An Interesting Symbiotic Relationship: Spending and the Economy.

Symbiotic (pronounced - "sim.bi.at.ik"): “of a relationship with mutual benefit/demise between two individuals or organisms.”

So here’s a thought that will boggle your mind: During an economic downturn people tend to work harder at paying off their debt, putting money into savings, and curtail spending - by doing so, they contribute to and exacerbate the downward spiral of the economy.

What? Isn’t paying off debt, saving and investing a good thing? Yes, it is…but only a good thing for the individual.

The growth of an economy is dependent on consumers spending their money. If our discretionary spending was actually going to savings and investing instead of being spent on luxurious vacations, dinners out, new clothes, the latest and greatest electronics, and a whole host of other meaningless and unfulfilling products, demand for such goods and services would go down. As demand goes down, production of those goods and services goes down (or is eliminated) – then there is less need for employees to work to produce the goods and services. Business profits decrease and unemployment occurs. Ouch.

Ironically, the only thing to help improve the economic situation is for all of us to spend, spend, spend. But no one wants to do so in bad times and instead goes into self-preservation mode.

Now to stray off topic…

So what is this economic downturn telling us? I’d suggest a couple of things:

We are a society that has grown from consuming for needs to wants.
In our great prosperity as a nation we’ve gone from providing for the essentials for ourselves – basic needs like food, clothing, housing, etc., to now splurging with our excesses for our whimsical wants – fillet mignon instead of sirloin, designer jeans instead of basic denim, the tricked out 5,000 square foot home instead of a 1,200 square foot 2 bed 1 bath for two people to live in. We no longer are concerned with just taking care of the basics, but are concerned with “quality of lifestyle.” Thus our “tastes get more refined” and we spend accordingly.

Our economy is overly bloated and based in the consumption of goods to fulfill wants, not needs.
With such whimsical spending based on desire and want creates new businesses and markets to fulfill the desires of the upwardly mobile populace. What has happened; however, is that the knowledge workers don’t care to work in basic manufacturing, agriculture, etc. for it is now “beneath them” and we delegate and outsource such functions. Then when the economy turns south and spending on luxuries slows, we wake up and realize that our economy is farce and built on the fleeting back of luxury goods and there are no businesses left in our own country that can produce basic goods to fulfill wants – we’ve delegated them all away!

We are a society that is immature, lacks depth, and lacks meaning.
In the great quest to attain a level of “quality of lifestyle”, we have borrowed to achieve our fancies. We can’t patiently build savings to buy what we want because we have to have it now. Such immature spending has put us in a bad spot as a nation and we are dealing with the fallout of debt. This also highlights something much deeper. Why must we spend to appear “to have it all”? Why must we “keep up with the Joneses”? Perhaps we lack the character and personal fortitude to not care what people think about us? Perhaps we spend and consume because we don’t know who we are as individuals? Perhaps we don’t like what we see in ourselves and just cover it all up with more spending. I think “yes” to all. Additionally, I think that what we spend our money on reflects our values. Any economy that has been built on ingesting luxury goods reflects a hedonistic value system. Unfortunately as we are witnessing, hedonism results in a dead end.

It’s time to get over ourselves.

For your consideration…

Don't Believe the Media Bull...

Contrary to what you may hear on TV and the financial channels (I like to refer to them as the “sensationalist talking heads”), American companies are NOT in as great of financial shape as we are led to believe. Federal Reserve data show that American company debt has been rising, not falling (note: this is debt of non-financial companies).

“But, companies are holding records amount of cash”, you’ll hear. Yes, it’s true – they are sitting on mounds of cash. But guess what? They borrowed out the wazoo to get that cash on hand! Total American company debt (again, debt of non-financial companies) is at a record $7 trillion. Depending on the sources you read, non-financial company debt translates to approximately 50% of GDP. That’s an incredible number folks.

So why are we being told in the media that companies are in great shape? A few thoughts:

1. “Record cash” is a great story. “Liabilities” are not. Just like the prophets of old telling of the disasters to come who were largely ignored for the favored false prophets telling of peace and prosperity ahead - such is the case with the media and the public when it comes to financial news. We want the hot sound bite: “piles of cash” and will ignore that pesky “liabilities” line on the balance sheet of the same company.
   
