An Open Letter to Washington: How to Slash the Federal Budget Deficit and Save the U.S. Economy

Dear Mr. President and members of Congress:

With your policymaking actions of November and December, you have given the U.S. economy a short-term boost of adrenaline.

But these short-term gains carry a long-term cost. In the wake of the biggest financial crisis since the Great Depression, the U.S. federal government is looking at running $8 trillion in deficits over the next 10 years. If that forecast becomes a reality, the already-onerous national debt would soar to more than $20 trillion.

Given that outlook, without additional action on your part, the U.S. economy faces a precarious future and won't return to full health.

Despite these daunting prospects, there are five clear steps you can take that would revitalize the U.S. economy. These moves will help reduce unemployment, and will keep inflation at bay. But, most importantly, by effectively slashing the federal budget deficit as well as the national debt, this plan will ultimately enable the U.S. economy to regain its former competitiveness.

Success, of course, is in the details.

Short-Term Gains Will Lead to Long-Term Pain

There's little doubt that policymaking moves of late 2010 will lead to near-term gains in the New Year.

For instance, your so-called "QE2" bond-purchase plan reduces the strain of financing the U.S. federal deficit, which will free up funds for private businesses to expand. Your tax-stimulus plan eliminates a January tax increase and provides further purchasing power to the American people, boosting consumer demand and economic output.

But these short-term gains carry a long-term cost. And without additional action on your part, the U.S. economy will not return to full health.

In fact, after a few months of stimulated activity, inflation will return, bond yields will soar to uncomfortably high levels, and the U.S. recovery will be choked off – which will prolong the misery of high unemployment.

To make sure the recovery continues beyond the middle of the New Year, you need to take action in five specific areas. And you need to do so in the next few months.

Let's take a look at the areas that need attention, one at a time.

Step One: Spending Cuts a Must

First and foremost, you must cut discretionary public spending by at least $150 billion per annum (the approximate equivalent of about 1% of current gross domestic product, or GDP).

Granted, it will take more than that to restore the federal budget to balance. But – as you are well aware – a larger spending cut would be deflationary in the short term.

Besides, that $150 billion figure is a gimmick-free number. So if you engage in any of the usual "funny" accounting – shoving programs into previous fiscal years or passing liabilities onto the states – those aggregate dollar figures would have to be added to the $150 billion.

And that's not all. Any additional spending – such as the implementation costs of "Obamacare," extensions of unemployment benefits, or payouts to 9/11 first responders – has to be fully offset with additional cuts.

Step Two: Revenue Must Increase

Tough times demand tough choices. And there's one tough reality that's unavoidable: Tax increases are inevitable.

However, there are a number of possible tax increases that, far from having a negative effect on the economy, would end subsidies for activities of little economic value.

Ending the tax-deductibility of corporate debt is a big one – it only encourages damaging leverage. Another tax you could usefully institute is a small "Tobin tax" on Wall Street transactions, which would sharply reduce rent-seeking "fast trading" and derivatives activities.

There are other increases that are worth discussing, too, including the removal of the home-mortgage tax credit and the end of the tax deductibility of charitable contributions. Charitable deductions, for instance, are very inefficient in producing charitable contributions for the genuinely poor, and arguably damage education by forcing it into inefficient "non-profit" status.

Eliminate these "tax expenditures" and you can afford to make the Bush tax cuts permanent. And if you have any money left over, you could eliminate the dividend tax and reduce the estate tax to 15% to 20%. You'll be amazed how much better the economy performs with these distortions removed.

Step Three: Heed the "Deficit Commission"

All of you know that the Bowles-Simpson commission's recommendations for making the Social Security entitlement program viable over the long term make sense. So implement them.

The commission did not recommend anything useful for Medicare/Medicaid. But solving that will require you to get the tort lawyers out of medicine and to eliminate the cross-subsidizations in the medical system. But I understand that healthcare is a sensitive subject right now, so maybe leave this one for 2012 or even 2013.

Step Four: Stamp Out Wasteful Subsidies

If you really want to make the economy work better, you could remove the subsidies for agriculture and "green" energy, especially the combined subsidy and tariff for corn-based ethanol. But I understand that may be asking too much!

Step Five: End the Fed Follies

Ben Bernanke, we have not forgotten you. Keep the "quantitative easing" in place for a few months if you must, until Congress finally executes the above steps one through three and actually reduces the U.S. deficit.

But for goodness sake, please stop subsidizing borrowing at the expense of saving.

We know what you refuse to admit, that the "true" rate of inflation in the U.S. economy is now at least 3% – and rising. That means the benchmark Federal Funds rate should be at least 5%, to give savers a reasonable real return on their capital.

