Laurence Kotlikoff on Debt, Default, and the Federal Government's Finances
Jan 13 2014

Laurence Kotlikoff of Boston University talks with EconTalk host Russ Roberts about the fiscal health of the federal government of the United States. Kotlikoff argues that the U.S. government is essentially bankrupt because future taxes will fall hundreds of trillions of dollars short of expected expenditures. Kotlikoff argues this problem can be solved by redesigning our tax code, but without changes such as this, large reductions in spending or large increases in tax rates will be necessary.

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Don Boudreaux of George Mason University talks with EconTalk host Russ Roberts about the nature of public debt. One view is that there is no burden of the public debt as long as the purchasers of U.S. debt are fellow...
Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Mark Wonsil
Jan 13 2014 at 10:08am

I’m glad to hear more people sounding the alarm on the mounting debt issue. (No pun intended) Excellent guest!

One question for Mr. Kotlikoff: Why are libertarians held to a higher standard when it comes to a safety net? The whole idea of liberty and personal choice is thrown out because there is no guaranteed safety net and yet thousands of people fall through the cracks of our publicly funded education, health, and protection systems. Why do we feel better about ourselves in light of these expensive and sad public sector failures?

Jan 13 2014 at 10:17am

Social Security is so easy to fix that it doesn’t warrant serious worry.

Just raise the retirement age until the system balances.

Mom keeps getting her check.

You’re promised that you won’t outlive your savings, not that you’ll get a forty year vacation at the end of your life.

Everybody can save for an average retirement; nobody can save for the longest possible retirement.

SS fills that gap. It’s insurance against outliving your savings.

If you want to retire earlier, bridge the age gap with additional savings of your own on your own dime.

Ice Cliff
Jan 13 2014 at 10:45am

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Jan 13 2014 at 10:51am

It seems that the problem would be easy for most of us to fix but not within the current political environment, at least not until voters really feel the problem good and hard. Meaning the only option is to wait until the Treasury cannot sell all the bonds that they need to sell, then the fix becomes politically possible.
Cut military spending by 50%, I doubt that would hurt defense, give all retirees the same SS payout, that would not hurt the poor retirees. Combine all fed. gov. medical spending into a single program to increase power to set prices and refuse to pay for treatments that do not have strong evidence of efficacy these combined could cut medical spending by at least 50%. Also muscle the states into easing medical licensing and practice riles and other medical regulation.

Raise a carbon tax.

You cannot do any of that now but should t-bills fail to sell it should become easier.

Why Eliminating the Deficit is Technically Easy but Still Politically Impossible

Jan 13 2014 at 10:57am

@rhhardin another easy way to fix SS would be take the total income from each month’s FICA and divide it by the number of recipients and send that amount to each recipient the next month. It is easy but any politician who would be part of enacting that would find himself replaced by someone who would have not part in it.

Steve Metcalf
Jan 13 2014 at 11:24am

Very frank presentation by Kotlikoff, who joins others like the Peterson Institute to wake Americans up. We have a Congress for higher – legislators who will sell their souls and the Nation’s welfare to retain their positions.

One of reasons the overwhelming debt message doesn’t gain traction is that most people do not understand the internal workings of the Fed and are not permitted to see much transactional detail. They, therefore, cannot connect the dots from quantitative easing (QE) to certain inflation. Kotlikoff again failed to delineate the linkage in specific detail.

If the Fed used all principle and interest payments resulting from the treasury securities it purchased in QE to repay the unrepresented liability it sustained in crediting “fairy dust” reserves for QE securities purchases, the pot would be right and the money supply would return to a legitimate, uninflated level in time.

On the other hand, if the Fed merely “tears up the treasuries at maturity, as Kotlikoff suggests, the money supply will have been permanently increased resulting in considerable inflation just as soon as the market herd instinct shifts… which it surely will.

A probe into, and reporting of, those internal Fed mechanics is what honest legislators in Congress, who cared more about their duty to the Nation than their jobs, would make.

Jan 13 2014 at 1:08pm

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Jan 13 2014 at 1:28pm

Rookie question: When we talk about “present value” of the “net obligations of the govt.”, is there a standard time period and discount rate used by budget wonks? What are these numbers for the purposes of this podcast?


Jan 13 2014 at 3:41pm

BTW I do not think that future medicare and SS payments should really be considered debt. In reality congress can spend as little as they want to on those programs even if tere was a real promise who could force the Fed Gov. to not renege? So the real problem is the voting power of seniors.

Michael Byrnes
Jan 13 2014 at 8:45pm

I don’t think it’s especially useful to talk about a “$206 trillion fiscal gap” as if it is an actual debt we owe. It’s not.

I think Stein’s Law (“if something cannot go on forever, it will stop”) is the right way to think about issues such as this. This $206 billion fiscal gap is an extrapolation of current trends… but that’s unrealistic. We don’t know exactly what changes will happen, but we can be certain that the only wy we run up $206 trillion in debt is if we can afford it.

Health care will not grow faster than the economy forever.

When the amount of money spent on Social Security benefits rises far enough above the amount of social security tax collected, benefits will be cut – and making those cuts will suddenly look quite good to the politicans even though it is unthinkable today.

That’s not to say these issues aren’t problems that will somehow need to be solved.

I think that ultimately we will move, one way or another, towards a system of “semi-retirement” for most people in their 60s and early 70s.

Russ Roberts
Jan 13 2014 at 11:09pm

Thomas L Holaday,

You find it impossible to avoid thinking that my desire to return to a government nearer to that of the Founders means I want to return to slavery?

Please try thinking something else. Try to imagine a world where someone who wants smaller government actually hates slavery as much as you do.

Large powerful centralized governments have a poor track record respecting human dignity. Slavery was maintained by the power of the state. I actually believe that reducing the power of the state means a smaller chance of monstrous acts like slavery and genocide. I may be wrong, of course. But please don’t misunderstand my motives or the outcomes I desire.

Al B.
Jan 14 2014 at 6:16am

In 1857, Abraham Lincoln wrote this about the authors of our Declaration of Independence:

They did not mean to assert the obvious untruth that all were then actually enjoying that equality, nor yet that they were about to confer it immediately upon them. In fact, they had no power to confer such a boon. They meant simply to declare the right; so that the enforcement of it might follow as fast as circumstances should permit.

Mr. Holaday, which is more monstrous: The Founders risking their blood and treasure to leave a country more free than the one they were born into; or the most prosperous society in human history, so reluctant to suffer any discomfort that we chose to seize the unearned wealth of unborn generations, willingly subjugating them to a poorer future with fewer opportunities and less freedom than we now enjoy?

Jan 14 2014 at 11:44am

Drs. Kotlikoff and Roberts very clearly demonstrate differences in fundamental assumptions.

Dr. Kotlikoff assumes that the debt problems facing the country are primarily technical — and can thus be solved a series of plans, carefully crafted by the best technicians (those with PhDs in economics). And his hope is that a politician will step forward that will embrace the right technocratic plans and solve the problem.

Dr. Roberts assumes that the problem is political (hence his referral to incentives), and thus plans won’t solve it. He also has made clear over the course of his program that believes that informational difficulties are insurmountable in an economy.

There’s little common ground other than agreeing that there’s a problem.

I have my biases, and I tend to agree with Dr. Roberts. So the “Purple Plans” look more like “Rainbow Fantasies” to my eye. They contain statements like “all investing [of Social Security] will be done by a single government computer at zero cost.” Even assuming this just means “zero explicit transaction cost charged to the investor’s account,” this is utter nonsense, and rife with many practical problems. Based on my reading of these plans, I do not believe Dr. Kotlikoff’s approach is the slightest bit realistic.

