short-term amphetamine injections and sugar highs, it is harmless, even desirable, when it is utilized to help pay for successful investments that deliver benefits long into the future.
Consequently, we can forgive Reagan for his minor mistake—not the deficits, but for being too hasty to regret them. They were precisely the opposite of a burden to future generations—a praiseworthy investment in war prevention and future prosperity. But we didn’t know that in January 1989, because his investments had not yet fully played out.
In 1977, Reagan told Richard Allen, his future national security advisor, about one of his first principles: “My theory of the Cold War is that we win and they lose. What do you think about that?” But it would take until 1991, two years after his farewell speech, for his peace-through-strength investments to finish delivering the win. With the fall of the Soviet Union in the summer of 1991, the Cold War ended, the threat of a thermonuclear war between superpowers was eliminated, and the Doomsday Clock was moved back to its safest-ever setting.
Were those events inevitable, as the anti-Reagan crowd asserts in hindsight? Was Reagan merely lucky to be the passive occupant of the White House at the time the Soviet Union began to implode automatically? Not according to Mikhail Gorbachev, who had this to say about Reagan’s role in the ending of the Cold War: “He was an authentic person and a great person. If someone else had been in his place, I don’t know if what happened would have happened.”
The deficit was precisely the opposite of a burden to future generations—a praiseworthy investment in war prevention and future prosperity.
In other words, according to the leader of the losing side of the Cold War, Reagan’s first principle of peace through strength had driven an effective investment in future U.S. security. Although he didn’t know it yet in January 1989, Reagan’s investment in long-run national security would ultimately pay off handsomely. It turned out to be one of our best investments ever—and as anyone with private-sector financial experience knows, utilizing debt financing to help fund good investments is perfectly sound financial practice. Contrary to the anti-Reagan crowd’s characterization of the ‘80s, Reagan didn’t use the nation’s credit card to “throw a party”; he used the line of credit, extended to us by the worldwide market for U.S. Treasury securities, to end the threat of a thermonuclear war between superpowers and to reinvigorate private-sector productivity and growth. It worked; we are still enjoying the benefits of those highly successful investments.
There’s a clue in that history lesson that might help us today. Instead of borrowing money to pay for more short-term stimuli prescribed by the government’s intelligent designers, we could do better by shifting much of it towards war prevention—for example, to bring our Asian wars to an acceptable conclusion and to protect our electric grid from cyber warfare or a crippling nuclear burst in the ionosphere over our heartland—and some of it towards reinvigorating private enterprise. If it would help to placate the Keynesians, we could call it a “stimulus,” even though it would actually be a good, long-term investment reminiscent of the Reagan Revolution.
Debt financing for good investments: we all do it
Reagan’s priorities reached further into the future than the current-year budget or the next election—and that’s one of the traits of a true statesman.
Families, private enterprises of all sizes, state governments, and local governments all employ a measure of debt financing to help fund good investments. Moreover, it is common practice for growing entities not just to roll their maturing debt over, but also to finance new growth by adding new debt on top of rolled-over debt, instead of paying the debt down. Wise use of debt financing is a valuable method for enhancing growth. Examples abound.
Families borrow money for good investments. Consider a two-generation snapshot of a typical family that has several outstanding loans for cars and homes. Just as some of the older generation’s loans are about to be paid off, the younger generation is taking out some new loans for houses and cars. In effect, the family is rolling the principal on older loans into new loans. The family isn’t “paying down” its loans, it is rolling them over. But the family’s total income is growing, too, as new retirees are replaced by younger workforce entrants. In short, houses and cars are good investments for the typical family, and borrowing money to help the family fund good investments is perfectly sound financial practice.
Private enterprises of all sizes borrow money to help fund their growth. For centuries, small, medium, and large firms have utilized debt financing as a key growth-enhancing tool. In growing firms that continually roll their debt over, the successful investments outweigh the unsuccessful ones and revenue growth is more than sufficient to pay the interest on the growing debt. In short, the borrowed funds that help many firms finance their growth are not just harmless, but desirable for reducing the cost of capital and for accelerating growth.
State and local governments do it, too. They issue bonds to fund capital investments in schools, roads, airports, water systems, bridges, and seaports, all of which yield benefits for years into the future. (When governors—particularly those running for president—tell us they “balanced” their state budgets, they are talking about the states’ operating budgets, not their capital budgets. Operating expenses must be funded with tax receipts, but capital budgets are typically funded with the help of bond issues—i.e., by borrowing money from willing lenders.)
