Fixing the US Budget. Here we go again.

Yesterday, a Norwegian classmate told me that the US may go bankrupt by 2020 and has 5 days to avoid a shut down...I should consider moving now. I chuckled and chose to shy away from the conspiracy, but deep down I knew there were problems that needed to be addressed. It is true that a budget needs to be signed to avoid shut down, and our fiscal path is unsustainable. Here is some background information, and alternatives to avoid the unthinkable.

On Tuesday, House Republicans proposed their budget plan for the 2011 fiscal year. It is projected to spend $3.5 trillion, $179 billion less than President Obama's plan. The goal is to balance the budget as soon as possible - Obama plans to do so by 2015. The budget proposed by the Republicans calls for a repeal of Obama-care and includes sharp cuts in Medicaid and the gradual phase out of Medicare. The WSJ provided some specific details:

People who retire after 2021 would no longer have access to Medicare, the government-run fee-for-service health-insurance program. Instead, Medicare for them would be converted into a "premium support" system, meaning beneficiaries would choose from an array of private insurance plans, with government helping pay the premium. People 55 and older would not be affected.

Medicaid would be converted into a block grant for the states. The GOP budget estimates it would save $771 billion on Medicaid over the next 10 years. It would also turn the Food Stamp program into a block grant system.

Pundits think the House Republican budget is a lost hope. It must be approved by a Democrat ruled Senate and signed by President Obama. Despite its projected decrease in government spending from the current 24% of GDP level to 22.5% next year, the specifics will be debated. It's a better alternative on paper, but politics will surely rip it apart with the possibility of putting us back on an unsustainable path - stalling the process for sake of re-election. Let's face it, people are not ready for strict austerity measures. Both budgets lack qualitative support. The programs that are cut or eventually phased out remain inefficient. Any thought as to what drives the cost? Some programs pose great externalities, where one cut may have a ripple effect on greater economic conditions. The structure of government services needs to be efficient - using less to serve more. The demand for a smarter government trumps the argument for a mere decrease in size.

President Obama called an eleven hour meeting to fix the budget and avoid government shut down. The current goal is to cut $33 billion for this year. House Republicans argue that this is not enough. The pressure is on to make bold moves, not little cuts here and there, we need a complete revamp of social programs. The focus needs to be on costs more so than revenue. A sustainable plan will need to bend the cost curve instead of just increasing revenue to pay for something that doesn't work. This calls for better talks with the private sector who provide the services in which we subsidize. Fueling demand for costly services does nothing to solve the problem - the government can make the necessary investments to create a  more efficient social services market.

There are talks of raising the debt ceiling from $14 trillion to $15 trillion for the seventh consecutive year. Nonsensical to do so as it continues the problem. We need to work within tight standards to force responsible action. Treasury Secretary Geithner argues that if the debt ceiling is not raised, there will be substantial negative effects. This coming from the guy who is in charge of selling US debt. There is an underlying interest here. The Dollar's stance as the reserve currency provides the US with the ability to run deficits and acquire more debt. But with the increasing prospects of Dollar reserve alternatives, the US needs to start taking precautionary measures to prevent a collapse. A good indicator of market jitters is the slowing demand for municipal bonds. The WSJ reports that last week was the slowest quarter for municipal bond issuance in eleven years. Local government is in fiscal disarray and its not flattering to borrowers. Continuing low interest rate levels is also a contributing factor to low demand for government debt, as borrowers don't see economic improvement by Fed standards in the near term. Most importantly, private sector borrowers don't see the possibility of greater gains through interest rates, and thus shift focus to savings or foreign investments (emerging markets anyone?). However, there are improvements as the savings rate recently declined, and employment picks up.

Private investment needs to be at the forefront of the US recovery plan. The WSJ  reports:

When private investment is high, unemployment is low. In 2006, investment—business fixed investment plus residential investment—as a share of GDP was high, at 17%, and unemployment was low, at 5%. By 2010 private investment as a share of GDP was down to 12%, and unemployment was up to more than 9%. In the year 2000, investment as a share of GDP was 17% while unemployment averaged around 4%. This is a regular pattern.

The article goes on to say that historically, increased government spending crowds out private investment. The government has the responsibility to encourage productivity by getting the economy back on track so that investors will fuel growth. Not necessarily a rate hike to create the false image of recovery (as this can do a lot of harm messing with the emotions of investors). We need to create a productive environment that will stimulate expectations of rate hikes and further economic growth. Employment, housing, smaller and smarter government that spends less, and business growth are among the many variables that will contribute to our comeback.

* Above charts from WSJ. See links for full articles.