John Covil
Jan 14 2014 at 11:56am

…people like Art Laffer who say that you can cut taxes presumably to zero and get more revenue; and then you’ve got people like Paul Krugman who say you can spend as much as you want and it will pay for itself…

(emphasis added)

Maybe they did, but did either of these men actually say these things? These struck me as strawmen. Unfortunately, they were in the middle of a longish rant, and I don’t think there was time to challenge them.

All-in-all, a minor quibble. I’ve enjoyed it so far, but haven’t yet finished (just listened to about halfway on the way back from picking up lunch).

Jan 14 2014 at 12:53pm

While I was encouraged to hear a guest that is legitimately concerned about the unsustainable nature of our current fiscal/monetary trajectory, I was struck by his naivete regarding nearly everything beyond that broad observation. For example, the idea that the current economic malaise could have been avoided if, after Lehman, “everyone was put in a room and told that nothing is wrong and there is no need to sell assets or fire people” demonstrates a fundamental misunderstanding of the issues underlying the crisis, and seems to be leading him to very bizarre solutions.

It is debt that fragilizes the system and makes it vulnerable to runs like we had with Lehman, not the other way around. We can control the level of debt, but we can neither predict when sudden losses of confidence will occur, nor control them once they have. This is exactly the kind of hubris that got us to where we are, and what causes those without skin in the game (economists, bankers) to wildly underestimate risk in economic/financial domains.

Jan 14 2014 at 1:11pm

@john covil

I noticed that as well. It sounded like a caricature of Art Laffer’s position. If you actually look at it though it’s preposterous. Laffer has soul pointed out that higher marginal income tax rates provide a disincentive to labor and that at some point you can raise the rates high enough that they will no longer be revenue maximizing.

Reasonable people can disagree as to where this point is, but Laffer, to my knowledge, has ever said the revenue maximizing point is zero.

Big Dog
Jan 14 2014 at 4:44pm

I don’t like the example Dr. Kotlikoff used when illustrating the problem with private charity. The man with a broken arm in the street is a brief, one-time event. In that kind of situation, I’m sure there are plenty of times everyone just sat around wanting the man to be helped, but hoping someone else would do it. However, the problems of poverty, education, care for the elderly etc. are not one-time events; they are continuous, and have been continuing for a very long time. If nobody does anything to help solve these problems after some period of time, and a person sincerely cares about those problems, you’d think that person would eventually give up the hope of another person taking care of it. That person would have to realize at some point it is up to them if they want it to be done. The hope of other people taking care of it can’t last forever (again, that is if they sincerely care about the problem).

Here’s another example you could use. Let’s say there is a bomb in a building that’s 3 minutes away from detonating. To defuse it, somebody has to go to up a ladder and press a button. I don’t think the time period of everyone waiting for someone else to go up the ladder will last very long.

More often I think the hope of having someone else take care of “public” problems is an excuse we use to convince ourselves that we care about some noble cause when in reality, we don’t care enough to do anything about it.

Jan 14 2014 at 7:23pm

Prof. Roberts asked an important question that I don’t feel was fully answered. That is if everyone sees the debt and expects default via high inflation then why are interest rates so low?

Stating that bond traders just want to keep their jobs, so will ignore risk until everyone sees that risk seems like an incomplete answer.

Did anyone else find that point a bit puzzling?

Greg G
Jan 14 2014 at 8:33pm


Interest rates are low because there is a shortage of credit worthy borrowers. Lenders must choose from the options that are available to them, not the ones they wish were available to them. U.S. Gov’t is still the tallest midget and probably will be for the foreseeable future.

Jan 14 2014 at 9:06pm

Thank you for a fascinating discussion. However I have trouble understanding how the money supply could be only $2B if the fed just injected $5B with QE over the last five years. I’m probably misunderstanding what M1 means, but this kind of funny economist math likely turns off many layman.

Are there any other metrics available to communicate how bad the problem is? For example, a person earning 2x the mean income would have to pay twice as much tax starting today? Or four times more tax if we wait five years? The layman likely needs a metric that is more accessible before political will to fix the problem can develop

Jan 14 2014 at 10:07pm

Would it be helpful to take a slice of daily life today and one thirty years hence? In both there would be a certain amount of resources and a complex political and social mechanism to distribute them. The two hundred trillion debt is a metaphor indicating excess comsumption today which could have been used by the next generation. Most of the wealth and the debt in “two hundred trillion” is virtual and can be ignored on both sides of the ledger(with virtual tears). In Herman Daly’s(and my) full world those present resources are being wasted. The future generation will not be indebted just pissed off.

Jan 15 2014 at 1:20am


A huge amount of the money created by the Fed is actually deposited with them as excess reserves. That money is not currently circulating, and I am pretty certain it is not counted in M1. This lack of circulation is one of the reasons inflation has been held in check. There simply is no velocity behind the new money.

Adam S
Jan 15 2014 at 2:43am

While I greatly appreciate a senior, distinguished economist proposes a balance of increased taxation and lower spending to resolve the debt crisis, I don’t think Dr Kotlikoff is the most personable advocate.

Basically what I got from Dr Kotlikoff was “A and B’s ideas were/are crap, X and Y are censoring information from the public, and only I have the ability to see through the smoke and mirrors.” When in actuality, he doesn’t. The data is publicly available. Politicians might have incentive to obscure it but journalists and economists can still access the raw data. Nearly all financial types are fully aware of the Fed’s actions and still choose to invest.

This wasn’t my favorite interview, Dr. Kotlikoff seemed way too “know it all”-y and was way too eager disparage the work of credible economists like Krugman or Laffer. Too much “the end is nigh” with out acknowledging that hey, maybe some of these crackpot economic ideas I don’t agree with might have some positive influence.

And -10 pts for referring to a genius new program that can fit on a postcard. That cliche is wearing thin, friend.

Sri Hari
Jan 16 2014 at 12:52am

You need to take some the intervewees to task for providing simplistic answers to the crisis. Kotlokoff is one of them!!

William Black in an earlier podcast has clearly explained to us the root of the crisis is dishonest underwriting rules and bad incentives.

Honest underwriting demands the buyer and seller conduct proper due diligence on the enterprises. Now, deliberate concealing of true facts and dishonest underwriting do not attract criminal sanctions. Banks made fraudulent loans, Treasury consistently lied on the capacity of the economy to repay borrowings by government, Feds lied on the need to expand monetary base. Banks lent to enterprises which were loss making in the long run, but pretended it was all kosher.

Bring back the criminal sanctions for bad underwriting within all financial institutions including treasury and federal reserve. This will cause massive political upheaval, since the entire political system is funded by the these finical institutions directly or indirectly.

Shawn Barnhart
Jan 16 2014 at 7:28am

I am not an economist only an interested layman, so this may sound ignorant but I’m curious about the risks of inflation. It seems to me that the notion that there will or should be inflation because of QE type policies is referred to reflexively as an iron-clad law of economics.

Others have posted explanations as to why it isn’t happening, but this leaves me to wonder — there seems to be a certain alarmism about inflation being a near certainty, yet it doesn’t happen for various reasons. If it doesn’t happen, does that mean that there should be less alarm about its probability?

It seems to me that it may be more complex with far more mitigating factors given the size and complexity of the US economy and its interrelationships with the world economy. If it is much closer to the we-should-be-alarmed end of the spectrum, it may be that our economy can handle much more money injection than we think it can.

Note, I’m not arguing in favor of these Fed policies, I think they seem to have other problems but perhaps risk of inflation is farther down the list.

Eric B
Jan 16 2014 at 9:41am

There are several alarming points discussed here that I was not aware of.

  • Paul Krugman (and therefore Obama, in my opinion) is advocating crude Keynesianism (that is, that Keynes himself would not have advocated)
  • The circumstances around the Bush administration’s implementation of Medicare Part D

Just to name two. Thank you, this was an excellent podcast.