We could do better by shifting much of government spending towards war prevention—to bring our Asian wars to an acceptable conclusion and to protect our electric grid from cyber warfare.
The federal government invests, too. Unfortunately, the “unified” budget makes it impossible for us to separate investments from current operating expenses—which is not much of a problem, because any attempt to separate them would be a nearly fruitless exercise in green-eyeshade busywork. Many federal “investments” yield future benefits that are intangible, i.e., impossible to quantify. For example, it’s impossible to compute the present value of preventing a future catastrophe, even though much of our national security spending is precisely for that purpose. Nonetheless, successful prevention of an attack or a war is the benefit of effective spending on national security; such spending can therefore be considered a good “investment.” Other types of spending also yield intangible benefits; weather satellites, GPSs, levees, and basic research can all yield valuable benefits that improve our future, even though the benefits may be intangible, or may be dispersed indirectly throughout the private sector. But whether the benefits of any given expenditure are tangible or not, the same general principle applies: borrowing money for good investments is perfectly sound financial practice.
Of course, that begs the following important question: How can we tell if any given expenditure is a “good investment”?
Which are the good investments?
When the supposed benefits of any given investment proposal are (a) intangible, and (b) in the future, it is impossible to don one’s green eyeshades, plug all the right numbers into a spreadsheet, and calculate the net present value of the proposal. Judgment, effective administration and management, and broad indicators of financial control are all necessary ingredients for achieving success in any case, but especially for investments that yield intangible benefits. For just a few examples, try answering the following:
What is the net present value, in U.S. dollars, of…
(1) …having several days’ warning before landfall of a category 5 hurricane?
(2) …reducing the time and paperwork required to start a company?
(3) …the dollar’s status as the world’s reserve currency?
(4) …preventing a thermonuclear war between superpowers?
(5) …thwarting a cyber warfare attack on our electrical grid?
Each one of these yields real, long-term benefits even though we can’t calculate the dollar value. But the question remains: Are the benefits large enough to justify the investment? The answer relies mostly on judgment and leadership—including the question of who should do the investing, because only a few specific types of investments belong with the government instead of the private sector. Where to draw that line is a lengthy debate by itself, but there is near-universal agreement on at least one point: the responsibility for a nation’s security is a fundamental duty of government. Circling the wagons (“providing for the common defense”) has almost always been the primary reason people have agreed to form a government.
Reagan knew that, and that’s why he never backed off from his principle of peace through strength—even when that investment required some help from debt financing. In spite of the Reagan-era deficits and the difficulty of quantifying intangible benefits, the net present value of, for example, item #4 above is likely to be an extremely large positive number.
The ‘debt burden’: too high, too low, or just right?
For a successfully growing “going concern” such as a family, a company, or a government, the so-called burden of the debt is the affordability of the interest payments—not the level of the debt, or the resources it would take to pay the debt down to zero. Successfully growing families, companies, and governments can continually roll old debt into new debt commensurate with their successful growth—just as the United States has been doing since 1837. The debt burden is therefore not the debt principal; instead, it is the affordability of the interest payments. The burden increases when interest payments become less affordable, and decreases when they become more affordable.
According to the leader of the losing side of the Cold War, Reagan’s first principle of peace through strength had driven an effective investment in future U.S. security.
A good indicator of the affordability of our interest obligations is the portion of total tax receipts required to pay the interest on the debt. It gives us a reading on the debt burden in total, even though many individual programs yield intangible benefits. When the economy grows, aggregate tax receipts grow (even if tax rates don’t change), which tends to make the aggregate interest obligation more affordable. Lower interest rates have a similar effect. Conversely, higher interest rates tend to make the interest obligation less affordable, as does an increasing level of debt.
In mid-2011, it is taking just under 10 percent of federal tax receipts to pay the interest on our publicly held debt. It may come as a surprise, but that debt burden is lower than it was for the entire 20 years between 1980 and 2000. How could that be, given that today’s debt level is skyrocketing? It’s because interest rates in this sluggish economy are nearly zero—which is short-term good news, but also a warning that the debt burden should begin to climb rapidly after interest rates return to typical non-recession levels.