   
2. Bottom line, Wall Street needs your money to get paid. Think about it: if companies aren’t in good shape and have taken on more debt than normal (commonly referred to as “overleveraged”), they are a more risky investment. Risky investments tend to scare people away. For-commission brokers and firms peddling the products that hold those companies suddenly don’t have customers. No customers means “no pay.” They need you to “play.” Their livelihood depends on you investing. Seems a little convenient to me (for the for-commission crowd) to tell the rest of us a half-truth making us believe that companies are in great shape. Thus, we have a conflict of interest.
   
   
3. We’re nearing elections. A “strong America” is a great story. Optimism, not doom and gloom, inspires people. I fully expect to hear more about this from both sides of the aisle the closer we get to elections – in spite of the data that suggests otherwise.

So, my soapbox statement for today: consider the source when you hear ANYTHING from the media or financial channels about the economy and the strength of American companies. It’s highly likely there’s a huge hidden agenda. Personally, I don’t even watch the stuff anymore…unless I want a good laugh.

Musings on the National Debt...Part 2

In part 1, we went over the main schools of thought of how the government attempts to pay down the national debt via accumulated savings. Let’s take a moment and gain a grasp of the magnitude of the national debt problem.

As you’ve probably noticed, there’s a national debt clock that is at the top of this blog. I think it’s pretty important to be aware of our situation as a nation. In the same vein, a pretty fun website for finance and economics nerds is http://www.usdebtclock.org/. The debt clock widget above is pretty cool, but USDebtClock is the widget above – on steroids! Check it out, if you dare…

Among all the information that is being continually updated on the USDebt site, here’s an important nugget: the ratio of U.S. public debt to gross domestic product (GDP), is around 62%. Total national public debt (as you can see above) is approximately $13.3 trillion – around $43,000 per citizen – and is growing (coincidentally, the average annual income in the U.S. is around that same $40-45K amount). At current rates of growth, the debt will actually be larger than GDP sometime around 2020. Not good folks.

Now, if there are any savings/surpluses or they just feel like throwing money towards paying back the national debt, the government voluntarily cuts a check to the Treasury.

Guess what? In fiscal 2009, the Treasury received a little over $3 million in voluntary debt-reduction contributions from the government. A whopping $3 Million!!! Based on that rate (known as “service rate”) it would take more than 4 million years to pay off a $13.3 trillion debt. Keep in mind that $13.3 trillion is growing every day too, so that 4 million years expands as the debt swells.

So let’s have some fun with numbers for a minute to get some understanding of the magnitude of our debt (I know, I know – “finance nerd”):

• With an average annual income of $42,000, it would take the country's 139 million workers 2 years and 3 months to pay off $13.3 trillion, if everyone simply wrote a check to the government in the amount of their average income (feel like not earning anything for 2.25 years?).
  
  What if we took our 2009 U.S. household savings of 1.2% (see Cause and Effect), set it aside, and paid it to the government? It would take 188 years to pay off the debt. Hmmm, not very encouraging.
  
  How about if we set aside 3% of household savings that would go to debt reduction? It would take 75 years. Not bad - only one generation of workers at 3% to pay off the debt…sounds good right?

How many of you feel like voluntarily writing a check to the U.S. government for 3% of your income for the next 75 years? No? Hmmmmm… Well, if you won’t voluntarily hand over money, it may become mandatory – spoiler alert: tax increases ahead!

Think I’m joking? Just the other week, Treasury Secretary Timothy Geithner said the current administration will allow the Bush era tax cuts to expire in 2011 (see the following charts for how that may affect you). Estimates are that allowing the tax cuts to expire for upper-income earners would increase U.S. revenue by more than $800 billion over the next 10 years (for perspective, that’s only about a 6% dent in the $13.3 Trillion debt total). There are also plans to reinstate the estate tax to 45%, possibly increase the tax on dividends from 15% to 39%, and add a 3.8% tax on investment incomes for high-income earners to help pay for the new health care legislation (a.k.a., ObamaCare).