Jan 16 2014 at 2:13pm

I think this issue deserves a somewhat more humble spokesperson. Has Kotlikoff never seen a country run by technocrats? To claim that “we know how to do it, we just need smart people in there” comes from a simplistic world view which doesn’t take into account issues like collective action, human psychology, or factionalism of any kind. Reality is not optional.

It’s also odd to me that someone who has been *somewhat* involved in the political process would dismiss all of this with a wave of the hand and a prayer for the “right” leader.

Jan 16 2014 at 3:27pm

So economists are going to save us, eh? Kotlikoff is that most frustrating brand of intellectual, the kind who can describe a problem in clear-headed detail but then goes on, in the same breath, to offer more of the same utopian, top-down prescriptions that got us in to the predicament. What a disappointment.

Mort Dubois
Jan 16 2014 at 3:44pm

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Augusto Lucarelli
Jan 16 2014 at 5:52pm

A reading for Professor Kotlikoff. He is still trapped in a fixed rate exchange perspective…..time to move on!

Jan 16 2014 at 5:54pm

Struggled to listen to this without getting irritated to be honest. I’m not particularly libertarian or conservative in my economics, considering myself a pretty conventional New Keynesian, but have always enjoyed listening to EconTalk without agreeing with the guests’ or hosts’ opinions a lot of the time. What annoyed me was the misrepresentation of opposing opinions in this episode.

I’m used to intelligent debate on this podcast and Keynesian economics being dismissed by people who don’t agree with it – which I welcome as a challenge to my views. I expect more from this podcast than the straw man dismissal of Laffer (0% tax maximises revenue) and Krugman (gov spending always pays for itself).

What annoyed me particularly was the comment that people who are advocating fiscal policy don’t have any theoretical framework for this. Having studied New Keynesian models, there is a clear theoretical framework for fiscal policy now.

By all means disagree with these ideas but don’t fail to engage with them and misrepresent them offhand. It puts off all but those who agree already, and falls below the normal standards of this podcast.

Jan 16 2014 at 10:46pm

The problem is not that those in charge are mistaken and think they are doing the right thing, the problem is that they don’t care. They serve the people who put them in office. A better plan will not help us.

I would like to hear more discussion of America’s fiscal situation.

Jan 21 2014 at 12:42am

I had trouble taking Prof. Kotlikoff seriously because he kept repeating $205 trillion without giving a description of how he reached that number.

Jan 22 2014 at 12:39pm

I have a problem with his $200T number versus the 17 (or 12; whichever) trillion commonly quoted one – the 17T is money that has already been borrowed, but the 200T is money that will need to be borrowed over the next 50 years (or however many years he used to calculate it) in order to abide by current legislation. Legislation can change though, new laws can be passed which supersede or repeal old laws and thus change the amount that will be borrowed.

In other words there’s a difference between a treasury-bond-promise and a social-security-law-promise. If the US govt reneges on the latter in order to satisfy the former it won’t affect their credit rating nearly as much as the reverse.

Jan 28 2014 at 8:55am

@Russ “I don’t think they are bending the cost curve.”

There is some evidence to the contrary.
Health Care Spending Growth Is Slow For Third Straight Year

Ric Caselli
Jan 29 2014 at 12:59pm

The grandchildren of the German hyperinflation are doing just fine… This is a problem only for Boomers and post-boomers like me.

Mr. Boomer, where were you when they wiped out the pensions of the flight attendants so you can have affordable flights to your cruise?

Inflation and currency devaluation is just the system taking care of itself, and like Russ said didn’t prevent the great depression to resolve itself.

Ron Crossland
Jan 30 2014 at 9:39am

The analogical reasoning in this discussion was strained it appears to me. Comparing the economics of a person, a business, and a government as if they were exactly the same is problematic. These type of comparisons can reduce complexity to a more simple and easy to see process, but the reality is all three economic levels have significant differences. To reason that government should operate like a person or a business has some fundamental fallacies.

I would have been interested in hearing more about the world economy. The entire discussion was centered on the US books, not the US portion of the world economy (and which other countries have future debts like ours). Russ did ask why US bonds were still purchased, but the discussion trailed away from answering that well, seeming to always revert to some level of quasi-conspiratorial reasoning.

Feb 7 2014 at 10:30am

I had a high opinion of Kotlikoff before I listened to this, not so much afterwards.

He argued that everything would be great if we just put the economists in charge. Russ pointed out one big problem with this, public choice incentive problems. Larry went on to show another big problem when the next thing he did was argue with Russ about public goods, showing that economists do not in fact agree about everything.

Kotlikoff insisted several times that the Fed is monetizing the debt. I wish Russ had pushed him here- a big reason inflation has not taken off is that markets expect that the Fed will sell off Treasury bonds within a few years. QE is countercyclical policy. You may or may not like it as countercyclical policy, but it is clear that their bond purchases are not meant to be permanent.

Feb 8 2014 at 1:38pm

Having reviewed several purple plans I see a world run by economists would involve higher taxes, mandated participation in markets, and several other things I would prefer did not evolve. This must be compromise in our modern world.

This was an unusual podcast because even when we have guests that run against me politically I tend to learn a lot and gain insights into their thinking. This was not the case here. Very little was new and much of it was presented in too rigid a fashion.

I am not a libertarian but found the jibe at libertarians otherworldly. Claiming that charity will not happen based on free rider problems while simultaneously knowing that charity happens on a huge scale means the theory is not working here. Even more perplexing is that free market leaning people tend to do more charity – further complicating this explanation for the un observed theoretical world.

Finally I do strongly agree with the guest that a society which steals from their children is deeply immoral. Politicians who debt finance current projects with little strategic value should be strung up. I can understand debt to finance a war of civilization but for drugs, healthcare, solar energy companies? I hope a future world will openly vilify these monsters as much as I do. At least my grandchildren could have that comfort.

Adam H.
Feb 10 2014 at 12:38pm

I just got around to listening to this podcast, and was very disappointed for reasons similar to those posted previously. I tried searching other sources, but couldn’t find where Kotlikoff’s claim of a $205T present-value budget shortfall came from, and I couldn’t find any other economist who agreed with him. The CBO’s alternative fiscal scenario extended forecast is serious (1.9:1 debt-to-GDP ratio in 25 years given somewhat pessimistic assumptions), but not as dire as Kotlikoff thinks it is and doesn’t match his $205T present-value debt claim.

Some economists have been warning since before QE was implemented that it would produce inflation, while others have said that monetary expansion isn’t inflationary when economic growth is constrained by an AD shortfall. Whether that explanation is correct or not for current low inflation, I seriously doubt Kotlikoff’s claim that it will produce inflation now that the policy is implemented or that herd mentality is preventing bond traders from capitalizing on inflation expectations. As one of my econ professors was fond of saying: when the market contradicts your theory, you should reexamine your theory rather than blame the market.

NPR’s Planet Money recently reported that QE is causing inflation, but only in countries like Brazil that didn’t have high unemployment.

Daniel E
Feb 11 2014 at 9:52am

Adam H, I had the same problem trying to validate the $205T number. While I don’t disagree that our fiscal policy is horrible, I don’t think it is quite as dire as Kotlikoff indicates. Total federal disbursements for the 2014 fiscal year are projected to be just short of $3.8 trillion. While social security and medicare outlays are expected to swell as the mass of boomers hit retirement age, I find it hard to believe that our non-debt obligations would equate to 50 years of total governmental outlays. I think his number more realistically includes only the forecasted outlays as “accrued” to government pension, social security, and medicare participants without considering the future tax receipts.

