Saturday, December 22, 2012

The Upside Of The Fiscal Cliff

Facing reality is positive. That’s the upside to the fiscal cliff.

There are two definite upsides to the fiscal cliff:

1. We are finally starting a national discussion of spending-taxation trade-offs

2. We are at last starting to (grudgingly) accept there is no free lunch, what I call the Free Lunch Fantasy of limitless borrowing at near-zero interest rates: taxes for upper-income wage-earners will revert to previous levels while those drawing Federal dollars must accept reductions in spending.

The last decade’s fantasy that we could borrow our way to prosperity while lowering taxes on upper-income earners (because it’s so cheap to borrow trillions at near-zero interest rates) is finally running into reality-based resistance: interest on all that debt is starting to squeeze the spending everyone wants, and long-term rates might rise despite the Federal Reserve’s constant intervention.

That would eventually raise interest costs paid by the Federal government.

How can interest rates rise if the Fed is buying much of the Federal Debt?

The first part of the answer is to accept the fiscal consequences of the Baby Boom entering Social Security and Medicare at the rate of 10,000 retirees a day: Federal spending will rise far faster than tax revenues, dwarfing the relatively minor spending cuts being discussed. Read more....

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