Down to Earth

So what will happen to the deficit?

Some people are worried that with all that debt out there, the government will try to inflate it away. After all, if inflation raises the general price level, then all debts are devalued. That’s what happened in the late ‘60s and ‘70s.

Only, a lot has changed since then. Government benefits are now indexed to inflation. Tax rates are indexed to inflation. Most debt is short-term, and the interest on that debt would accrue more debt. And a lot of debt is now inflation-adjusted.

So accelerating inflation wouldn’t really help. We’d be in the same pickle we’re in now, only more so. And default isn’t an option. A country can default, but only if it doesn’t plan on borrowing again for decade or two.

There are really only two solutions. From 1947 through 1960, the top marginal tax rates were more than 90%. The post-war economy soared and the combination of tax-receipts and economic growth helped shrink the debt from 120% of the economy to 35%. But post-war growth is out, and I don’t think we’re going back to FDR’s taxes. The other solution? Cut discretionary spending: raise the retirement age, means-test Medicare, fold Federal pensions into Social Security.

But no one gets elected with a down-to-earth fiscal policy like tax hikes and spending cuts. So they pray for growth. But at least we know that inflation is no solution at all.

Douglas R. Tengdin, CFA
Chief Investment Officer
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