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Podcast Episode Highlights
0:33Intro. [Recording date: January 6, 2014.] Russ: Before we get started I want to encourage you again to send me your favorite episodes of 2013. Send me an email at with the word 'Favorites' in the subject line. List 5 favorites. You can find all the episodes listed in chronological order by going to which will list all 400-plus episodes of EconTalk. They are all available online, despite the fact that some of them I was a less skilled interviewer. They are all up there, going back to 2006.
1:16Russ: Now, you've been writing for some time about America's fiscal problems. A lot of people disagree about how serious those problems are. You argue that they are serious. How bad is it? Guest: I think it's terrible. I think we are probably in worse fiscal shape and any developed country. The reason, Russ, is we've been piling up debts for over 6 decades; and when I say 'we' I'm referring to Republican and Democratic administrations and Congresses. And we've been hiding them. We've been keeping them off the books and using economic labels, words, to pretend that they are not real liabilities of the government. To give you an example, take the Social Security checks that your mother might be collecting right now. My mom is 94; she gets a monthly check. There is no way that anybody's going to take her check away. This is a payment that's coming from the Federal government. It comes in the form of a Treasury check, a check from the Treasury, which is a color yellow on green, and it looks just like the checks that come from the Treasury that are called principle plus interest payments on official government debt. But only the checks that are called principle plus interest payments on Treasury debt are being reported in terms of their value in the present--their present value--as being an official liability of the government. So we have all these obligations to something like 30-40 million current retirees and close to 80 million baby boomers who are about to start collecting Social Security benefits if they haven't already. All those obligations are not reported as part of the government's debt, so we are missing those off-the-book obligations. The accounting here is much worse, far worse than anything that Bernie Madoff, who ran that big pension Ponzi scheme engaged in, and anything that Enron engaged in. It's really horrendous because the true debts of the country total about $205 trillion. The official debt that's being reported is only about $12 trillion--it's in the hands of the public, the debt in the hands of the public. So we're missing the vast majority of the obligations. And this $205 trillion 'fiscal gap', which is what economists refer to this as, which is all the liabilities to paying my mom's Social Security benefits, your grandmother's Social Security benefits, etc., all the Medicare, Medicaid, other spending obligations--defense spending, paying for the President's lunch--those are all obligations. They are going to have to be paid. And then if we net out all the future taxes that are going to be coming in as projected, in both cases by the Congressional Budget Office (CBO), when you see in present value, the value in the present of this net obligation being $205 trillion. So we are in terrible shape. Our GDP (Gross Domestic Product), the national output that we produce, is about $17 trillion--we are talking about $205 trillion, which is many times a single year's GDP. We would have to raise taxes by close to 60% immediately and permanently, every single Federal tax, to come up with $205 trillion in present value. So the country really is bankrupt and nobody sees it because of the bookkeeping. Russ: Well, that sounds horrible. But a couple of thoughts seem a little cheerier. One is, this has been true for a long time. The major cause of this gap is the generosity of these promises combined with the magnitude of the number of people who are going to be owed these promises--that is, the baby boomers, which would be me, among those 80 million. I'm happy, by the way, to give mine up or to take less; but most people don't feel that way, as you point out. Most people expect to get that money. And the government would be very hard pressed--politicians would be very hard pressed--not to keep those promises. But we've done that for a long time, haven't we? So one is, if it's really a problem, why hasn't it reared its ugly head; and in particular, if we are really bankrupt, why do people keep buying our bonds, and happily, at low interest rates? Guest: First question you had is, our issue here that you are raising is the fact that we've had this problem for a long time. It's true we've had the problem for a long time, but it's getting worse every year and at an accelerating pace because we have 78 million baby boomers who are about to collect on average about $40,000 in today's dollars when they are fully retired. So the fiscal gap this year could easily rise by $6 trillion because we are not paying it off--it's like your credit card bill; if you don't pay it off you have to pay interest on it. It gets bigger. If you don't pay the interest what you owe gets bigger. We are not paying the interest, let alone paying the principle of this obligation. So, because we are getting closer, the problem is getting closer, put it this way: I'm 62 as I speak with you right now. I'll be collecting my Social Security benefits in 8 years. Ten years ago I was 52. That problem was further off. It's value in the present ten years ago was smaller. So, because of the aging interacting with growth of the benefit levels for [?] health care, interacting with the number of baby boomers poised to collect benefits, these things are making the problem acute. We are getting very close to--we're not bankrupt in 20 years. We're really bankrupt today. It's just like Detroit. They could probably get by for a little bit longer, maybe a couple more years; they could sell off their art museum and some other things and squeeze by. But basically they are looking at the future and saying, 'Gee, we can't cover all the expenditures with the revenues we are going to be getting in, so we are bankrupt, and we are bankrupt right now.' And if you look at our situation, many, many economists have looked at it and come up with really the same answer, that we are doing phony-baloney accounting and that we actually are broke. And we need to get our fiscal house in order immediately. This doesn't mean that we can't invest in critical things that we need to investment in like education, infrastructure, research and development. But we may need to raise taxes; and I think we do need to raise taxes. But we also have to cut some of the spending. We have to get our health care spending in particular under control, but in a way that doesn't leave people uninsured. Russ: That'll be challenging. As we see right now. Guest: I have proposals--these are not bills before Congress or anything like that, but I have proposals that I've laid out for how to fix health care and stay within 10% of GDP. I wrote a book called The Health Care Fix--very simple plan, fits on a postcard; it's been endorsed by five Nobel Prize winners and many, many economists, top economists who aren't Nobel Prize winners. There are ways to fix these problems without and still give people a terrific policy and not have to go broke. But we don't have political leaders who are willing to say, look, you've got a system which is so screwed up you have to basically eliminate it and start from scratch, build from scratch. Rather than taking a bridge which is about to collapse and patching it up and then you know for sure you are going to have a disaster; it's going to collapse at some point. Better to knock it down and build a safe one.
10:11Russ: I don't disagree with that. But let me try to find--make sure I've got the numbers right and what the implications are for other kinds of spending. The fiscal gap, what you are calling the fiscal gap, is $206 trillion, approximately? Guest: No, $205 trillion. Russ: Oh, phew. I thought it was 206. So $205. The amount of publicly admitted debt, the number that gets published when they say what's the debt--the debt you say is $12. I know there is a debate about how to measure that; some of that is being held now quite a bit at the Fed. Guest: Yes. So, just on that point: the gross debt is about $17 trillion. So the Treasury has borrowed about $17 trillion cumulatively from the public. But then the Fed has printed up about $5 trillion dollars' worth of dollar bills and bought that money. In effect they printed up $5 trillion and handed it to the Treasury to spend, because the Treasury takes that, when it issues debt, if the head of the Treasury, Secretary Lew, were to borrow some money from you right now, let's say he borrows $10,000 from you right now, Russ, he gets the $10,000 bucks. Now he's sitting there with an IOU. And then the Federal Reserve Chairman Bernanke [N.B. Yellen was not yet confirmed by Congress at the time this episode was recorded.