An Age of Illusionists

An Age of Illusionists

By Steve H. Hanke

Watching Barack Obama and Mitt Romney duel in the presidential campaign should have convinced the spectators that we live in an age of illusionists. Few of the assertions and conjectures thrown around have been subjected to what the political chattering classes deem to be the indignity of factual verification.

As a point of departure from illusion to factual reality, I present the accompanying chart, which traces the evolution of federal government expenditures, as a percent of GDP, since 1952. Based on the data, from 1952 until 2008 – when President Obama was first elected – we would expect, with an assurance of 95%, that the relative size of the federal government would fall in a range of 16.5% to 23.4% (see the accompanying chart).

US Federal Expenditures as Percent of GDP

Since President Obama’s election, in 2008, the federal government has been in uncharted territory. Today, for example, federal government expenditures, as a percent of GDP, register at 24.3%. This is nine tenths of a percentage point higher than the high end (23.4%) of the so-called 95% historical range. For many people and businesses, this unusually elevated level of government spending is a source of uncertainty and anxiety.

Before proceeding, another inconvenient little fact must be mentioned. The economic cost of a dollar’s worth of government expenditures is more than a dollar, because taxes must be imposed to finance government expenditures. These taxes impose distortions (costs) on the economy, and these distortions cut the economy’s potential and reduce economic productivity. The costs created by taxes are referred to as the “excess burden” of taxation.

Since 1992, even the White House Office of Management and Budget (OMB) has recognized the existence of the excess burden. For purposes of evaluating federal projects, the OMB requires that an excess burden of 20% be employed. A wide range of scholarly research indicates that the average excess burden of the federal tax system is actually closer to 35%. Accordingly, the real economic cost of a dollar’s worth of federal spending is $1.35, not $1.00. To put this fact into context requires us to expand the level of government expenditures by 35%. After we do that, federal government expenditures, as a percent of GDP (including the excess burden of taxes), rise from their current level of 24.3% to a whopping 32.8%. By adding this little inconvenient fact into the mix, the “big” versus “small” government debate comes into sharper relief.

The accompanying table allows for a more precise look at the fiscal record of U.S. Presidents. Let us begin with President Bill Clinton. The Clinton presidency was marked by the most dramatic decline in the federal government’s share of the U.S. economy since Harry Truman left office. The Clinton administration reduced the relative size of government by 3.9 percentage points. Since 1952, no other president has even come close. At the end of his second term, President Clinton’s big squeeze left the size of government, as a percent of GDP, at 18.2%.

Percentage Point Changes in US Federal Expenditures as Percent of GDP

What is noteworthy is that the squeeze was not only in defense spending, but also in non-defense expenditures. Indeed, the non-defense squeeze accounted for 2.2 percentage points of President Clinton’s 3.9 total percentage point reduction in the relative size of the federal government. Since 1952, the only other President who has been able to reduce non-defense expenditures was Ronald Reagan.

The Clinton squeeze didn’t last long, however. By President George W. Bush’s second year in office, the federal government’s expenditures (both defense and non-defense) were exploding. By the time he left office, his administration had added a whopping 2.6 percentage points (equally split between defense and non-defense expenditures) to the federal government’s share of the economy.

With President Obama, the size and scope of the federal government has expanded at an accelerating rate. In his first four years, President Obama has operated in the twilight zone, with government expenditures, as a percent of GDP, exceeding the top of the 95% historical range in each year of his first term. In just four years, President Obama’s administration has added a record 3.5 percentage points to the federal government’s share of the economy. It took George W. Bush eight years to reach what was then a near-record increase (2.6 percentage points).

The astounding thing about this brief account of the evolution of the relative size of the federal government is President Clinton’s change of mind. During his presidency, Clinton squeezed and squeezed hard, and his rhetoric matched his actions. Recall that in his 1996 State of the Union address, he declared that “the era of big government is over.”

By contrast, the champion of “big government” – in both rhetoric and deeds – is President Obama. And who was a champion of the President’s reelection? None other than President Clinton – the illusionist?

This brings us to the sharp pencil people in the Obama administration, specifically the OMB. They claim to know what the relative size of the federal government will be in 2016, at the end of President Obama’s term. According to the OMB’s plans, the federal government, as a percent of GDP should be 22.5%. That’s a 1.8 percentage point drop from the current level. Given that President Obama’s first term recorded a record growth in the relative size of the federal government, and that the President campaigned on a platform of more big government, it is doubtful that he will come close to meeting his own OMB forecasts, in his second term. Yes, the illusionists, not the President’s sharp pencil people, will probably carry the day.

What will make the President’s task even more onerous is money – as in the money supply. It turns out that the Obama administration, led by U.S. Treasury Secretary Timothy Geithner, has embraced the imposition of more stringent capital requirements on banks. And, the Obama administration isn’t alone. All the major powers have backed the use of Basel III bank capital requirements. These elevated bank capitalization mandates, when applied in the middle of a slump, are misguided and dangerous. They have forced banks to deleverage on a massive scale. In consequence, bank money (the portion of the money supply created by the banking system) has contracted in most countries. And, since this portion of the money supply is so much larger than that accounted for by state money (the portion of the money supply produced by central banks), the net result has been a tight monetary reality in most countries – with a few exceptions, such as Canada, Germany, and several Asian countries. This explains why we are witnessing so many credit crunches at the same time central banks are pouring out liquidity.