I ran across the chart below showing the tax rates under the Bush tax cuts and what the rates would return to if the cuts expire…

You may be flabbergasted to see that the lowest tax bracket’s marginal rate will go up 5%. Don’t worry, the current administration knows how to get votes and won’t let the lower and middle classes be hurt by tax increases, thus they will most likely extend the Bush era cuts for the lower and middle classes and let the cuts expire for upper-income earners (keep in mind, not everyone pays taxes…in 2009, 47% of people didn’t owe any taxes come April 15th). The rich will get hit the hardest under the 2011 proposals (see this second chart below with proposed 2011 tax policies).

Finally, here’s a chart with some different tax scenarios and where that puts national debt as a percentage of GDP. I thought this was a great illustration.

1) 100% debt to GDP happens in 2020.
2) 100% debt to GDP happens in 2022.
3) 100% debt to GDP happens after 2030.

Remember from Part 1, we mentioned that tax increases historically have the opposite effect from what was intended: weakened incentives for production and ultimately, lower tax revenues. Not to mention, if you raise taxes on the rich, they tend to find ways around tax laws - having a team of lawyers and accountants to find the loop holes (my personal opinion, of course).

All of these proposed tax changes are just a start. Don’t be surprised if you see more taxes initiated or value added taxes (VATs) proposed in the near future.

So bottom line, what’s the solution here? It’s hard to say. From the debt to GDP chart above, you’ll notice the three trends are still upward sloping. So, all the current proposals will do is buy us a little more time and extend the timeline for us to hit the 100% debt to GDP ratio. Historically, nothing has really worked to curtail spending over a long period of time. As I mentioned in part 1, you don’t get to $13.3 trillion if you’re doing things right.

If true change is to happen, some politicians may have to do some very unpopular things in the best interest of the nation – and they need to be long-lasting changes. Tax increases are inevitable and we may very well have to suffer with tax increases for quite some time. It would be a nice gesture; however, if the government stopped its runaway spending in light of the burden they are about to put on us to bail out their spending. Think they have it in them to stop the spending bleeding?

Then again, “we the people” could always voluntarily write a check to the government to pay down the debt…

Anyone? Anyone?

A Short History in Economic Thought...

John Maynard Keynes and Friederich Von Hayek. Remember these two names for they are the fathers of two of the most prominent economic schools of thought. They are also the theorists of two viewpoints that are in direct contrast with each other.

“Why should I care?”

Answer: Understanding their views will help you understand current courses of action (or lack of) by our government in response to the recent financial crisis. I’ll try to keep this simple…

John Maynard Keynes is most well associated with “Keynesian economics”. In the simplest explanation, Keynesian economics would be - “government intervention” in the markets. The argument is that, sometimes the private sector (anything not a part of the government) doesn’t do a good enough job and makes mistakes; therefore, the public sector (the government) has to step in to help stabilize things. This is done through short-term stimulus during the bad times in hope of bolstering long-term growth, then saving surpluses during good times. This sounds relatively simple and not too involved, right? Just like a drug addict; however, you have to wonder if/how such stimulus can be pulled and whether or not governments can actually relinquish their positions of control after having stepped in.

Consider that the economies of the Soviet Union, China, and much of Europe during the 30s, 40s, and 50s were overly involved in the aspects of their respective economies. Setting prices on everything from wages and the price of commodities (grain, oil, metals, etc.) and/or either owned or took control of the major industries of the economy (railroads, steel, oil, coal, telephones, etc.). They took responsibility for the distribution of goods and social welfare (sometimes referred to as “central planning”). During the Great Depression, these European and Asian countries actually flourished while the capitalistic and free market oriented United States floundered. It would not necessarily be fair to say that Keynesian economics results in socialism or communism; however, many of the practices of Keynesian economics can be found in countries with such governmental systems.

