In his press conference Monday night, President Barack Obama offered a pair of estimates that would have been taken as signs of an apocalypse a decade ago. They slipped by almost without notice, technical arcana in an answer about the future national debt. The press attention was on the projected $10 trillion in debt, a huge number. But someone should have mentioned two startlingly small numbers: 2.2 and 2.6.
No billions or trillions or other long strings of zeros following. In fact, the "percent" inflates them from their actual values of 0.022 and 0.026. Small numbers that tell a big story.
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The Buried Lead - Small Numbers
We've grown numb to big numbers lately. AIG bonuses of $218 million, paid from a taxpayer bailout of $180 billion, part of the $700 billion TARP fund. Almost the same amount as the recent $700 billion stimulus bill, a mere one-fifth the size of President Obama's $3.5 trillion budget for 2010. President Obama inherited a $1.3 trillion annual budget deficit, which is expected to grow the national debt to over $7 trillion - the Congressional Budget Office (CBO) estimates $9.3 trillion - by 2019. All very big numbers.
But the buried lead in President Obama's press conference may be two very small numbers given to explain the difference in the debt projections from the CBO and the administration:
Where the dispute comes in is what happens in a whole bunch of out years. And the main difference between the budget that we presented and the budget that came out of Congressional Budget Office is assumptions about growth. They're assuming a growth rate of 2.2. We're assuming a growth rate of 2.6. Those small differences end up adding up to a lot of money.
Small numbers can tell big stories.
Those two numbers, 2.2 and 2.6, are annual GDP growth expressed as percentages. The "percent" actually inflates them by a factor of 100, something we often do because brings it the numbers into a range that seems more "real." If you answer 17 of 20 questions correctly on an exam, and the questions are equally weighted, you expect a grade of 85%, not 0.85. The former looks like a solid B, while the latter looks like you misspelled your name and left the rest of the page blank. The annual GDP growth projections are really 0.022 and 0.026, but we bump them up into percentages.
But those small numbers tell a big story, and one that directly relates to our discussion yesterday about the futile search for a Smaug sitting on a pile of gold under the Lonely Mountain. We're all used to those numbers being bigger. In fact, expecting those numbers to be bigger is how we got into this financial crisis.
The seven percent solution.
That's actually the popular title of a 1974 novel about Arthur Conan Doyle's famous detective, Sherlock Holmes, written by Nicholas Meyer. The full title is The Seven-Per-Cent Solution: Being a Reprint from the Reminiscences of John H. Watson, M.D. The novel purports to explain why Holmes disappeared from 1891-1894. The real reason is that Conan Doyle was tired of writing the stories, and killed Holmes in the 1893 story The Final Problem, set in 1891. Eight years later, Conan Doyle was lured back by their popularity and the paycheck, and revived Holmes in The Empty House, set in 1894. In Meyer's novel, Watson explains that both stories were fabrications, and the real reason Holmes disappeared for three years was his addiction to a "seven percent solution" of cocaine.
Holmes' alleged cocaine addiction is not unlike the housing bubble, which was also based on a "seven percent solution." Specifically, the infamous CDOs and other mortgage-backed derivatives were premised on an assumption that housing prices would rise at about 7% per year, into perpetuity. It made no sense when set against the fact that the median family income had been flat since the late 1990s, but that "seven percent solution" was built into every model used to evaluate the return on those derivatives.
Why seven percent?
That figure comes from the average GDP growth rate in the decade or so following World War II. And that was an economic boom period. The U.S. accounted for almost 50% of the world's GDP, because the rest of the industrialized world had been bombed almost to rubble. The U.S. had been "the arsenal of democracy" in the early years of the war, selling munitions and other war materiel to our allies. In the process, the U.S. had accumulated over 90% of the world's gold reserves, and the Bretton Woods Conference of 1944 had put most of the world's currencies were on the gold standard. And the U.S. was still the world's largest oil exporter, in a world economy based then as now on oil.
Americans got addicted to our "seven percent solution," not of cocaine but of annual GDP growth. But by 1970 the conditions that had made that possible were changing fast. Pre-war industrialized nations had rebuilt and their economies were booming. We no longer held 90% of the world's gold reserves, and indeed were about to abandon the gold standard. We were nearing peak domestic oil, after which we became an oil importer rather than an oil exporter. Our annual fix has been cut and diluted ever since.
We should have been in rehab.
A leader with moral courage would have told us the plain facts: the post-war boom is over, and we need to reset our expectations. The leader we had was Richard Nixon, never renowned for moral courage. Jimmy Carter may have tried to deal honestly with it, but only in vague terms that left most Americans feeling depressed. Ronald Reagan promised "morning in America." And on it went.
The U.S. economy became about identifying the fewer and fewer industries that were still growing at or above 7% per year, and putting as much money into them as possible. From 1980-2006 our annual GDP growth hovered around 4%, but the Dow Jones Index was growing at almost 14%, in part due to lower taxes on the wealthy and especially capital gains, but in larger part due to shoving more and more money into fewer and fewer economic activities. The result was a predictable series of bubbles: mergers and acquisitions in the 1980s, the dot-coms in the 1990s, and then housing.
They were inevitably bubbles because no one sector could pump out enough growth to change the overall numbers: we were limping along at about 4%, in a system built to function at 7%. Supply side economics allowed the illusion to continue only because the wealthiest Americans continued to get wealthier by putting their money in the fewer and fewer high-growth sectors. When that wasn't enough, the complaint was that ordinary Americans were earning too much for businesses to be profitable - and that was true if the business model relied on 7% annual growth - so our jobs began going overseas. When even that wasn't enough, deregulating Wall Street kicked off a boom of speculative investing, with most of our own and much of the world's economy keyed to the "seven percent solution" of perpetual U.S. housing price growth.
It's time to detox.
The CBO estimates annual GDP growth over the next decade at 2.2%. The Obama administration estimates 2.6%. Neither is close to the 4% average GDP growth from 1980-2006, and even President Obama's estimate is barely over a third of the boom times of the 1950s. And that's not per-capita GDP growth. Subtract the forecast 0.9% annual population growth over the next decade and we're down to just 1.3-1.7% per-capita GDP growth.
That is very nearly the "steady state" economy that many progressives have been forecasting for decades. In that economy, you can't rely on fanciful ideas of "making the pie bigger," the sine qua non of supply side economic theory. The premise of supply side economics is that by making the wealthy even wealthier, they will fund enough economic growth that the pie will get bigger - enough bigger that everyone gets "more pie." The wealthy of course get more "more pie," but in theory everyone gets "more pie." But that only works if the pie is going to grow at such a huge rate that there will be plenty of pie for everyone.
In reality, the pie is hardly growing at all. It hasn't been growing by the rates we were told - and more importantly, the rates most business models and government budgets are based on - for a long time. And Monday night, President Obama admitted that. In that economy - our real present economy - if you're an investor or corporation whose business model is keyed to that "seven percent solution," you're going to fail ... unless you can seize most of that seven percent from someone else.
A decade ago, had a president calmly explained that the difference between his and the CBO's debt projections was that his administration forecast 2.6% annual GDP growth while the CBO forecast only 2.2%, that would have been the front page headline and the lead story. But with Americans' minds focused on billions and trillions, little numbers slip by without a mention.
It's a pity. Because those little numbers are the death knell of supply side economics, a cornerstone of modern conservatism. And our president wasn't afraid to speak them to the nation, or the world.
Happy Thursday!