--Econlib Ed.] comes and prints $10,000 bucks and buys back that IOU from you. Okay? So had the $10,000; you give it to Lew, the Treasury Secretary; now you are sitting here with an IOU, a government bond; Bernanke hands you $10000 bucks and takes back the IOU. Now, if you look at this shell game, you are still at the end of the day sitting there with the $10,000 bucks that you started with. Treasury Secretary has $10,000 bucks. And the Federal Reserve has this piece of paper which they can rip up. So what's gone on here is that the Federal Reserve has just been printing money, in this case, and in general, to pay the government's bills. And when countries are broke, that's what they resort to. They get their Central Bank just to print money, and eventually it leads to high inflation, hyperinflation. If you look at Argentina today; if you look at Zimbabwe, you look at countries that can't afford what they are trying to spend; they resort to central bank money creation. And that's what we've got going on in the United States right now. We've got the Federal Reserve printing up $0.29 for every dollar that's being spent by Uncle Sam. The Federal Reserve, which is printing $0.29 cents of it out of thin air. So that's another problem that we face, which is very high inflation because all the money that's being printed and all the money the Fed will need to continue to print in order to help pay the government's bills because the bills are out of control and the taxes are too low to cover the bills. Russ: But the optimist would respond and say, I think two things. The optimist would say: There isn't any inflation. We've printed $5 trillion and look, there's been nothing. So there's nothing to worry about. And they'd also say--and this is what I'd like to get at with the numbers' precision--if the actual true indebtedness of the United States is $217 trillion--is the fiscal gap $205 over the $12 or $205 over the $17? Guest: $205 versus the $12. Russ: Okay. So $205 is the extra amount that we need relative to the $12? Guest: It includes the $12. Russ: Okay. So we really owe $205; but we only publicly admit to owing $12. Guest: The $205 is the net number. It's net of all the future taxes to pay it. Russ: I understand. So one unfortunate consequence of that arithmetic is, I think--and I'm not on this side, but many are: 'Well, then we don't have to worry about the $12. That's nothing. So in the short run we need to get the economy going; we have to borrow more money, or print more money, it doesn't matter; we need to get the economy going; we've got too many people unemployed.' And what people are worrying about, about the deficit or the debt in any one year--a trillion dollar addition to our debt each year, roughly, in the last 4 years--that's nothing. It's the difference between $212 and $204--forget it. That's a rounding error. What's your response to those two points--inflation and the 'therefore we should be spending like crazy now?' Guest: Economies are slow to adjust and recognize realities, but when they do, things happen pretty quickly. So, right now you have folks on Wall Street, they see these problems but they are waiting for other people on Wall Street to see them. And I just spoke with about 50 bond traders, and they are very interested in whether or not the government is broke and whether or not we are going to have inflation. And what the true fiscal situation is. So I tell them about that; they have a lot of questions. Then they ask me at the end of the session: What do other bond traders think? And: What are the other bond traders going to [?]? Russ: Sure. Guest: What they are interested in is making money in a pack and losing money in a pack, and if you have a bond trader that loses money by himself, he loses his job. If other people lose money with him, no problem. So at some point the entire bond market will flip and we will have interest rates go up and we'll have inflation take off. The United States cannot indefinitely print, pay for these obligations with money creation. It can't print $205 trillion dollars. The basic money supply, which is called M1 as you know--let's see: today's M1 is probably about $2 trillion or so. It's not $200 trillion; it's not $10 trillion. So there's a limit to how much money is able to going to be printed, and it may be a few years before everybody understands it. But over time the official deficit will start getting bigger and bigger. If you look at the CBO's projections of our fiscal affairs, which is called their 'Alternative Fiscal Scenario Projection', and they've done their best to hide this from the public. But they put out what's called the 'Baseline Extended Budget Forecast,' based on forecast which is a complete fabrication of what they really think; and they also have put out, but rather quietly, this Alternative Fiscal Scenario, which shows the official debt, as it's currently measured, exploding through time. Russ: And the difference between the two is that the so-called 'baseline' has assumptions that have never held for very long, assumptions about cuts in payments to doctors for Medicaid and Medicare and things like that, right? That's what the difference between the Baseline and the Alternative. The Baseline is this rosy think that "everyone agrees" is not true. Guest: Yes. Exactly. Everyone in the CBO agrees it is not true. But that's why they have this Alternative Fiscal Scenario that shows just [?]. And even with the Baseline Extended Forecast you've got a $50 trillion dollar fiscal gap. It's a quarter of the right number but it's still very big. Wall Street somehow failed to see the crash in 1987; they seemed to fail to see the crash in 1929; in 2008 they didn't see the crash. The value of Lehman Brothers' stock was quite high even a month or two before it went to $0. Bear Sterns' stock was quite high even a week before it went down the tubes to like $2 a share. So, Wall Street is not a place to look for perspicacity in terms of what's coming, honest or reasonable forecasts of what's coming. They are always behind the 8 ball, as far as I can tell. But the CBO doesn't lie. The demographics don't lie. At least the CBO doesn't lie when it comes to their Alternative Fiscal Scenario. They are saying, look, you've got this many baby boomers, 78 million. They are going to be collecting Medicare, Medicaid, Social Security benefits. And we can reasonably say how big they are; and they are going to collect them at these dates; and that's going to be like $3 trillion each year in today's dollars when they are fully retired. That's a huge amount of money that we are not prepared for. This is just like Detroit saying these firemen and policemen and teachers, and it knows pension payments to, and ignoring the fact that obligation is around the corner; and then they turn the corner and they can't pay those bills. And they declare bankruptcy. So how does the United States declare bankruptcy? Well, it's declaring it by printing money. Because that's the easiest thing to do.
20:28Russ: I agree with you. But wouldn't Ben Bernanke and other economists of stature argue--I don't agree with them, but don't they argue that: Of course in the long run there are going to be some problems but we are going to grow a lot in the meanwhile. We'll have some political solutions. The main thing right now is to get the economy back to health, to get growth back in the 3-4% range, which would help reduce this problem. Guest: Russ, the CBO projections already incorporate the economy getting back to full employment within a couple of years. So even if you spent extra money now to get the economy back to full employment a little bit faster, and you could do that--it would pay for itself, which is the kind of Keynesian magic that Paul Krugman of the New York Times' op ed page has been selling, kind of demand side magic, voodoo economics as I would view it, you'd still have an enormous fiscal gap. It's not like these problems are going to go away. The CBO is already projecting the economy will be back to full employment in a couple of years. So it's not that you can spend your way out of this problem or cut taxes out of your way of this problem. What we've got is a vast populace of economists who have been well trained who think that people on the far right and the far left who are getting so much press attention when it comes to economic policy pronouncements, that's people like Art Laffer who say that you can cut taxes presumably to zero and get more revenue; and then you've got people like Paul Krugman who say you can spend as much as you want and it will pay for itself, the economy will expand so rapidly it will pay for itself. Well, the vast majority of economists think this is voodoo economics and they don't believe it. And there's no real evidence to support it. We've spent a lot of money, wasted a lot of money, given much bigger bills to our kids, and it hasn't turned the economy around. Because the economy really, in my view--and I'm not a full-fledged macroeconomist, so there's my [?] disagree--but I think the economy is very fickle. If everybody believes there are going to be bad times, they take individual actions to make that happen. If they believe there will be good times, they'll get that to happen. So you have Lehman Brothers fail on September 15, 2008. It fails. And everybody in the press and the politicians start talking about the Great Depression. And the searches on Google spike like crazy for the Great Depression. And very quickly employers start laying off vast numbers of people. Now, if you look at it in physical terms, Lehman Brothers' building didn't collapse; none of the people were killed. Nothing physical happened to the economy's productive capacity. But all these employers started hearing stories about the Great Depression, and they said: I'm going to have to fire my employees, my workers, before my customers don't show up; I'm going to get ahead of this problem. And over the next 19 months 8.5 million Americans were thrown onto the streets, were laid off, in droves--700,000 a month, almost a million people a month were being laid off at the end of 2008. Now that's a coordinated failure. That's coordination failure--everybody coordinates in bad times, making them happen. And spending more money to fix things, having this TARP (Troubled Asset Relief Program) bill that Henry Paulson put forth, $700 billion to try and save Wall Street, having the Federal Reserve engage in great, fantastic and unprecedented money printing to try and save the economy, have the President come up with the Cash for Clunkers, this big stimulus bill--all this stuff may have scared the economy even more and kept the economy in a state of fear. When Roosevelt said fear--what is it? Russ: 'We have nothing to fear but fear itself.' Guest: I think that's the most insightful few words about the actual macroeconomy that anybody's ever stated. Right now the economy is doing better. It's not because of the Fed policy, I don't think, of printing a lot of money and keeping interest rates low, or the government's extension of unemployment benefits or any of its spending. I think it's because people have been pessimistic for a long time and it's hard to keep Americans down psychologically. And now they are just a little bit more upbeat and they are turning things around.