For the U.S., Keynesian economics took front and center stage when President Franklin Delano Roosevelt (FDR) took office. FDR initiated massive government intervention during the Great Depression (The New Deal) – employing the unemployed to build highways, bridges, dams, airports, railroads, etc. It was one of the largest expansions of infrastructure in our history. All paid for by the government and via debt. Then World War II occurred and we produced bombers, tanks, bullets, and bombs. Again, all paid for by government debt. See the chart below for a visual on how much government spending went on during that time without the revenue to back it up. Wow!

The Great Depression ended with the advent of WWII. Post-WWII saw the return of economic prosperity. Keynesian economic thought was on the upswing and was held up as the reason for the return to prosperity. Thus, the government continued on instituting Keynesian ideals and practices in the economy until the mid-to-late 1970s. Organizations like the IMF were born out of the Keynesian movement after WWII.

Friedrich Von Hayek could most be identified with “free market” economics – unconstrained from the hand of government meddling. His groundbreaking work, The Road to Serfdom, was a response to much of what he saw wrong with central planning and the European socialist systems around him during the 30s and 40s. If you’ve heard the term “laissez-faire” (meaning “let it be” or “hands off”) regarding economics, his ideas of free market economics support a similar viewpoint. Hayek wasn’t completely government averse, he believed the government did have a role to play with monetary policy and work-hours regulation, but only a small role. The major force of his arguments; however, was that market forces should be unleashed and unhindered. Then, and only then, will we have truly optimal efficiencies and prices in the markets. Similar to the tide of an ocean, unleashed markets are not meant to be controlled, but rather one is to come alongside and flow with the tide of the market forces

However, because of the prominence and seeming success of the Keynesian approach from the 1940s to the 1970s, Hayek was vilified by the economic establishments and his ideas mostly disappeared into obscurity in the economic world. His work did find favor with the London School of Economics and the University of Chicago; however, where he worked during that time and a small but growing underground of free market economists began to emerge. Milton Friedman was a student of his and also helped popularize the ideas of the free markets in the 70s and 80s.

During the 1960s and 1970s, the governments of the United States and the United Kingdom became more and more involved in the affairs of the economy. By the time Richard Nixon was in office, a crisis was growing as inflation and unemployment was a huge problem – known as “stagflation” (ironically, Keynesian economics suggests that inflation and unemployment cannot occur if proper planning and intervention are in place). True to Keynesian economics, the government stepped in and set maximum prices on goods and commodities as well as wages. However, the basic principles of supply and demand overwhelmed the price ceilings and shortages occurred. Farmers, for instance, stopped selling because the prices set for their goods did not cover their costs of producing. The same was true for oil. Shortages were such a constant thing that the government initiated a rationing system for fuel for vehicles.

Similar problems were also occurring in the United Kingdom. However, in 1979, a woman by the name of Margaret Thatcher (an adherent of Hayek’s free market principles) was elected as British Prime Minister. She set out to release many of the government entities, or government supported entities (coal, steel, airlines, railroads, electricity, etc.) to the private sector through deregulation – freeing them to market forces. At almost the same time Ronald Reagan was elected President in the U.S. Reagan, like Thatcher, was a believer in free market economics and begin enacting policies to free up markets to perform on their own without government controls. What we saw was massive deregulation of many markets, privatization, and dismemberment of many monopoly type institutions. Over time, competition and market forces brought about stabilization to prices and the economy began to recover. With the U.K. and U.S. leading the way in prosperity, other nations begin to follow suit in enacting free market policy in the 1980s and 1990s.

History is quite interesting – and not without its irony. We’ve had wild swings in these two viewpoints: From the success of early 1900s free market capitalism to its collapse in the 30s, to the success of socialism and communism beginning in Europe and Asia in the 30s and the success of Keynesian economics from the 40s in the U.S. to its collapse in the late 70s, to the emergence of free market capitalism from the 80s to the 2000s.

