The Big Picture (Deficits Galore) Jude Wanniski August 26, 2003

Last week we took a big picture view of the U.S. as “King of the Mountain,” especially the unintended consequences of trying to single-handedly manage the world political economy with an emphasis on military power. This commentary extends the discussion into the realm of public finance. How does the U.S. economy support an American Empire and all that goes with it?

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The Roman Empire lasted as long as it did because men who appreciated supply-side economics constructed its foundation. Julius Caesar and his adopted son Augustus were schooled in the classical ideas that evolved at the time of Alexander the Great and his teacher, Aristotle. Julius Caesar was assassinated because he was a populist with grand ideas of sharing political power with the masses. After a period of political turbulence, Augustus picked up where his father had left off in terms of economics, but held back on the populism. His early Keynesianism was sound in the decision to drain the swamps around Rome and make it more habitable. His supply-side showed up in his commitment to monetary reform and a gold standard to replace the hodge-podge system of competing monies that brought inflation and a breakdown of moral standards. At the same time he undertook the revolutionary fiscal reform Julius had envisioned, broadening the tax base by having all of Rome paying some tax instead of having a small number pay all the taxes. The Empire thrived for more than a century in the economic boom that followed these reforms, but gradually declined thereafter as succeeding Emperors pushed taxes higher to feed their ambitions and inflated the Roman coinage. The real weakness was in the problem of political succession, with no systematic way for the Roman electorate to choose the leaders who would know how to keep the boom going.

The British Empire lasted as long as it did, roughly 200 years, because it did produce a superior system of political succession at the same time it followed classical ideas of economic management in both monetary and fiscal policies. It ran up enormous debts as it financed the war against Napoleon, but soon after the war ended the populist forces in the Parliament succeeded in rolling back taxes a bit each year and every year between 1815 and 1875. At the same time, it restored the convertibility of sterling to gold at the pre-war exchange rate, which had originally been set by Isaac Newton, the master of the Mint, in the early 18th century. Except for the dustup in the American colonies, the Crown managed the Empire rather well and with a relatively small military establishment. It did so by sharing its expertise in industrial innovation, banking and finance with its other colonies and commonwealth partners. There was an army and a navy that ruled the waves, but for the most part the Empire ran on skilled diplomacy and its wealthy open market to foreign commercial interests that would rather trade than risk acquisition by force of arms. The Empire was forced into decline by the expenses of the Great War, which grew out of the tariff wars between the monarchies on the Continent.

There is going to be an American Empire to take the world into its next stage of history, but we are now seeing how expensive it will be. “It costs to be boss” is the first lesson I learned in Political Science at UCLA in 1955 from Professor Titus, who wrote the phrase in big block letters on the chalkboard. In Monday’s New York Times we find the following headline on page 7: “Senators Say Iraq Needs More U.S. Troops and Money.” At the same time there are headlines about the growing costs of stationing an American legion in Europe and in Asia and now in Africa. The Pentagon wants a zillion-dollar missile-defense system to defend against the not-yet-built nuclear missile system of North Korea and is discouraging attempts by the State Department to solve that problem with diplomacy. All Pyongyang wants is a promise it will not be attacked by the U.S. and it will scrap its nuke program. Meanwhile, the Pentagon wants to build 30 new nuclear submarines at several billion dollars each, even though no foreign power will have a single sub anytime soon.

While the political getting is good, the military will gorge itself, just as the domestic spenders gorged themselves with Great Society spending in the LBJ/Nixon years. Everyone is entitled to pig out at the trough, especially if someone else will have to pick up the tab in another time, another Congress, another administration. The political class also has learned how great debts can be dissolved with a monetary inflation. We see the gorging on guns-and-butter taking place with new commitments on prescription drugs piled atop multi-trillion unfunded liabilities in the public and private pension systems and Medicare/Medicaid. Out of what magical cornucopia will these goodies come? In 1965, after the Kennedy tax cuts boomed the economy, I remember serious economists arguing that the problem facing the government in the years to come will be in deciding how to spend all the riches flowing into the Treasury. The Keynesians truly believed they had unlocked the secrets of perpetual economic growth. A year later, in 1966, the Dow Jones Industrials briefly hit 1000 and today, correcting for the price of gold which was then $35, the DJIA should be at 10,000 and it is still struggling to stay above 9000.