Put short-term interest rates at that level, and allow long-term rates to rise to their market level of around 6%, and you've given the U.S. public a proper incentive for saving. At the present time, you and Congress are combining to de-capitalize the U.S. economy, penalizing saving and encouraging huge balance-of-payments deficits. In the long run this will force U.S. wages down to emerging-market levels.

Stop doing this. Now!

The Bottom Line

I realize that I'm making some tough calls here, but none of these recommendations were made lightly.

The reality is that this country – and its economy – has to change course.

To understand the urgency – and the stakes – think of it this way: If we continue along this path and achieve the currently projected debt level of $20 trillion, every American's share of the national debt would exceed $65,000.

And that's not the half of it. According to the U.S. Congressional Budget Office (CBO) U.S. federal debt ballooned from 40% of gross domestic product (GDP) at the end of 2008 to more than 50% last year. And in a report issued last spring, the CBO warned that unless we change course, the U.S. public debt could reach 90% of the nation's economic output by 2020.

America's debt-to-GDP ratio hasn't been near the 100% level since the end of World War II, when it peaked at 109%. When Greece touched off the worldwide sovereign-debt panic last year, its debt-to-GDP ratio was right around 120%.

Even without such default fears, high debt loads stifle economic growth. In fact, one recent research study – conducted by economists Kenneth S. Rogoff of Harvard and Carmen M. Reinhart of the University of Maryland – concluded that when debt-to-GDP ratios exceed 90%, median growth rates fall by 1%, and average growth falls considerably more.

As Isabel Sawhill of the Brookings Institution noted: "The interest can get so burdensome that the country can't afford to repair its highways or educate its children or provide other essential services. You become a much weaker nation."

We can't let that happen.

But what is key to understand here isn't that this is a convenient time to act. It's the only time to act. If we allow the insane deficits to continue, and the national debt load to mount, we won't be able to act later.

If you guys take the steps that I've outlined above, you will all deserve to be re-elected and U.S. Federal Reserve Chairman Ben Bernanke will deserve another term of office in 2014.

If you don't take these steps, and the U.S. economy fails to recover, the American people will rightly react harshly in 2012.

And none of you will like the result, which will make the Tea Party seem like – well, a tea party.

Sincerely,

Martin Hutchinson
Contributing Editor
Money Morning
(www.moneymorning.com)

[Editor's Note: If you have any doubts at all about Martin Hutchinson's market calls, take a moment to consider this story.

A bit more than three years ago - late October 2007, to be exact - Hutchinson told Money Morning readers to buy gold. At the time, it was trading at less than $770 an ounce. Gold zoomed up to $1,000 an ounce - creating a nice little profit for readers who heeded the columnist's advice.

But Hutchinson wasn't done.

Just a few months later - it's now April 2008 - with gold having dropped back to the $900 level, he reiterated his call. Those who already owned gold should hold on, or buy more, he said. And those who failed to listen to him the first time around should take this opportunity to remedy their oversight, he urged.

Well, we all know where gold is trading at today - in the neighborhood of $1,380 an ounce.

For investors who heeded Hutchinson's advice, that's a pretty nice neighborhood.

Investors who bought in after his first market call are sitting on a profit of as much as 79%. Even those who waited, and bought in at the $900 level, have a gain of as much as 53%.

And let's face it, if the "Inside-the-Beltway" crowd can't change our current course, inflation will be a key part of America's future. And that means that gold, silver and other commodities are likely headed much higher.

But perhaps you don't want just "one" recommendation. Indeed, smart investors will want an ongoing access to Hutchinson's expertise. If that's the case, then The Merchant Banker Alert, Hutchinson's private advisory service, is worth your consideration.

For more information on The Merchant Banker Alert, please click here. For information about Hutchinson's new book, "Alchemists of Loss: How Modern Finance and Government Intervention Crashed the Financial System," including how to purchase the book at a 34% discount, please click here.]

News and Related Story Links:

• Money Morning Open Letter to Washington:
  An Open Letter to Washington: How to Fix the Deficit and End the Bush-Tax-Cuts Debate.
• Money Morning Commentary:
  Will America Choke on its Own Debt?
• Website:
  How to Contact Your Representative in the U.S. House.
• Money Morning "Outlook 2011" Economic-Forecast Series:
  A Bond Investment Strategy For the New Year.
• Money Morning News Archive:
  News Stories About Obamacare.
• Money Morning Investment Research:
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• Money Morning Special Report:
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• The National Commission on Fiscal Responsibility and Reform Report:
  The Moment of Truth (December 2010).
• Tutor2u.net (Economics):
  Balance-of-Payments Deficits.
• Money Morning News Analysis:
  Why the Federal Reserve's Quantitative Easing Strategy Won't Save the US Economy.
• FreeDictionary.com:
  Real Rate of Return.