Present day? What would you guess? We are seeing a swing back away from free market capitalism and much more governmental involvement. Courtesy of our financial crisis, the government has stepped in and “rescued” many failing organizations with bailouts. It has propped up home owners and banks by taking care of bad mortgages. It has provided money to state governments for spending on infrastructure. We are crossing the dividing line and moving back to Keynesian economic viewpoints. Even in the White House, Lawrence Summers, Assistant to the President for Economic Policy and Director of the National Economic Council; and Christina Romer, Chair of the Council of Economic Advisors (it was actually just announces that Christina Romer is stepping down to return to teaching) are both outspoken Keynesian economists and huge influencers of the President.

So here’s the trillion dollar question (I bet some of you have been thinking it)…it is the question that has been asked a lot as of late: “Are we better off over the past few years having had the government inject stimulus via bailouts and taking an activist role in intervening in the markets?” There is much debate about this. I won’t go into it here. Ultimately, what’s done is done, “it is what it is” as the saying goes.

The greater issue at play is: “how will the embracing of the Keynesian economic viewpoint by our government affect our economy and financial system in the long-run?” Will it spur economic growth or just create more unserviceable national debt? How much longer can we try and spend our way out of a crisis? Can the government stop its spending habits once we get out of our mess or, like a crack addict, will it have an incredible taste for spending that it cannot wean itself from?

Thoughts and questions for your consideration…

Musings on the U.S. National Debt…Part 1

So how do we reverse the upward national debt trend? If you haven’t already, you’re going to be hearing a lot more about the national debt between now and November elections.

From the July 11th, 2010 article Debt Happy, I noted there are four ways to reduce debt burdens. The most viable option is:

By paying down debt via accumulated savings

So how can the government have accumulated savings? By spending less than they take in (a.k.a., having a budget surplus). How does that occur? There are three schools of thought (some of which you may have already heard in the media):

1) Cut spending – if you cut spending, maybe income will outpace spending.

2) Increase/raise taxes – forget spending, just raise income to be greater than spending.

3) Cut taxes – with less taxes levied, maybe the economy will be stimulated – people will spend more and new businesses and jobs will form, resulting in more streams of tax revenue than before.

Each school of thought has its problems…

1) Cutting spending is political suicide for politicians – creating a conflict of interest. When entitlements go away, the low to upper middle class electorate who receive the entitlements (and who represent the largest chunk of Americans) get angry and vote politicians out of office. Additionally, and this is important, tax increases are permanently adopted into law BUT spending cuts are almost NEVER fully adopted. Thus, a long-lasting effect is not realized for spending cuts as they go by the way side rather quickly and spending continues.

2) Obviously increasing taxes is not a popular option for politicians either. Just like cutting entitlements, politicians risk being voted out over tax increases by the lower and middle class. Sure, the ultra rich get angry too with tax increases, but they only represent less than 5% of the population. The only thing they can do to get even is reduce campaign funding contributions. Plus, “they can afford it” right? Understand this, however: Increasing taxes for the purpose of raising revenue sounds good, but additional taxes actually weaken the incentive for production and consumption. Weakened production and consumption of goods results in fewer goods sold, fewer employees needed to make the goods, and then less people with jobs spending in the economy – all resulting in less taxes being received by the government (a “trickle down” effect, if you will – only in the negative). Thus, tax increases historically have the opposite effect – less revenue received than what was initially projected. Not to mention, this option does nothing to address government spending problems.

3) Cutting taxes to stimulate the economy can also have issues. For one, it just sounds counterintuitive…how can cutting taxes actually cause more revenue for the government? Two, the rich somehow tend to get more favorable treatment from tax cuts than the rest of the country…strange phenomenon that is. Three, and more importantly, if tax cuts happen at the wrong time (during an economic depression, for instance), there is no guarantee that those cuts will help incentivize production or spending. Having to pay less taxes doesn’t do much good for someone who’s already out of work or for a business that has had to close its doors.

Historically, what you’ll find is one or a combination of these strategies (mostly just one). Most have had very little success, obviously. Progress in these things doesn’t land you at $13.2 Trillion in debt. Bottom line, we’re in this mess because the government can’t stop run-away spending with their credit card – and the bill comes to us. Regardless, whatever solutions are enacted to try and fix the problem, it will take a long time to reverse the upward trend and most likely be a painful road…