Unfortunately, there is no theory of economics that will be able to deal with perpetual deficits without perpetual negative adjustments to the national standard of living. The $480 billion deficit now being projected for the next fiscal year is nominally smaller when adjusted for the deficits of WWII, as some GOP economists now are pointing out. But WWII was a one-time financial event, not perpetual, which is what we can expect from the Pentagon’s approach to global empire. In the same way, the deficits now contemplated to fund Social Security, Medicare and the pensions of government employees, including the armed forces are perpetual. This is especially the case as life expectancy increases and innovations in medical science continue to add to the costs of both Social Security and Medicare.

For the most part, supply-side economic policies could handle the domestic costs, by dramatically increasing the capital/labor ratio as I have many times suggested. If two workers will have to support a senior in another decade, where three now do the job, a 50% increase in the C/L ratio will manage the financing with no decline in living standards. President Bush, along with House Ways and Means Chairman Bill Thomas, at least moved in the right direction with this years cuts in capital taxation, but the rest of the gap will have to take the DJIA up to 15,000 at $350 gold to roughly equate with a 50% increase in the C/L Ratio. That will require a full-scale tax reform, at least of the kind Steve Forbes and Dick Armey proposed: a simpler, flatter tax system. Or perhaps a single-source business tax of the kind Gary Robbins has been promoting may work. This would not only liberate capital now trapped in the morass of the federal tax code. It would also free for productive work that segment of the work force that lives off the complexities of the tax code.

To manage the expenses associated with an American Empire, there would be no imaginable source if the military-industrial complex ran the show as it has been doing. By provoking hostility in the global family, the costs are already evident in the direct outlays for the Pentagon and associated nation building. The hidden costs are in the reduced willingness of the U.S. economic system to take risks that could be produce negative returns, should there be a repeat of 9-11 in some form or other.

On the other hand, a benign imperium headquartered in Washington, D.C. would open up considerable sources of revenues both public and private. Instead of the rest of the world sending human capital to the United States to finance our aging population, we need a change in foreign economic policy that promotes economic growth instead of smothering it at every IMF/World Bank opportunity. Financial capital would flow out of the United States to take advantage of those opportunities in Asia, Latin America and even Africa and the dividends on that invested capital would return in time to get the baby boomers through the bubble of their retirement years. This could only realistically be done with an international monetary system keyed to a gold/dollar exchange rate. Look at the silliness now with American businessmen promoting the idea that China is a source of their miseries because they have been linking the yuan to the dollar. If the dollar/gold link had been established in 1994 when China began its fixed-dollar policy, there would have been none of the dislocations caused by the dollar and the yuan deflating and then reflating in tandem.

If national currencies around the world could fix to a dollar/gold rate, there would be an immediate release of capital that exists in every impoverished country in the world but is smothered by currency risks. China is red-hot these days because it has been released from the dollar deflation, but now must worry about U.S. policies that would drive it back into deflation either by another dollar deflation or by pressure to have it deflate on its own. Brazil, Argentina, Mexico were all thriving economies under Bretton Woods and all have been wrecked by the floating dollar. Liberia is a basket case because it has been on IMF tax programs that inflated the work force to the very top of the Laffer Curve, but nobody in Washington seems to have noticed or seems to care. Why fix Liberia (or Haiti) easily when you can send warships and troops?

These necessary economic and political reforms would not be possible if we did not have the kind of political system that could respond to necessity. In my next Big Picture essay, those possibilities will be explored.

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