25:42Russ: Well, I think there's something to that. When people ask me if the Great Depression wasn't ended by WWII, which I don't think it was--I think that's a very difficult case to make--and if it wasn't ended by the New Deal, which I don't think it was, they say, 'Well, what did end it?' And I always say: People got tired of being depressed and pessimistic. They said: Let's go invest in something; let's take a chance. So I do think animal spirits--that's an untestable theory, though. Pretty untestable. People have tried to test some aspects of it. Ironically, it's a Keynesian story to some extent: it's a story about animal spirits. And I think they do matter. We don't know how much is the problem. Guest: It's not a Keynesian story. It's a Keynes story. Keynes himself [?] in his book and it's kind of like the Bible, you can make of it what you want--we are talking about the General Theory of Employment and Prices, his masterwork. It's written in a way that anybody can take anything from it. But Keynes himself rejected simple Keynesianism, crude Keynesianism of the kind that Paul Krugman is advocating. You've got people like Krugman and Larry Summers and other economists on what I would say the far Left or at least the Left who say we just need to spend more and more money to get the economy turned around. But the funny thing is they don't give you any theoretical framework for where that's coming from. The standard Keynesian model is one in which prices are supposed to be too high--either regular retail prices for consumption goods and services or wages are being set too high. But when Lehman Brothers failed in 2008, I don't know anybody, any employers, who went out and raised their prices sky high or any unions or set of workers who started setting their wages too high. And the prescription that comes from models where wages are set too high, yes, is to spend more money or to print more money. But that's not the right description or set of conditions that we are looking at. We are looking at collective panic that led to this recession. And their spending more money and printing more paper is not necessarily going to alleviate the panic. It may deepen the panic. So, what President Bush should have done the day after Lehman Brothers failed is to have [?] New York, all the press conference right in front of the Lehman Brothers building, and say: 'Take a look at this building; has it fallen down? It still looks pretty solid to me; I'm going to tap on its wall and see if it crumbles. And look at all these people walking out of the building. Yeah, they've been fired, but they are going to go get new jobs. And if you in the country want to panic and bring the economy down and sell all your assets at fire sale prices, we, the government, are going to buy up all those stocks and bonds that you are selling for nothing and print money; and [?] low-paying bonds; we'll print money, and we'll make a killing in the market. So, be my guest. Step right up.' Russ: But you know what actually did happen is that most of the people who worked at Lehman Brothers were re-hired by Barclay's, who bought the building. Barclays didn't buy Lehman Brothers, but my understanding is they rented or bought the floor that Lehman Brothers was on. But a lot of the same people. They avoided all the obligations that they didn't want to take on if they'd bought the actual company. Guest: So, had the President explained that, and said, 'Look, it's still in operation. If you are worried about the banking system collapsing, we've got a huge bank that can handle all your transactions called the Federal Reserve, the bank of banks. You need to use a bank, use this one.' Okay? But he didn't get it across to the public to calm the public. He left the public panicked. He said, basically, the sky is falling in. And he said this in a public way. And he panicked himself, and so did all his Cabinet Members. And of course, President Obama--well, he was a candidate at the time--was also interested in making this out to be a [?] of problems and he could come and fix it. But nobody seems to put their finger on the problem like Roosevelt did. You would have thought, you know, if I had been the President I would have not only gone to New York and talked about the [?] but I would have taken the top talents and employers, the ones who had the most employees, put them in a big room, had NFL (National Football League) football players at each doorway to keep people from leaving. I would have let them leave had they really insisted on leaving, but when physically [?] them, but I'd make clear that I wanted them to stay. And then I would start talking to them about not firing anybody. About turning this situation around. And not only hiring back who they just fired, but hiring more people. And if they all do it, guess what? They would all have more customers. Because but they have to do it [?] together; I would talk about collective, coordinated hiring as a policy to engage in. Russ: Yeah, that's called jawboning. Meaning persuasion without the use of force. It doesn't have a great history in political effectiveness. Guest: Well, it had a good history when President Kennedy used it with the steel companies, as you know, in the early 1960s, to keep prices down. And Hoover tried this to some extent, but I don't know if it was that effective or if we had the communication technology to try and make a sociodrama[?] the entire country could see. Russ: But we didn't have the NFL, either, so they could easily have got out of the room. Guest: Uh, yeah. Exactly. Russ: Sorry about that.
31:52Russ: So, let me ask you a different question. We are talking about the longer run perspective. Of course, the long run can come tomorrow. If I understand you correctly, you are saying: In these kinds of situations, things are fine until they are not. And then suddenly, the case of Greece being an example, or other, many, many examples throughout history, countries, banks, institutions look okay; and then all of a sudden they are not. They lose confidence; and that process is not well understood. Guest: Right. Russ: I get listeners who ask me, they send me email saying: Well, what's the level of debt we can run and be okay? Russ: And I always respond: There's no such number; it's a psychological factor. So why don't you talk about that and talk about the Reinhart and Rogoff work, which seemed to suggest to some people that there is maybe a cutoff at which point things start to get, at least, negative for growth. But is there any cutoff for a precipitous fall off the table? Guest: Well, I think if people really understood the situation the fall off the table would have been 20 years ago or 10 years ago. Or certainly today. So, we have here, in capacity--the government hasn't made clear, it's intentionally not made clear for decades, what the true fiscal position is. The fiscal gap that thousands of economists advocate, that we start[?] reporting at a government level--those numbers-- Russ: But this isn't a secret. Not only does every EconTalk listener this week know about it, but every economist knows about it. Most pundits know about it. Every politician knows about it. It's true there are people in Dubuque, Iowa who are leading normal lives because they have too many things to do aren't paying attention to it. Guest: I don't know but the CBO put out its Alternative Fiscal Scenario, its Extended Baseline Forecast, in October, and they didn't reveal the Alternative Fiscal Scenario until people like myself started screaming at them. Two days later they stick it into an Excel spread sheet. Meanwhile the press reports that the country's fiscal policy looks pretty good. So, I don't think they know about it. I think they've been intentionally--I think the government has intentionally kept this information out of the public's eye. I prepared a fiscal gap and generational accounting analysis because--why generational accounting? Because the fiscal gap, if it's not paid for by current adults, will be left or be dumped into the laps of our kids. So Alan Auerbach and I, and Jagadeesh Gokhale, Alan's a professor at Berkeley, I'm at Boston University, Gokhale is now at Cato but he was at the time a grad student with me at Boston U., we did a study in the first full year of the Clinton Administration's term on fiscal gap accounting, to be included in the President's budget. And that document, which we worked on with the OMB (Office of Management and Budget) staff the entire fall of 1993 was censored by Gene Sperling, who was the Deputy Director of the National Economic Council, two days before it was supposed to be included in the President's budget. So, you tell me why that happened. Now, Sperling, under this Administration has been made Head of the National Economic Council--I'm not sure he still is, but he has been director. Under George W. Bush, Treasury Secretary Paul O'Neill commissioned a fiscal gap study; had a team of economists working on it for almost a year; put together the study. It was supposed to be published in the President's budget. December 7, 2002, they fire O'Neill. Dick Cheney, who was the Vice President, announced that O'Neill was leaving--you know, one thing the guy resigned or anything. It was a very insulting way that he fired Secretary O'Neill. Anyway, two days later, the guys preparing the study find out that that's not going to be in the President's budget any more. So this is two examples of censorship of the truth. That if you look at how Medicare Part D was introduced into legislation and how Rick Foster, who was the Chief Actuary at Medicare, how he was muzzled, he'll tell you--just google it. So I'm not saying we have a collective conspiracy of everybody in Washington to hide the truth. But we've seen enough real examples of people lying and hiding the truth and censoring the facts to know that the public doesn't know it's being kept in the dark.