The Obama administration (and the Bernanke-led Federal Reserve) isn’t the first to be caught wrong-footed by the embrace of more stringent bank capital requirements. In 1988, Basel I was approved. It had been supported by President George H.W. Bush and then-chairman of the Fed Alan Greenspan. As the accompanying chart shows, the money supply growth rate slowed sharply in anticipation of the more stringent capital requirements, as banks reined in loan growth. The result was a mild recession; one that cost H.W. Bush a second term.  In the case of both Basel I and Basel III, the illusion of “safer banks” ultimately weakened the economy and made the banks less safe.

Divisia M4 Excluding Treasuries (DM4-)

Back to Basel III and President Obama’s money supply woes. As the accompanying chart shows, the Fed has dramatically increased the supply of state money since the fall of 2008, when Lehman Brothers collapsed. But, state money (monetary base) only makes up roughly 15% of the total U.S. money supply. Bank money is the elephant in the room, and due to the anticipation of more stringent capital requirements (Basel III), bank money has been contracting. In consequence, the total money supply (Divisia M4, excluding treasuries) has slumped.

Since money dominates, the economy has failed to ever recover to its trend rate of growth. A U.S. growth recession – growth, but below the trend rate – at best, will make it very difficult to push government expenditures, as a percent of GDP, down into the normal range, let alone reach the fanciful OMB target of 22.5% by 2016. It would seem that the President’s promises of future cuts are nothing more than an election-year illusion.

Divisia M4 Excluding Treasuries (DM4-) and Monetary Base (MB)

Thanks to Basel III, the U.S. money supply isn’t the only one creating growth headwinds. Europe faces significant money supply deficiencies (see the accompanying table).

Eurozone Money Supply Gaps

It’s no surprise that the Eurozone has just fallen into a recession. When it comes to the money supply, just about the only bright spots are in Asia (see the accompanying table).

Money Supply Gaps - Selected Countries

Will Asia continue to be the world’s locomotive? We will have to wait and see. At present, though, one thing is certain – an age of illusionists has arrived.

 

Steve H. Hanke is a Professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C.

Add Comment

By posting your comment, you agree to abide by our Posting rules

Text

Comments (26)

  • Automatic Transmission July 13, 2013 at 4:59 am

    My husband and i were delighted when Albert managed to deal with his researching through the precious recommendations he was given using your web pages. It’s not at all simplistic to just possibly be releasing tactics that a number of people could have been selling. Therefore we take into account we have got the website owner to give thanks to because of that. All of the illustrations you made, the simple site menu, the friendships your site help to instill – it’s got everything overwhelming, and it’s really aiding our son in addition to us reckon that this matter is excellent, which is especially mandatory. Thank you for all!

    Reply
  • amplificadores valvulados July 13, 2013 at 8:12 am

    Great post. I was checking continuously this blog and I am impressed! Very useful information specially the last part :) I care for such information much. I was looking for this particular information for a long time. Thank you and best of luck.

    Reply
  • suggestions pertaining to July 15, 2013 at 4:25 pm

    You actually make it seem so easy along with your presentation but I to find this topic to be really one thing which I believe I’d never understand. It kind of feels too complex and very large for me. I am taking a look forward on your subsequent publish, I¡¦ll attempt to get the hang of it!

    Reply
  • Financial Services July 18, 2013 at 3:51 am

    Great post. I was checking continuously this blog and I’m impressed! Extremely useful information specifically the last part :) I care for such information much. I was looking for this particular info for a very long time. Thank you and best of luck.

    Reply
  • face creams July 18, 2013 at 4:34 pm

    I¡¦ll immediately grasp your rss as I can not find your e-mail subscription hyperlink or newsletter service. Do you have any? Please allow me understand so that I may just subscribe. Thanks.

    Reply
  • Cheap Vacation July 18, 2013 at 11:43 pm

    I do trust all of the concepts you have introduced for your post. They are very convincing and can certainly work. Nonetheless, the posts are too quick for beginners. Could you please lengthen them a bit from subsequent time? Thank you for the post.

    Reply
  • Rock Climbing Equipment July 20, 2013 at 12:48 pm

    I have recently started a blog, the information you offer on this site has helped me greatly. Thank you for all of your time & work.

    Reply
  • iPad Tablet July 20, 2013 at 2:50 pm

    Very well written article. It will be helpful to anybody who employess it, including myself. Keep up the good work – i will definitely read more posts.

    Reply
  • educational games July 20, 2013 at 6:42 pm

    you’re actually a excellent webmaster. The web site loading velocity is amazing. It sort of feels that you’re doing any distinctive trick. Moreover, The contents are masterpiece. you have done a fantastic job in this subject!