When is the debt burden too high? That’s difficult to answer, but it is obviously something much less than 100 percent (the point at which interest payments consume every dollar of tax receipts). Based on our track record, 20 percent seems to be a rough ceiling for comfort—as long as we stick to Reagan’s principles of investing for the long term and trusting the private sector to deliver growing prosperity in a favorable environment. With today’s debt burden of 10 percent, we have some runway remaining, but it won’t last forever.
Might a Reagan recipe work today?
Reagan’s views of government’s limited responsibilities were: to provide a secure environment for the long term, enable the free market, and invest in the financial health of the private sector.
What’s to lose? It’s true that our economic and political conditions have evolved since the 1980s; we’ve learned some things, and we need to adapt to a few new developments. For example, one necessary adaptation will be rule changes in the financial sector to prevent system-gamers from enjoying privatized profits while socializing their risks. Morally, that’s cheating—obviously not the conditions of a free market. Again, as Reagan said: “Trust ‘em, but cut the cards.” Another example: We could get a lot better at identifying government waste and reallocating those funds more productively. Nonetheless, all the necessary adaptations fit within Reagan’s fundamental principles: investing in national security; improving the private sector’s financial competitiveness; attracting capital to our economy; investing in growth-enhancing projects unaffordable by the private sector, including basic research; and finally, trusting the private sector to work within that framework to innovate, evolve, select, adapt, grow, and prosper.
A private sector that is protected, enabled, trusted, and permitted to evolve in directions that, by the way, are almost always unpredictable is the best path, arguably the only path, to long-run prosperity. As Steve Forbes said years ago, you can’t cut your way to prosperity, you’ve got to grow the economy.
Both Republicans and Democrats need to budge, just a little
Today’s Republicans unabashedly invoke Reagan’s name in their talking points and their debates, but they just can’t bring themselves to advocate a truly Reagan-like fiscal policy because it would mean admitting that deficits are acceptable under certain circumstances. Today’s GOP consists of three main factions, and Reagan’s heirs make up only two of them: the national security Republicans and the Chamber of Commerce Republicans. The new, third faction is the Tea Party—the anti-deficit, anti-spending Republicans—to whom “investment” is now just a “code word for government spending,” as if there’s no such thing as investing by government. For a contemporary Reagan recipe to have a chance, that attitude will need to change. Reagan proved that, yes, it is possible for the government to make lucrative investments for the long term. He also demonstrated that, as in the private sector, borrowing money for excellent investments is financially sound, even desirable. Debt-financed national security investments that prevent future wars are excellent investments—but, paradoxically, would be illegal if a balanced budget amendment were in place. Republicans would be well-advised to think just a little harder about what Reagan accomplished, and how he did it. Deficits and debt aren’t necessarily always bad, and quite a few Republicans need to get over it.
The debt burden is not the debt principal; instead, it is the affordability of the interest payments.
Not to be outdone, today’s Democrats—although they advocate policies exhibiting a few Reagan-like aspects—just can’t bring themselves to openly advocate boosting instead of cutting the defense budget, or to trust private sector businesses and entrepreneurs with a lower tax and regulatory burden. They say deficit spending for “investments” is desirable—which is correct as far as it goes—but they seldom if ever consider defense spending or corporate tax cuts to be investments; it’s as if money allocated by intelligent designers to prop up politically favored companies like General Motors and Solyndra is an investment in our future, but extra money spent to better protect against future military threats is not. Boosting the defense budget or simplifying business taxes and regulations should be (to a Keynesian) government “stimulus” programs with a different face. But for the new recipe to have a chance, these anti-defense and anti-corporate attitudes would have to be shelved at least temporarily. Like it or not, Keynesians must admit that the Reagan-era policies, to the extent they contributed to the deficits, were a form of stimulus in which their Keynesian multiplier was presumably at work. Reagan’s policies may have been conservative, but they were investments in the future, and also stimuli—and Democrats need to get over it.
Reagan’s conclusion—and the next president’s?
Reagan concluded his farewell address with the following, characteristically modest assessment of his tenure:
I’ve spoken of the shining city all my political life… And how stands the city on this winter night? More prosperous, more secure, and happier than it was eight years ago…
We made the city stronger. We made the city freer, and we left her in good hands. All in all, not bad, not bad at all.
A contemporary version of Reagan’s recipe might prove to be just the change we need. It would require both sides to back off their ideological rhetoric just a little; but if it can happen, the next president might be able to say something similar in a few years—one generation after Reagan was able to say it.
Now there’s something to look forward to.
Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy.
Image by Rob Green | Bergman Group
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