36:57Russ: Well, I agree that the public doesn't know precisely what the numbers are. But I think a lot of people know that they are roughly, that they are "large." But I think the other question is there are people in our profession who argue that they are no big deal: 'They are large, but it's okay. It's not a big problem. Those are the folks who don't understand.' Guest: I don't understand these people, either. I don't know if they've got kids or grandkids, [?]. There are some people in the profession who think we can just print money up forever without any implications, that we won't ever have inflation. Now it could be that everybody in the world for the next 200 years starts wanting to use more and more dollars and we can just print them and take back all their goods and services just for printing money. That's a possibility. So there are extreme scenarios. But in the history of the world we haven't seen any country able to get by with running a fiscal policy like this, that is this out of control and involves this much printing of money. We've basically quadrupled, increased by a factor of roughly 4, what's called the monetary base, the amount of money that the Federal Reserve prints. And most of that right now is being held in the banks as reserves. But it could get loose and get into the bloodstream of the economy and start leading to price increases. Or people could just decide tomorrow that the government's printing money like crazy, which it is to pay for its bills, and therefore we are going to have an inflation and therefore I'm not going to stop holding long-term government bonds and nominal bonds, and I'm going to start turning money into a hot potato. And overnight inflation could take off because people think inflation is going to take off. And here again we have psychology with respect to the timing. Russ: What about in the shorter run? Let's talk about the $12 trillion that is owed in Treasuries, which if I understand it is financed in very short-term ways and world over. Which means that when interest rates begin to rise, which of course the Fed has been diligently keeping them down--at least that's the claim--our interest costs in the very near future--forget 2030 when the baby boomers are swelling in very, very large numbers. In very short order we could have some fiscal issues just because of the Treasuries, correct? Guest: Well, the Treasury debt, which is $12 trillion, about 70% of GDP, if that was our only problem we would have not a big problem paying off that debt over time. But we have your Medicare benefits to pay, your neighbor's Medicaid benefits, your Social Security benefits; Obamacare could turn out to be enormously expensive. We are not organizing getting everybody health insurance in a way that fixes a total spending cap-- Russ: I don't think they are bending the cost curve. Guest: No, they are not. So this is just irresponsible behavior on the parts of politicians of both sides who are trying to get the elderly's vote. When President Bush introduced Medicare Part D, which is prescription drug insurance for the elderly, he didn't produce an extra $15 trillion, add another $15 trillion to the fiscal gap. He didn't ask a single old person, including Warren Buffett to pay a penny for this extra form of social insurance. Now I think that older people need to have insurance against very high costs of paying for their medications. But I don't think that the bills should be left to some poor kids who are being born today or being born in 10 years. And that's what we are doing. So a lot of people like to portray this as the Right vs. the Left, the poor vs. the rich, but it's really adults vs. children. The government has engaged for decades, both parties, in take-as-you-go policies, each generation of all people gets to take from the young people and the young people are told, 'Don't worry, you'll get your chance to take from your kids when you are older.' Russ: It's a beautiful social contract. Guest: Yeah. Russ: I've always found it mildly offensive, compared to a true family relationship but some people can romanticize it. It's interesting. Guest: Generational theft. And it's all under the rug. And we have the [?] running rampant throughout the Federal government in terms of its accounting but also in the banking system. Nobody knows what any of these banks hold in terms of assets. There's no disclosure. The fact that Bear Stearns could be worth a lot of money a week before it bailed and worth nothing the day it failed--well, it didn't actually formally fail; it got bought up by J.P. Morgan Chase. The fact that it could move that quickly means that nobody had any idea whatsoever about the true assets that it held and what the value of those was. The whole thing was [?] banking--we believe that Bear Stearns has valuable assets because Bear Stearns tells us that it has valuable assets. Right up to the point where everybody says, I'm not sure but what I'm really not sure about is whether anybody else is sure, and I'm worried that they are going to pull their money out. So we had the hedge funds engage in a run on Bear Stearns because they thought other hedge funds were running. So, bingo. That's the fragility of the banking system, and that interacting with the leverage permitted the entire financial system basically to fall apart at a moment's notice because of the opacity. Nobody knew what those banks had. Just like if you go back to 1982 with the Tylenol scare. Are you familiar with that? Russ: I am. Guest: Okay. So what happened there was 4 bottles of Tylenol were tainted with cyanide in a couple of drug stores in Chicago. And 7 people died in short order from buying these bottles. And all around the world we had 30 million bottles of Tylenol. And everybody decided overnight all around the world--in Thailand where there are shelves, drugs [?]--that Tylenol was tainted because what was important about those Tylenol bottles was that there were no safety seals at that point. So there was no real disclosure as to what was in those bottles. Johnson & Johnson lost $100 million; they threw away all that Tylenol; 30 million bottles they recalled, threw it away, and put on safety seals, and put Tylenol back into the marketplace. And they did by putting on safety seals was to disclose what was inside the bottle. Russ: More or less. I'll just say more or less. But I'll take your point. Guest: More or less. Russ: It's not 100% still but it's higher than before, because a stranger couldn't walk into a drug store in Chicago and inject something into a bottle once it was on the shelf. Guest: Yeah, I'm sure you are right. And somebody inside Johnson & Johnson could still try and-- Russ: Correct. It's an interesting point. There's an enormous amount of trust inherent in our economic system no matter what. Guest: Yeah. But overnight we had the Tylenol market disappear, and it was because of poor bottles. And overnight we had an entire financial system fall apart because of some rumors about buyer loans and no-doc bonds and ninja loans, many of which were true, but we to this day don't know the extent of the fraudulent mortgages. But it doesn't take much when you have no information about what these banks hold to have everybody run on them. And that's what happened. And that's what needs to be fixed. We need to have financial reform--I call it 'limited purpose banking', which requires the banks to fully disclose everything they are holding and also to have no leverage--to be fully equity financed. And this is called mutual fund banking--that's another term for it; equity finance, mutual fund banking. But that's probably for another day. Russ: It is, but it's a very interesting issue and we've talked about it on this program.
45:49Russ: I want to go back to the issue of the fiscal gap. Let's talk about government spending and the lack of transparency. Let's accept the point that this is--well, actually, let's forget whether my point is true or not. I could be right; you could be right; maybe people could be aware of it, maybe they aren't, maybe they are. We don't know. But let's suppose that at one point we do wake up either because there's more transparency, or because we realize that, oh my gosh, it really is a problem; the long run is here. And we have a serious fiscal problem. I'd like two pieces of analysis from you. One is, what do you think we ought to do in the face of the problem; and what do you think we would do in the face of the problem, if it were more widely known? Guest: Well, we need to have fundamental structural reform of our tax system, our Social Security system, our health care system. So, I have a series of plans. They are not yet legislation so I am not advocating specifics of bills at this point; but they are called the Purple Plans, if listeners want to go to They are called purple because they are designed to appeal to both people in the Right, who are red, and people on the Left, who are blue, and mixing red and blue leads to purple. So these are very simple plans that would eliminate the fiscal gap and produce fundamental reform in the tax system. I have a tax proposal there that involves consumption taxation. But I've come up with one recently which involves fixing up the income taxes, and that's called the Common Sense Tax. So, is the place to go to see that proposal. So, there are ways that this can be fixed. If we leave it in the hands of economists like you and me. You and I, Russ, could fix this country in a matter of weeks if we had complete dictatorial power-- Russ: I'm not as optimistic as you are. Guest: [?] screw things up. How else [?] the actual institutions are in this country, they could not be more poorly designed, and they are designed to drive us broke. Russ: But let's take the two parts, the two big pieces of the puzzle: taxes and spending. I'm a classical liberal. I want a much smaller government. It's easy for me to solve the problem. It would make a lot of people unhappy. I'd be killed probably or certainly thrown out of office. If I were a dictator there would probably be a coup. But it's easy for me to suggest a way to solve this problem, which is I don't believe in public provision of retirement benefits. I think that's infantilizing. I think people should stand on their own two feet. I think there should be charity for people who don't want to or who can't or who have bad luck, and so I have no