    Reply
  • technology July 21, 2013 at 12:45 am

    obviously like your website but you need to test the spelling on several of your posts. Several of them are rife with spelling issues and I find it very troublesome to inform the reality on the other hand I will certainly come again again.

    Reply
  • cheapest rental cars July 21, 2013 at 5:35 am

    My spouse and i got really glad when Raymond could complete his preliminary research by way of the precious recommendations he was given through your web pages. It is now and again perplexing to simply be offering tips people today may have been trying to sell. And now we fully understand we now have you to be grateful to for this. The most important illustrations you made, the straightforward site navigation, the relationships your site assist to create – it’s mostly spectacular, and it’s leading our son and the family consider that that situation is excellent, and that is really vital. Many thanks for the whole lot!

    Reply
  • Education Grants July 21, 2013 at 12:40 pm

    naturally like your web-site but you need to check the spelling on quite a few of your posts. Several of them are rife with spelling issues and I find it very bothersome to inform the reality on the other hand I will definitely come again again.

    Reply
  • Sofa Set July 22, 2013 at 8:18 pm

    I think other site proprietors should take this website as an model, very clean and magnificent user genial style and design, let alone the content. You’re an expert in this topic!

    Reply
  • Leather Jacket July 24, 2013 at 12:22 am

    I¡¦ve read a few excellent stuff here. Certainly price bookmarking for revisiting. I surprise how so much effort you set to create the sort of wonderful informative web site.

    Reply
  • pertaining to search July 24, 2013 at 5:25 am

    I wanted to draft you that very small word to help say thanks a lot as before about the striking information you’ve shown at this time. It has been simply tremendously open-handed of people like you to supply easily all a lot of folks could have supplied as an e-book in making some bucks on their own, primarily now that you could possibly have tried it if you ever considered necessary. The good ideas likewise served to become a fantastic way to fully grasp other people have the identical zeal just like my own to know the truth great deal more pertaining to this matter. I believe there are numerous more pleasurable situations in the future for many who check out your blog post.

    Reply
  • automobile sun visor July 25, 2013 at 5:01 am

    Hiya very cool site!! Man .. Beautiful .. Amazing .. I’ll bookmark your web site and take the feeds additionally¡KI am happy to search out so many useful info right here in the submit, we’d like work out extra strategies in this regard, thank you for sharing. . . . . .

    Reply
  • Guitar Lessons July 25, 2013 at 2:54 pm

    Thanks for sharing excellent informations. Your web site is very cool. I’m impressed by the details that you have on this site. It reveals how nicely you understand this subject. Bookmarked this web page, will come back for extra articles. You, my pal, ROCK! I found simply the info I already searched everywhere and simply couldn’t come across. What an ideal website.

    Reply
  • diet food July 26, 2013 at 8:05 am

    You could definitely see your skills in the paintings you write. The arena hopes for more passionate writers like you who aren’t afraid to mention how they believe. Always go after your heart.

    Reply
  • local seo July 26, 2013 at 10:52 am

    I have to show my passion for your kindness for folks who really need help with this one area of interest. Your very own commitment to passing the solution all-around had become remarkably helpful and have made those like me to attain their goals. This helpful report can mean much a person like me and substantially more to my mates. Regards; from all of us.

    Reply
  • Business Management July 27, 2013 at 8:34 am

    I am glad for commenting to make you understand what a useful encounter my friend’s daughter developed studying the blog. She figured out a lot of details, which included what it’s like to possess an amazing giving spirit to have others with ease grasp a variety of complicated issues. You actually surpassed people’s desires. I appreciate you for delivering these informative, safe, revealing as well as easy guidance on your topic to Julie.

    Reply
  • healthy snack foods. July 28, 2013 at 4:33 am

    I have not checked in here for some time because I thought it was getting boring, but the last several posts are good quality so I guess I¡¦ll add you back to my everyday bloglist. You deserve it my friend :)

    Reply
  • gold July 29, 2013 at 4:47 am

    Hello, i think that i saw you visited my web site thus i came to “return the favor”.I am trying to find things to improve my web site!I suppose its ok to use a few of your ideas!!

    Reply
  • Diamond Necklaces August 1, 2013 at 11:11 pm

    whoah this weblog is excellent i love reading your articles. Stay up the good work! You realize, many people are hunting around for this information, you can aid them greatly.

    Reply
  • Party Dresses August 2, 2013 at 2:57 am

    Wonderful site. Plenty of useful information here. I¡¦m sending it to a few pals ans additionally sharing in delicious. And naturally, thanks to your effort!

    Reply
  • Portable Projector August 6, 2013 at 7:21 pm

    Well I really liked studying it. This subject procured by you is very effective for accurate planning.

    Reply
  • Computer and Technology August 6, 2013 at 11:39 pm

    Nice weblog right here! Also your web site a lot up very fast! What host are you the usage of? Can I get your affiliate hyperlink for your host? I desire my web site loaded up as fast as yours lol

    Reply

© 2013 Energy Tribune

Scroll to top