What the US Treasury and the Federal Reserve should announce:
1) The fiscal house needs to be put in order right now:
a) Introduction of a federal VAT at a rate of 10%.
b) Social Security: the retirement age will immediately be increased by two years. In the future, the retirement age will be linked to US national life expectancy. The same indexation will apply to the Medicare eligibility age.
c) The revenues will be used to turn the Social Security system into a fully funded system. The VAT is what pays for the transition – one generation would otherwise have to pay twice.
2) A nominal freeze on all federal spending until the structural budget balance has been restored. With NGDP growing at 4%, this cuts federal spending as a share of the economy by around 4% a year without a single nominal cut.
3) All tariffs will be scrapped immediately.
4) A framework for nominal stability:
a) A 4% NGDP level target, with today’s NGDP level as the starting point. The target path will be adjusted upwards once, by the estimated one-off price level effect of the VAT net of tariff removal, so that a tax change is not mistaken for a monetary one.
b) Interest rates will be fully market determined.
c) Every quarter, the Fed will announce the growth rate of the money base it will maintain until further notice to keep NGDP on the target path – and it will be judged, and correct itself, against that path rather than against any forecast of its own.
d) The Fed and the US Treasury will refrain from all intervention in fixed income and FX markets, other than the Fed buying a predetermined basket of currencies and commodities to ensure the announced growth rate in NGDP for the coming period.
This would ensure that the budget situation improved dramatically and very fast. NGDP would settle at 4% growth, which would deliver inflation of around 2% over the medium term, and US Treasury yields would stabilise, likely just below 4% at the long end of the curve.
The problem: the US population has not been told the scale of the fiscal challenge facing the nation, and both the Democrats and the Republicans have only unrealistic quick fixes that won’t work. Tariffs and “DOGE” failed, and “taxing billionaires” will fail in the same way.
The federal government is running a structural deficit of around 6% of GDP at full employment, and that is not sustainable for much longer. If Americans don’t realise this very soon, the US is heading for a major fiscal and financial crisis.
If you want to avoid the fate of Argentina over the past 60 years, it is time you stopped behaving like Argentinians – the road there is not hyperinflation overnight, it is a fiscal position that eventually decides monetary policy for you.