problem with privately-organized aid to people. But it's easy for me to describe ways that government spending could shrink dramatically. I think defense spending is way too big; I don't think there should be farm subsidies. Those are easy to describe. The real issue is: Is there a way to make the system work under something remotely like the actual political constraints that we face? Now, yes, you and I could design a much better tax system, a much more effective tax system that didn't award accountants and tax lawyers and that didn't award special interests with special favors. A consumption tax. There are twenty that are better than we have now, that are easy to describe. Yes. But even those, it seems to me, would only raise a fairly limited amount of money relative to the amount of fiscal gap we are talking about. So ultimately--and again, Liberals and Conservatives disagree about this saying no--but it seems to me the promises to those baby boomers, that's a big problem. Without the reduction in spending, either means-testing Social Security and Medicare, which would be the obvious way to fix this and that's my prediction about how it will get fixed. There's really no other way to do it. Do you disagree with that? Guest: The problem is if we don't do this, really fix these systems fundamentally, we are going to end up with marginal tax rates that are sky high. They may not be explicit, but they are going to be implicit. Like for example, the Obamacare plan that's now being implemented, one of its problems is that it has very large subsidies but every dollar that you earn, you lose a lot of money in a subsidy if you are in that range where you are getting a subsidy. I've seen estimates of $0.25 on the dollar. So it's like an extra 25% marginal tax that people are facing. So you can easily get people onto the 60% marginal tax bracket. And if we keep raising these effective marginal taxes to 75, 80%, you'll have nobody with any interest in working. It will be a total mess. So what we need to do is get control of the spending, limit on the growth in health care spending, but do it in a way that everybody has a basic plan, health insurance plan; and have an efficient tax system that doesn't involve armies of lawyers and accountants to screw around with it. And have a Social Security system that people can understand. The Social Security system has thousands upon thousands of rules that nobody can remotely decipher. And it's completely underfunded; it's in probably worse shape by itself than Detroit is. If you look at it, it's 32% underfinanced, if you look at Table 4.B6 of the trustees report. We have to figure out what--both Republicans and Democrats at this point have agreed that we need a Social Security system; we need to force people that save and have some basic retirement income. They've all agreed effectively that we need to have universal health insurance. And there's consensus really that we shouldn't have a tax system that's crazy, but we want to have one that's progressive. Our system I don't think is all that progressive, if you really look at it carefully. Russ: It's somewhat progressive. Guest: Somewhat. But there's actually more consensus among these two sides. What's lacking is plans for how to fix them, because you've got 535 members of Congress, not a single one of them is a Ph.D. in economics. So they've made a mess. So it's time for them to start listening to economists now. You say it's not going to happen--they are not going to listen to me.
52:37Russ: No, I said something worse than that. I said it would probably be better if they didn't. I like you; I haven't looked into the Purple Plans. They sound like they might be okay. I might like them relative to the current situation. But there are a lot of other economists you don't like. So I'm not really confident that if they start listening to economists, they will listen to the right ones. And I really don't think that the economists, once they have the opportunity to steer things, are going to steer them the way their textbooks or hearts or family values to care for their children and grandchildren would have them do. Don't you think that's the problem? Don't you think every member of Congress understands what a marginal tax rate is? Don't you think they understand that our tax system is rife with complexity? And they like it that way. It's not because they don't understand it. It's good for them. Guest: I think your understanding--I think that's an overstatement. You take the 535 members of Congress and you show them the equation for the benefit for a married person under Social Security, the mathematical equation, which has got 10 functions on the right-hand side; some are minimum functions; some are maximum functions; they are certainly not smooth functions. One is in four dimensions. They will have no idea right now, as we speak, of the complexity of the system that they've produced, of the fact that people can't remotely understand what they have put into place. Russ: I agree with that. Guest: The degree of knowledge about what they've actually done and what's going on is very limited. And it's time for economists to help save the country. So I have a different perspective. I think we need to prescribe solutions, not just describe the problems. And we can do it; and there is hope. And frankly, I realize that your libertarian views aren't necessarily the same as my views about what should be done, but you libertarians have a fundamental problem that you don't seem to get, I think, which is that you are altruistic; you care about people; and when people care about other people we have the free rider problem. Who is going to take care of other people? You say charity. But if I care about that person who has got a broken arm laying in the street, and I know you do, I let you go out and try and help them; and then you let me go out and try and help them. And the guy stays there in the street with a broken arm. That's what we have--it's a public good taking care of that person. Russ: That's one explanation. That's the textbook explanation. It's not the only explanation. Because we see lots of examples in our economy despite the size of government, despite the intensity, the government does lots of things crowding out private initiative--we see lots of areas where people donate and give and volunteer even though there's an incentive to free ride. Now, that means it's not as large as it would be. I certainly don't disagree with that. I certainly agree that private aid to the poor would not be as large as the government's budget for education. But that has nothing to do, fortunately, with how much education we get. We live in a world right now where public education is free, out of pocket, to every American, and yet people donate to private charities to give scholarships to kids to get them out of those "free" schools because they are so horrific. They don't free ride. They free ride maybe in the amount they give; they don't give the full amount they'd give if they could collectivize. Guest: I agree with you. We do have a lot of charity and people are very kind-hearted and they do go out in the street and grab that person with a broken arm. But it's not a guarantee. And so I think that we have to recognize that we are going to have the government involved pretty heavily in the economy. It has to be done at--you are right, a much more efficient scale and a smaller scale so it doesn't drive us broke. And that can happen. There is reason to be optimistic. There is also reason-- Russ: Before you add on, let's do the optimistic part. Guest: Well, you know--I think we need to have a politician come forward, and I think there are politicians I've met with in Washington who do embrace real radical reforms that can fix our problems and are looking at plans that I've proposed and that others are proposing and taking them seriously. So I'm keeping my fingers crossed and still fighting the good fight.
57:14Russ: I don't disagree with that in the sense that I do think it's possible that when things get really horrible, the normal interactions of the political parties and the 'where's mine' impulse that everybody has and that the political process tends to pamper--right? We live in a world where people have a temptation to live at the trough. And that includes my profession, our profession, the economists, who get a tremendous subsidy in my opinion through government. Our salaries are dramatically higher than they would be in a free market. So I think we're as bad as everybody else. But maybe there would come a day where things were so horrific that people would say, maybe we need to band together, and not just say: Where's mine? And that will require a change in our political incentives, is what I believe. It may also require a visionary. Which is a very tragic thing to count on, because most visionaries don't turn out to be very visionary, Left or Right. They always disappoint us. So to count on that visionary--my fantasy version of it is that visionary steps forward and says, We have to go back the Constitution; government does too many things that aren't allowed by it; we've got to go back to the values of the Founders. And that's a fantasy. I like the fantasy. But it's probably not going to happen. I don't know if we are going to get any other kind of visionary that would do any different in terms of improving things. I'm not sure any of them are realistic. One who listens to good economists is going to be a very difficult President to stay in office, it would seem to me. Guest: Me, too. But I do think that the problem is not going to get--if we wait for everybody in the country to recognize the situation it will be too late. Herb Stein, who was the Chairman of the Council of Economic Advisers under Nixon said that things that can't go on will stop. But what he really should have said is that things that can't go on will stop too late. And the hour is far beyond too late. We don't have a crisis in 20 years or 30 years or 10 years. We had a crisis 10 years ago, 15 years ago. We've got a disaster right now, and we have to fix it right now.

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